Home Depot Earnings Preview: Low Housing Activity Could Slow Sales This Quarter

American home improvement retailer Home Depot (NYSE:HD) is scheduled to announce its Q1 results on May 20. Earlier in the year, the unusually cold months of January and February slowed down growth in the housing industry, which had a strong last couple of years. In addition to bad weather conditions, higher mortgage rates and rising house prices somewhat deterred growth for the housing market. Sales of existing homes in particular, which form around 90% of overall house sales, were the most hit in the first three months of the year. Home Depot believes that the GDP growth rate and credit availability will be the major drivers for home sales, and expects housing turnover to boost comparable sales growth by 2% this year. As cold weather continued till February, quarterly sales of weather-related products for the company such as snow shoveling equipment and heating devices are expected to rise. Although Home Depot expects margins to remain flat this year, slow sales of low-margin outdoor project categories due to bad weather could improve the overall profitability for the company this quarter. The company had comparable sales growth of 6.8% last year, but expects the figure to be around 4.6% this year.

We have a Trefis price estimate of $81.48 for Home Depot’s stock, which is roughly 6% above the current market price.

Our complete analysis for Home Depot’s stock

New And Existing Homes Sales Decline

Home Depot’s business is dependent on the number of house sales, as new occupants spend on home improvement supplies and construction products and services. House sales in turn are influenced by factors such as housing prices, mortgage rates, and the general business environment that impacts job creation and incomes. With housing prices and mortgage rates remaining high, sales of existing homes declined from a seasonally adjusted annual rate (SAAR) of 4.87 million in December to 4.62 million in January, 4.6 million in February and 4.59 million in March. ^[1] In fact, sales in March represented a year-over-year decline of 7.5%. New home sales also remained low, and fell to a SAAR of 384,000 in March, from 449,000 in February.

The average interest rate on a 30-year fixed-rate mortgage this year has been 4.3%, up from 3.45% last year in April. ^[2] Lending rates have been on a rise since last year, fueled by the Federal Reserve’s announcement of reduction in bond purchases, which had kept the long-term interest rates low. High mortgage prices, coupled with high housing rates, are hurting consumer affordability. However, Home Depot expects home prices to grow by 6% in 2014, much lower than the double-digit increases in previous years. ^[3] Although home sales in March were slow despite the commencement of spring, housing activity is expected to have picked up in April, bolstered by pent-up consumer demand. This could boost home improvement sales for Home Depot this quarter.

Margins Could Remain Flat To Slightly Positive

Gross margins for Home Depot were 35% last quarter, up 10 basis points from Q3 2013. An improvement of 6 basis points in gross margins was due to increased supply chain productivity, whereas 8 basis points were contributed by a favorable product mix. Overall, the U.S. business reported a 14 basis point increase in margins. Home Depot expects margins this year to remain flat, as the company aims to utilize cost savings for the purpose of growing low margin products, thereby limiting any margin expansion. Hurt by poor weather conditions, sales for outdoor project categories such as building materials and lumber were negative in the last quarter. As the harsh weather conditions continued till February, outdoor project category sales could remain low this quarter. However, since this category has relatively narrow margins, a lower proportion of its sales could provide a slight boost to the overall profitability for the company this quarter.

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1. “New and existing home sales, U.S.“, National Association of Home Builders [↩]
2. “U.S. existing-home sales fall slightly“, April 2014, wsj.com [↩]
3. “Home Depot earnings transcript“ [↩]