Unfavorable Weather Conditions And Slow Housing Activity Stall Top Line Growth For Home Depot

America’s largest home improvement retailer Home Depot (NYSE:HD) announced its Q1 results on May 20. ^[1] Revenues grew 2.9% year-over-year to $19.69 billion but missed analysts’ estimates of $19.95 billion. ^[2] Comparable sales growth of 2.6% through April also lagged the previous year’s 4.3% growth. However, Q1 2013 witnessed considerable repair sales following hurricane Sandy, which had improved comparable sales growth. As expected, disruptive cold weather conditions at the beginning of the year and a slow start to the spring selling season contracted sales in the first quarter for Home Depot. Bad weather conditions along with high mortgage rates slowed housing recovery in the first three months of the year. Home Depot maintained its full-year outlook of flat gross margins, following a marginal margin expansion of 5 basis points in the first quarter. ^[3] Harsh winter conditions impacted the company’s U.S. comparable sales growth by 1%, but it expects a stronger Q2 on the back of pent-up consumer demand and spring repair sales.

We have a Trefis price estimate of $81.48 for Home Depot’s stock, which is roughly 5% above the current market price.

Our complete analysis for Home Depot’s stock

Housing Slowdown Deters Growth For Home Depot

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 rising home 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. ^[4] 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 had been 4.36% till April, up from 3.45% last year in April. ^[5] 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, according to Blue Chip Economic Indicators, net disposable income is expected to increase by 2.3% this year, up from a small 0.7% growth in 2013. In addition, the unemployment rate in the U.S. had also fallen to 6.3% in April, down from 7.5% a year ago. ^[6] The creation of jobs should facilitate home sales, and in turn bolster home improvement sales in the next few months.

Interest rates on mortgages have also fallen slightly in May, which could provide a slight boost to the housing industry going forward. ^[7] On the other hand, Home Depot expects home prices to grow by 6% in 2014, much lower than the double-digit increases in previous years. ^[8] Going forward, the company expects stronger sales in the second quarter, bolstered by pent-up demand, aging housing stock, and higher consumer affordability.

Interconnected And Pro Retail Boost Home Depot’s Sales

Amid less than expected sales for the quarter, Home Depot continued to improve its online retail business, which saw a nearly 40% sales growth through April. Strong sales through the interconnected channel also fueled transaction growth, which rose by 2.2%. Online retail now constitutes around 4.2% of the net sales, up from 3% in the last quarter. The company continues to focus on delivering an integrated experience across all platforms, which also increased the conversion rates on its site. In Mexico too, the company launched an online e-commerce site in some regions, with plans of coverage across the country eventually.

Professional (pro) customer sales for Home Depot also grew in the first quarter, with sales from pro-customers that spend more than $10,000 annually rising more than twice the company average. This also boosted growth in the average ticket size, which however dragged down due to commodity price deflation. Pro customers generate around 35% of Home Depot’s sales, and the company’s Pro Xtra loyalty program has signed up over 1.5 million such consumers. Going forward, the company aims to add incremental sales by capitalizing on the growth potential of the professional customer market, which is growing faster than the retail consumer market at present.

Gross Margins Remain Flat For Home Depot

Home Depot’s gross margins stood at 34.97%, a small 5 basis points increase from the previous year. As expected, bad weather conditions slowed sales for outdoor project categories such as lumber and garden, which have relatively lower margins. However, this rose the overall profitability for the company slightly. Home Depot expects margins to remain flat to negative in the second quarter, as the outdoor category sales are expected to gain traction in the summer. For the full year, the company expects margins to remain flat, as the company aims to utilize cost savings for the purpose of growing low margin products, thereby limiting any margin expansion. Home Depot already reported May sales to be robust, and reaffirmed its guidance of 4.8% sales growth and comparable sales growth of 4.6% for 2014.

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1. Home Depot 8-k [↩]
2. Home Depot says may sales robust on post-winter demand, May 2014, reuters.com [↩]
3. Home Depot earnings transcript [↩]
4. “New and existing home sales, U.S.“, National Association of Home Builders [↩]
5. U.S. existing-home sales fall slightly, April 2014, wsj.com [↩]
6. Unemployment data [↩]
7. Current mortgage rates today, May 2014, southerndailypress.com [↩]
8. Home Depot earnings transcript [↩]