Home Depot: Could The Impact Of The Data Breach Be Significant?

Falling unemployment rates, rising builders’ confidence and increasing number of housing starts- all bode well for the U.S. housing industry in the near term. In turn, this trend should benefit the largest home improvement retailer, Home Depot (NYSE:HD), which depends on consumers who look to buy home improvement goods and services to furbish their newly bought/rented homes. However, in light of the recent news of a massive data breach at the retailer, the expected rise in sales for the retailer in the latter half of the year could be drastically hurt. Moreover, Home Depot will also incur costs of system upgradation and compensation claims. With 1,977 stores across the U.S., Home Depot has been a one-stop shop for many consumers looking to buy home improvement goods. However, the security mishap could significantly impact the retailer’s business, going forward.

We have a Trefis price estimate of $92.65 for Home Depot’s stock, which is roughly in line with the current market price.

Our complete analysis for Home Depot’s stock

Home Depot’s Data Breach Larger Than That At Target

Home Depot was the latest in the chain of large companies under a cyber attack targeted at their payment terminals, when the retailer announced at the start of the month that a security breach might have left large volumes of customer credit/debit card data exposed. Late last year, Target Corporation, the second largest discount retailer in the U.S. behind Wal-Mart, also suffered a huge security theft that compromised around 40 million credit/debit cards. Target allegedly failed to aptly react to the security warnings that succeeded the malware’s entrance into its payment terminals, leaving around 70 million consumer records vulnerable. ^[1] Why the impact of the Target data breach is significant for Home Depot is because of its similarity in scale and possible repercussions. In fact, Home Depot announced this month that around 56 million customer cards might have been compromised in a cyber attack on its payment systems, lasting about five months, bigger than the credit/debit card and other personal information theft at Target. ^[2]

This revelation leaves the investors wondering whether Home Depot is also fated to lose a lot of business, and witness a significant fall in stock price, similar to what seen with Target at the tail-end of last year. Target’s stock fell almost 14% in a couple of months after the news surfaced in mid-December. The news of a large security theft also impacted consumer sentiment, dragging down profits by 46% year-over-year in Q4 2013 at Target. The retailer has incurred cumulative expenses of $146 million in data breach-related expenses since the news broke, reflecting total expenses of $236 million, partially offset by insurance receivables of $90 million.

Could Home Depot Meet The Same Fate?

Home Depot’s data breach news has surfaced before the holiday season and amid encouraging activity in the housing market. This means that while the overall home improvement market could still grow at a brisk pace, Home Depot might suffer due to lost consumer confidence and additional costs of security restoration and recuperation. The retailer witnessed a tepid first quarter as consumers looked to wait out the extreme winter weather to make home improvement purchases. However, pent-up demand and repair and retrofitting activities in spring and summer fueled growth for the retailer in the second quarter, with comparable sales rising 5.8%, up from only 2.6% in Q1. Home Depot expected sales to further accelerate in the latter half of the year, particularly during the holiday season.

However, the recent news of the massive data breach and security threats is expected to cast a shadow over customer transactions in the near term. Home Depot has said that around $62 million could be needed to cover the investigation, credit monitoring service, call center staffing and other steps in the aftermath of the breach, slightly offset by the expected insurance reimbursement of around $27 million. As a result, the retailer’s top line, which rose by 4.4% in the first half of this fiscal year ending January, could fall well below the targeted growth of 4.8% for the full year. In fact, the damage might not be limited to this fiscal year, and could also spillover to the next fiscal and drag down revenues. If Home Depot gains no net market share in home improvement categories in the U.S. in the ongoing and next fiscal year, and adjusted EBITDA margins remain flat, hurt by data breach-related costs, our price estimate for the retailer would fall by 6%.

Data Breach Impact At Target Might Not Be Mirrored At Home Depot

Data breach-related expenses and loss of consumer confidence is expected to impact Home Depot’s business. However, the extent of the impact could be milder than assumed till now. Unlike Target, which is a frequent second to Wal-Mart and faces stiff competition from Costco and Kohl’s, Home Depot dominates the home improvement market, with around 27.2% market share. Home Depot enjoys a strong brand recognition and loyal customer base, and could continue to be the first choice retailer for many of these customers, despite the unfortunate data breach. Lowe’s, with a 18.4% value share, might be a potential threat to Home Depot’s sales, as the news of the security breach could drive consumer traffic to the former. However, data breach is a threat to Lowe’s as well as customers might look to avoid payments on credit or make large ticket purchases, which typically are done through credit/debit cards, at this retailer as well. Seeing how Home Depot was a victim to cyber theft, after the Target incident last year, customers might be wary of making credit purchases at another large retailer.

In addition, part of the reason why Target’s Q4 2013 results were weak was because of its Canadian business’ disappointing performance. ^[3] The retailer reported losses of nearly $1 billion in Canada last year. In contrast, Home Depot’s organic growth has continually outpaced that of Lowe’s. Target’s stock has also rebounded since the news surfaced last year, and is trading at the same level as it did before the data breach episode. Almost unaffected by the news of the data breach, Home Depot’s stock surged to a record high of $93.75 last Friday. Home Depot is also trying to placate customers by offering a year of free identity protection services, including credit monitoring, to those who used a payment card at the retailer, from April on. However, there could be a negative impact on sales and margins, due to higher expenses related to the security breach, which could soon catch up with the share price.

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1. The Target breach, by the numbers, krebsonsecurity.com [↩]
2. Home Depot breach bigger than Target’s, wsj.com [↩]
3. Target press release [↩]