Home Depot Earnings Preview: Better Macroeconomic Conditions To Aid Sales

America’s largest home improvement retailer, Home Depot (NYSE:HD), is scheduled to announce its fiscal fourth quarter and 2015 financial results on February 24. In the past year, the stock price climbed almost 44% to register a 52-week high at $ 112.24 on February 21. In Q3, revenues grew 5.4% year-on-year to reach $20.5 billion, with a strong comparable sales growth of 5.8% in the U.S., in spite of the data breach. We expect Home Depot to continue growing in the fourth quarter backed by improving macroeconomic conditions and renewed housing market activity in the U.S.

Our complete analysis for Home Depot’s stock

We have a price estimate of $100 for Home Depot’s stock, which we will update post the earnings release.

Improving Economic Prospects To Steer Growth For Home Depot

After contracting by 2.1% in the first quarter, GDP in the U.S. grew at 4.6% and 5% in the second and third quarters of 2014, respectively, to register an eleven-year high. ^[1] Although GDP grew slower at 2.6% amid weaker business spending and a wider trade deficit in the fourth quarter, consumer spending in the U.S. continued to increase from $10,999.50 billion in the third quarter to $11,114.90 billion in the fourth quarter backed by falling gasoline prices,  leaving people with more discretionary income. ^[2] Unemployment rates also declined further to hit a six-year low at 5.6% in December. Higher job growth and improving consumer spending could boost spending on home improvement in the U.S., where over 87% of Home Depot’s stores are located. Furthermore, the improving macroeconomic prospects since the recession have also spurred activity in the housing market, which could impact the retailer positively.

Home Depot’s business is highly correlated with activity in the housing market, with existing home sales being one of the most important drivers for the industry. This is because existing homeowners usually make home improvements before putting a house up for sale. This is usually followed by further changes made by new homeowners. After the first quarter, home sales have picked up in the U.S., with existing home sales reaching a seasonally adjusted annual rate (SAAR) of 5.25 million in October, the highest sales figure in over twelve months. ^[3] Furthermore, new home sales also increased to a SAAR of 481,000 in December, the highest recorded in over a year. The higher activity in the housing market could propel demand for home improvement spending in the quarter.

Notable Business Developments Could Drive Revenues

Apart from better macroeconomic prospects, some internal developments are also indicative of better results for Home Depot. For one, the retailer has been working to build its online platform to successfully compete with the likes of Amazon, who has been eating into traditional home improvement retail sales by offering similar products online. In this respect, Home Depot introduced its “Buy Online Pickup In-Store” service, which accounted for approximately 40% of online sales in the last quarter. Although e-commerce currently accounts for a small percentage of total sales for the company, it has been growing fast. In the first three quarters, Home Depot’s online business grew at approximately 40% on a year-on-year basis. According to our estimates, Home Depot’s online sales currently account for approximately 5% of total sales, up from 1% in 2010 and 2011. ^[4] We expect continued growth in the online segment to benefit Home Depot in this quarter.

Additionally, Home Depot declared the launch of “Home Depot Delivers” in late 2013, which would allow same-day shipping for all online orders placed before 5 p.m. ((Home Depot tests delivery-from-store expansion)) This is expected to boost the company’s online sales further in the future by improving efficiency through reduced standard shipping time. Moreover, a “centralized e-commerce fulfillment” will also help reduce transportation costs to improve supply chain utilization. ^[5] This initiative could strengthen Home Depot’s professional contractor base, which currently accounts for around 35% of its sales, and includes those customers who would not mind paying a small premium to save an extra trip in between home improvement jobs.

However, the big news for the retailer in the last year was the appointment of Craig Menear as Chairman after the great Frank Blake, who was instrumental in steering the company through the lows of the recession. With seventeen years of experience across the company’s supply-chain networks, private brand operations, marketing, online businesses, and international sourcing, Menear’s leadership could carry Blake’s legacy forward to see the company touch greater heights.

Data Breach Could Impact Home Depot Negatively

Amid all the optimism, however, a major factor looming over Home Depot is the impact of the massive data breach, which compromised credit and debit card details of almost 56 million customers last year. The company’s forward-looking statements for the fourth quarter reported in November did not reflect the “breach-related losses,” which the management said, “cannot be estimated at this time.” Although the company maintains an insurance coverage worth $100 million to safe-guard it against losses such as those related to the breach, it could incur significant expenses in terms of “legal help, credit card fraud, and card re-issuance costs,” which could weigh on Home Depot’s prospects going forward. ^[6]

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1. United States GDP growth rate [↩]
2. United States Consumer Spending [↩]
3. “New and existing home sales, U.S.”, National Association of Home Builders [↩]
4. Home Depot Earnings Review: Solid Growth On High Demand, Despite The Data Breach [↩]
5. Home Depot opens second fulfillment center dedicated to e-commerce [↩]
6. Home Depot Q3 2014 10-Q, SEC [↩]