Home Depot Builds Momentum; Western Digital’s Murky Data
Stock Exchange gives readers a chance to listen in as staff writers James Peltz and Michael Hiltzik debate the merits of individual stocks.
Home Depot (HD)
Jim: Up first today, Mike, is the Atlanta-based retailer that revolutionized the do-it-yourself hardware industry with its enormous stores, huge selection and low prices.
Mike: Yeah, Home Depot is the epitome of a “category killer,” meaning it’s so big and successful that it’s been knocking much of the competition out of the box.
Jim: True. Founded in 1978, Home Depot now has 720 stores and expects to have more than 1,300 within the next couple of years. And as it’s grown, many other chains have dropped from sight.
Mike: One reason is that Home Depots are more than just hardware stores on steroids. They provide the kind of service you’d expect to get at your small neighborhood hardware store. The company actually staffs its stores with professional plumbers, builders and the like.
Jim: Though I must say that I’ve often found Home Depot’s service less than thrilling, especially on weekends. Sometimes I feel like a rat in a maze in those giant stores, and the checkout lines tend to get very long.
Mike: Right, you always run the risk of getting into a line behind some local contractor who’s buying a forklift worth of drywall.
Jim: There’s no getting around HD’s success, though. A decade ago its annual sales were $2 billion; now they’re $24 billion. Its stock is up 75% in just the past 12 months and now trades in the mid-50s.
Mike: It wasn’t always so.
Jim: No, Home Depot’s stock went flat in the mid-1990s, mainly because Wall Street got worried that the chain wouldn’t be able to sustain its sizzling growth.
Mike: That’s less of a worry now. And HD’s latest move sets it up to be a category killer in yet another category.
Jim: Which is?
Mike: The small hardware store. Home Depot is looking at opening smaller outlets in storefront locations, the idea being that you’ll get the same personal touch that you would at the corner hardware store where you now buy a bag of brads.
Jim: It makes sense. The vast majority of hardware stores are mom-and-pop outlets.
Mike: And Home Depot already has wiped out many of the national or regional building-supply chains. In fact, on a national basis it really has only one competitor left.
Jim: Lowe’s Cos.?
Mike: Correct. And in a bid to at least stay close to Home Depot, Lowe’s is buying one of the few remaining chains, Eagle Hardware.
Jim: All you have to do is look around Southern California and you can see what’s happened. Home Depot’s only chain rivals are Orchard Supply Hardware, owned by Sears, Roebuck & Co., and the ailing HomeBase Inc. Home Depot also has benefited from the resurgent housing market. You’ve got low inflation and low interest rates, which are helping spur housing sales and consumer spending.
Mike: Home Depot also is trying to sell us on the notion that if housing sales turn down, it will still do fine because people will be upgrading the houses they’re already in.
Jim: So here’s a stock that’s been surging and now carries a very rich price-to-earnings multiple of 53. In fact, I’d venture to say that’s one reason Home Depot is one of the biggest targets of short sellers on the Big Board. As of Jan. 15, some 32 million shares had been sold short and not yet repurchased, though that’s still only 2% of its total shares outstanding.
Mike: Where I come from, that’s a bullish argument for this stock, because those shares will have to be repurchased eventually, and that will send the price higher.
Jim: Well, I think the shorts are wrong on this stock in any case, and it’s a buy.
Mike: Gee, I was worried there for a minute. Usually when you start talking about rich multiples, you’re lookin’ to bail out. I’m glad to hear you agree with me.
Jim: Home Depot deserves that rich price. Look, despite its huge expansion to date, it still has less than 20% of the U.S. do-it-yourself hardware market. That means there’s tremendous growth potential left. Also, the economic and housing conditions that have helped Home Depot aren’t likely to change much in the next 12 to 18 months.
Mike: There are a couple of minor caveats with this company. One is its increasing size. You know, the legendary founders of Home Depot--CEO Arthur Blank and former CEO Bernie Marcus--took pride in visiting every new Home Depot they opened. But now the chain is so big they can’t do that anymore.
Jim: Which raises the question of whether they’ve got the people in place to make sure their edicts are carried out.
Mike: That’s right. On the other hand, this is a company that’s got terrific momentum and a great track record. So even with its rich valuation, this stock has a ways to go.
Western Digital (WDC)
Mike: Now we move from a stock that’s pretty easy to value to one that, I think, is a lot thornier, because it’s in a much tougher business. I’m talking about Western Digital, the Irvine-based maker of data-storage disk drives for personal and higher-end computers.
