Home Depot Shuts Down Remaining Big Box Stores In China, Announces Change In Strategy

Home Depot (NYSE:HD), the world’s largest home improvement chain, has announced that it will close its remaining seven big box outlets in China. It will instead focus on Internet-based sales and specialty stores. Home Depot is the latest in the long line of retailers to feel the brunt of the slowdown in Chinese economy. The company also admitted that its “do-it-yourself ” business model has failed to work in China, which is largely a “do-it-for-me” market. ((Home Depot’s do-it-yourself model fails in China’s do-it-for-me market, Reuters))

Around 850 associates will be affected by the closings and they will receive severance packages and job placement assistance.Our complete analysis for Home Depot’s stock

Failure To Understand The Chinese Market

Home Depot ventured outside North America for the first time in 2006 by acquiring The Home Way, a 12-outlet chain of stores whose Chinese founder modeled it on Home Depot itself. At that time, Home Depot declined to disclose how much it paid for the company but Chinese news reports speculated the figure at $100 million. It has struggled to expand ever since, as it was a relatively late entrant into the market behind other international chains such as Britain’s Kingfisher, which ventured into China in the late 1990s. Six years on, Home Depot finally admitted defeat in its attempts to win over the Chinese home decorators and is now shutting down its stores that offer everything under one roof. ((China: Home Depot packs its bags, Financial Times))

Home Depot tried to replicate in China what it does in America — it offered scale and convenience to shoppers rather than choice and competition they can find on the high street. It turned out that Chinese shoppers were extremely price-sensitive and valued discounts, low prices and the ability to compare products over good service. The runaway success of western stores like Wal-Mart (NYSE:WMT), Tesco and Metro, which offer heavy discounts and low prices bears testimony to this fact.

The Chinese have taken to shopping at these stores quite enthusiastically. Add to this Home Depot’s emphasis on the “do-it-yourself ” philosophy, and you have a perfect recipe for failure in a market that prefers a “do-it-for-me” approach. It’s true that the economic downturn had a part to play in the company’s poor performance, but we think that it would have merely stalled the inevitable. The business model was fundamentally flawed in the context of the Chinese market and would have failed sooner or later. When the economic tide turned, the metaphorical music stopped and Home Depot had to stop dancing, pack up its big box format and head home. ((Home Depot closing last 7 China big box outlets, Associated Press))

Going Forward

However Home Depot is not exiting China completely. It will continue to operate two small specialist stores in Tianjin and will have an online retail presence. It will continue to employ 170 personnel in its specialty stores, including people in its sourcing offices in Shanghai and Shenzhen. It also intends to retain a team to work on new retail formats. The focus will now be on opportunities to expand presence in specialty stores and e-commerce segments. The company expects to incur an after-tax  charge of $160 million in the third quarter as a result of the closures, but it maintains that this will not affect its full-year earnings forecast. The charge will include lease terminations, severance and other costs.

Home Depot International, the division which operates the company’s stores outside the US, constitutes just over 9% of the Trefis price estimate for Home Depot. Also, the Chinese business is a very small portion of this division’s business. To put things in perspective, of the 276 stores which Home Depot had outside the US at the end of 2011, only 8 were in China. Hence, the shutdown of stores in China will have a negligible impact on our valuation for the company.

We think that Home Depot can derive some comfort from its overall strong performance. Its share price has gone up by almost 80% in the past 12 months.

We have a Trefis price estimate of $56 for Home Depot’s stock, which is in-line with the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis