Home Depot Earnings Preview: Could Data Breach Overshadow Q3 Results?

America’s largest home improvement retailer Home Depot (NYSE:HD) is scheduled to announce its third quarter results on November 18. After relatively tepid growth in the first quarter, hurt by unusually cold weather conditions and slow business activity in the U.S., retail sales of home improvement goods have increased sequentially owing to pent-up demand. Following a 2.1% contraction in U.S. GDP in Q1, the country’s GDP returned to positive growth in the second and third quarters, increasing by 4.6% and 3.5%, respectively. ^[1] Unemployment rates in the domestic market have fallen, buoyed by the improving economic conditions, also prompting increases in new and existing home sales in the last few months. These trends should favor strong growth for Home Depot this quarter, as the retailer depends on consumers who look to buy home improvement goods and services for their newly bought or rented homes. However, Home Depot’s results could also paint a different picture this quarter, despite an improvement in macro conditions, depending on the extent of the negative impact of the massive data breach at the retailer during Q3.

We have a price estimate of $93 for Home Depot’s stock, which is slightly above the current market price.

Our complete analysis for Home Depot’s stock

Macroeconomic Conditions Support Growth For Home Depot

Home Depot depends on home sales, as new occupants spend on home improvement supplies and construction products and services. Following the first quarter, home sales have picked up in the U.S., with existing home sales reaching a seasonally adjusted annual rate (SAAR) of 5.17 million in September, the highest sales figure in over twelve months, and also higher than the overall adjusted figure of 5.07 million for 2013. ^[2] New home sales also rose to a SAAR of 467,000 in September, the highest in over a year. Increases in new and existing house purchases during the last few months could mean more business for Home Depot this quarter, as customers likely looked to purchase home improvement goods and equipment.

The U.S. housing industry has picked up from the lows of 2010-2011, but the growth rate this year has slowed down in comparison to last year. However, this might not be a serious cause for concern. Although slower than 2013 levels, home prices have grown by around 5% this year. ^[3] The unemployment rate in the U.S., where over 87% of Home Depot’s stores are located, fell to a six-year low of 5.8% in October. ^[4] The recent job growth and higher consumer sentiment could boost home purchases and spending on home improvement goods, all of which bodes well for Home Depot this quarter.

Could The Data Breach Impact Results This Quarter?

In light of the news of a massive data breach at Home Depot, the expected rise in sales for the retailer in the latter half of the year could be hurt. Home Depot announced in September that a cyber attack targeted its payment terminals, which might have left around 56 million customers’ credit or debit card data exposed, bigger than the card and personal information theft at Target late last year. Home Depot’s data breach news surfaced before the holiday season and amid encouraging activity in the housing market. This means that while the overall home improvement sales in the U.S. might have grown at a brisk pace, Home Depot might suffer due to lost consumer confidence and additional costs of security restoration and recuperation in Q3. For reference, Target saw a 46% year-over-year drop in profits in Q4 2013, when the news of the data breach at the retailer surfaced. In addition to a possible loss in customer traffic, Home Depot will incur around $62 million in expenses 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.

It remains to be seen if the impact of the data breach drags down Home Depot’s sales by a significant amount this quarter. The retailer witnessed an impressive 5.8% rise in comparable sales in Q2, after only a 2.6% growth in Q1, and previously expected robust comparable sales through the latter part of this fiscal year ending January 2015. But the possible decline in customer transactions this quarter, as customers might look to avoid payments on credit or large ticket purchases – which typically are done with credit/debit cards – could hinder growth for Home Depot, lowering full-year comparable sales growth to below the targeted figure of 4.6%.

In fact, the damage might not be limited to this fiscal year, and could also spill over to the next fiscal year 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%, bringing our price estimate to 10% below the current market price.

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1. U.S. GDP growth rate [↩]
2. “New and existing home sales, U.S.“, National Association of Home Builders [↩]
3. The U.S. housing market in 10 charts, wsj.com [↩]
4. U.S. labor market tightens, but wages still anemic [↩]