Jim: Several readers have asked us to review this stock, no doubt because for several years--basically from ’93 to mid-’97--this company and its shares were real highfliers. Then they came crashing back to Earth, and now they’re starting to recover yet again.
Mike: Care to give us the details?
Jim: Western Digital was started in 1970 as a semiconductor company, but it moved into disk drives in 1988 when it bought the drive business of that former San Fernando Valley company, Tandon Corp. Today it’s the nation’s fourth-largest drive maker.
Mike: What any investor needs to know upfront is that the disk-drive industry as a whole is one of the classic boom-and-bust industries within high technology. It’s either going whole hog or emitting death rattles.
Jim: And the reason is?
Mike: Because disk drives, although they are high-technology devices, are very close to being commoditized. Certainly there are fine distinctions in terms of speed and manufacturing capability, but to the average user--and consequently to the computer manufacturer--there’s very little reason to choose one over another. So it’s easy for there to suddenly be too many disk-drive companies around.
Jim: The move to sub-$1,000 PCs hasn’t helped matters. As the PC makers began building more of those machines, they needed to buy cheaper drives to keep their own costs down. That, combined with new competition from some Asian players, served to push drive prices lower and wipe out profit margins.
Mike: There’s also a phenomenon that’s endemic to many parts of the computer industry, including drives, which is that product cycles come and go so quickly that price cutting begins to become a major factor.
Jim: The obsolete problem.
Mike: Right. The industry can bring out a new generation of technology and, sometimes within months, find it becoming obsolescent. To move the products that they’ve already built, they have to cut prices very sharply to make room for their next generation of devices that are just coming on line.
Jim: Which is why one of the measures of health of companies in this field is their “time to market”--how fast they can get a product cycle developed and out to buyers in order to exploit a price advantage, if only for a short while.
Mike: And this is something that’s been a problem for Western Digital lately, although the company is hoping that it’s solved that problem.
Jim: In good part because of a deal it struck with IBM last year.
Mike: Exactly. Western Digital is licensing some of IBM’s disk-controller technology, which it hopes will enable the company to get its next generation of disks to customers very fast.
Jim: Now it appears that the whole drive industry is starting to come back. New orders are going up, prices are firming. Demand for PCs remains strong. The drive companies, Western Digital among them, are promising a return to profitability.
Mike: It’s got Wall Street all giddy.
Jim: I know. Since it bottomed last October, Western Digital’s stock has soared nearly 60%, although it’s begun falling off again lately. It now trades around 13 bucks, even though Western Digital is still losing gobs of money. But that’s a far cry from the $50 a share it reached in mid-’97.
Mike: Whatever. I’m going to put my stake in the ground here and say I think this is the moment to catch the wave on Western Digital.
Jim: Not me.
Mike: You really don’t like to buy at the bottom, do you?
Jim: Very funny. Trouble is, I see Western Digital continuing to scrape along the bottom, and I don’t see this wave you’re talking about.
Mike: Well, I just believe this whole industry is going to be bid up by investors.
Jim: It already has been.
Mike: But it’s still got a lot further to go, and at $12 or $13 a share, I think this is a good time to buy the stock. Even though we’re not expecting earnings from this company for at least another three to six months, this is a good time to buy because all the drive makers are going to look very good over the next nine to 12 months.
Jim: I’m not convinced. Frankly, I think investors already have gotten too far ahead of themselves, and that’s why we’ve seen Western Digital dropping back in recent days. Don’t forget, this company lost $277 million in the six months ended Dec. 31 on a 33% drop in sales.
Mike: But we’re expecting a couple of profitable quarters coming up.
Jim: Sorry, its prospects are just too iffy. Competition and pricing pressures remain fierce in this industry, and Western Digital has three bigger rivals to deal with. I’d buy Home Depot instead.
Mike: Well sure, if you’re going to buy only one of these two stocks this week, I think we’d agree that it should be Home Depot. But this stock has merit, because we could see very handsome growth in the overall computer industry over the next year or so.
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Do you have a stock you would like to see discussed in this column? Michael Hiltzik can be reached at michael.hiltzik@latimes.com; James Peltz can be reached at james.peltz@latimes.com. Or write to either at Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053
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Home Depot, Monday: $55.50
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Western Digital, Monday: $13.03
