Harsh U.S. Winter Dampens Home Depot’s Revenues, Strong Spring Sales Expected

Home improvement retailer Home Depot (NYSE:HD) released its Q4 results on February 25. Earnings for the quarter stood at $1,013 million compared to $1,021 million in Q4 2012, a slight drop of 0.8%. Net earnings were impacted by an unusually harsh winter season and one less week in the period compared to Q4 2012. The performance in Q4 2012 was also helped to a great extent by the increase in sales following Hurricane Sandy. The company’s net sales for the fourth quarter stood at $17.7 billion, a decrease of about 3% over Q4 2012. ^[1]

Home Depot’s sales in spring are expected to be higher than usual as homeowners go about carrying out repair jobs due to the damage caused by the snow to driveways, roofs etc. The company expects comparable sales growth of approximately 4.6% and total sales growth of approximately 4.8% in 2014. Since Home Depot has a fairly steady record of being relatively conservative about its growth expectations and frequent upward revisions as the year progresses, we expect actual growth figures to be 1-1.5% higher than those stated.

We have a Trefis price estimate of $77 for Home Depot’s stock, which we will revise shortly now that the company’s fourth quarter results are out.

Our complete analysis for Home Depot’s stock

Effect Of The Housing Market

The housing market recovery continued in October in the fourth quarter of 2013, spurred by strong consumer confidence and low mortgage rates but a slowdown occurred in November and December. New home sales rose were 463,000 in October, 445,000 in November and 414,000 in December. Sales of existing homes dipped compared to levels observed in Q2 and Q3. The reason that sales of new as well as existing homes are important for Home Depot is the spending on home improvement by new occupants. ^[2]

We had stated in our earnings preview note that the mixed nature of housing market data in the recent months is most likely an aberration due to unforeseen factors such as an unusually harsh winter season that slowed down business activity. Home Depot’s management expressed a similar view in the earnings conference call. The company said that it expects the housing recovery to continue and home prices to increase, even if at a lower rate than last year. This will contribute to growth in the home improvement market. ^[3]

Home Depot’s management stated in the third quarter earnings conference call in 2013 that construction of new homes is a less significant driver of the company’s business than the turnover in existing house inventory and appreciation in home prices. The commentary in the fourth quarter earnings call was consistent with this view. Home Depot thinks that the housing market growth will contribute about 200 basis points to the company’s growth in 2014, which is lower than its contribution of 250 points in 2013. Growth rates are expected to be lower this year because home price appreciation, which is the biggest driver of the housing related growth for Home Depot, is expected to be around 6% in 2014 as opposed to the double-digit growth in 2013. ((Home Depot Q3 2013 Earnings Conference Call, Seeking Alpha))

Quarterly Performance

Home Depot’s maintenance and repair categories like pipe and fittings, air circulation, cleaning and HVAC had comparable sales growth above the company average. Sales of light bulbs showed double-digit positive comparable sales growth for the fourth consecutive quarter. This is mainly due to increased adoption of bulbs working on the LED technology where rapid innovation is taking place. Comparable sales growth in product categories that serve mainly Home Depot’s professional contractor consumers were also above the company average. These include sales of dimensional lumber, insulation, concrete and pneumatic fasteners.

Home Depot did well on days such as the Black Friday Holiday and Gift Center event day. It saw strong growth in interconnected retail with online sales growing by approximately 50% for the quarter on a 13 week basis. The online customer satisfaction scores improved as Home Depot focused on delivering an integrated experience across all platforms and this also increased the conversion rates on its site.

Sales attributed to transactions amounting to less than $50 per transaction, representing approximately 20% of the company’s U.S. sales, rose by 2.5 % for the fourth quarter. Sales for transactions over $900 per transaction. which also represent approximately 20% of Home Depot’s U.S. sales, rose by 5.5% in the fourth quarter. Growth in big ticket purchases was driven by continued strength in the company’s pro business that targets large customers, appliances, counter-tops and in-stock kitchens.

Margins Remain Strong

Home Depot’s gross margin was 35% for the quarter, up by 10 basis points from Q3 2013. The increase in gross margins was driven by the company’s U.S. business and was attributed various factors.

Home Depot reported an improvement of approximately 6 basis points in gross margin due to increased supply chain productivity. Margins also improved by 8 basis points due to the net impact of a change in the product mix and higher discounts. Overall, the U.S. business reported a 14 basis point increase in margins.

In 2014, Home Depot expects no gross margin expansion. This is because while the company expects to generate cost savings, it intends to take advantage of this to support the growth of lower margin product categories. Therefore, the overall margins will likely stay flat in 2014. We think that lack of margins growth will temper the upside to the stock price. If the company’s projected growth rates are not revised upwards later in 2014 as we expect them to be, there will be a nearly 5% downside to our valuation.

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1. Home Depot Q4 2013 8-K, SEC [↩]
2. Home Sales Data, National Association of Home Builders [↩]
3. Home Depot Q4 2013 Earnings Conference Call, Seeking Alpha [↩]