Home Depot Earnings Will Show Housing Recovery And Storm Effects

Home Depot (NYSE:HD), the largest U.S. home improvement retailer, will report its Q3 results on November 13. We expect higher year-over-year revenues and earnings owing to better demand for housing this year. Hurricane Sandy may also have contributed in some measure to the company’s business as people stocked up on items like generators, flashlights, plywood and pumps in anticipation of the storm. ^[1]

We will look out for Home Depot’s outlook on the upcoming holiday season when homeowners carry out a lot of refurbishing and renovation, contributing to a rise in demand. Secondly, Home Depot’s portfolio has a lot of holiday decorations, including Christmas trees, lights and outdoor and indoor decorations. Also, looking at the destruction wrought by Sandy, we think that the reconstruction and repair work will boost Home Depot’s business next quarter.

In the third quarter, Home Depot took the critical decision of shutting down its remaining seven big box outlets in China. This seems to be a signal that the company will, for the foreseeable future, concentrate on consolidating business in its traditional stronghold markets of U.S. and Canada. The company will incur a one-time after-tax charge of $160 million on account of losses here.

Our complete analysis for Home Depot’s stock

The housing market this year is in much better shape than last year owing to a nascent economic recovery. This has been confirmed by steel companies in their quarterly earnings results. Therefore we expect Home Depot to report higher sales for the third quarter and will be interested in its comments regarding its future expectations about the housing market demand.

The China Setback

In August this year, Home Depot announced that it would close its remaining seven big box outlets in China and instead focus on Internet-based sales and specialty stores.

Home Depot tried to replicate in China what it does in America — it offered scale and convenience to shoppers rather than choice and competition which 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.

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))

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.

While announcing the decision to shut down stores, Home Depot had said that it would incur an after-tax charge of $160 million in the third quarter as a result of the closures, but maintained that this would not affect its full-year earnings forecast. The charge will include lease terminations, severance and other costs.

Future Plans

With efforts focused on better service, technology support and store remodeling, Home Depot has historically outperformed the sector, taking away market share from its largest competitor Lowe’s in a still mixed housing market, by making its operations and supply-chain more efficient.

Home Depot expects to achieve its target of 10% operating profit and 15% return on invested capital (announced in 2009) by the end of fiscal 2012 and has announced new long-term goals, including 12% operating margin with 24% return on invested capital by fiscal 2015.

We have a Trefis price estimate of $56 for Home Depot’s stock, which will be revised once the third quarter earnings results are declared.

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1. Earnings preview: Home Depot 3Q results, CBS [↩]