Home Depot Earnings Preview: Weaker U.S. Economy Could Mean A Slower Start

America’s largest home improvement retailer, Home Depot (NYSE:HD), is scheduled to announce its first quarter financial results on May 19. In the face of strong macroeconomic fundamentals and an upbeat U.S. housing market, the stock registered an almost 400% increase over the past five years, with a 45% increase in the last year alone. In 2014, Home Depot witnessed a 5.5% growth in revenues, with profits increasing almost 16%, even in the face of an infamous data breach that left credit and debit card details of close to 56 million customers compromised. While upbeat projections for the U.S. economy, and the housing markets, coupled with promising company-specific strategies might ensure sustained growth in 2015, Home Depot may be off to a slower start.

Our complete analysis for Home Depot’s stock

We have a price estimate of $120 for Home Depot’s stock, which is above the current market price.

U.S. Economy and Housing Markets Did Not Meet Expectations

The U.S. is an important market for Home Depot since approximately 97% of its stores span across the country. Hence, developments in the U.S. economy and the housing markets are vital indicators for determining Home Depot’s performance. For the full year, the U.S. economy is expected to continue doing well, with GDP projected to grow at about 3% and unemployment remaining below 6%. Furthermore, key determinants of home improvement spending, such as existing home sales and new home sales, are also expected to witness notable gains in 2015. These factors, more than anything else, bode well for Home Depot.

In spite of the optimistic projections, the first quarter of this year failed to stand up to its forecast levels. According to preliminary estimates by the Commerce Department, the U.S. economy grew just 0.2% in the first three months, as opposed to the predicted 2.3%, against trade disruptions on the West coast, a stronger dollar choking off exports, and a weaker global economy. Furthermore, a harsh winter led Americans to save in the quarter, with consumer spending increasing just 0.1% in February after declining for two consecutive months for the first time since 2012. Spending failed to pick up even as oil prices continued to drop, leaving Americans with higher disposable incomes. ^[1] The slow down in the U.S. economy at large, also exerted an impact on the housing markets in the earlier part of the quarter. The sale of existing houses, among the most important drivers for the home improvement industry, fell 4.9% in January to a seasonally adjusted average rate (SAAR) of 4.82 million, the lowest recorded since May 2014. ^[2] Against these circumstances, home improvement spending may have suffered to an extent in the quarter.

This weakness in the U.S. economy and housing markets however, may just be a temporary phenomenon for a number of reasons. For one, the economy experienced this slowdown even in 2014 when GDP contracted 2.1%, but soon recovered to post growth at 4.6%, 5%, and 2.6% the following quarters. ((U.S. Economic Outlook: April 2015)) Hence, even this year, the slowdown in the first quarter may be offset by better performance in the other quarters, to set the U.S. economy growing at its forecasted rate of 3%. However, continued strengthening of the greenback and weakness in the global economy could loom over these prospects. Second, although the housing markets showed slowdown in the beginning of the quarter, it picked up, with existing home sales surging 6.1% to reach a SAAR of 5.19 million in March, the highest in 18 months. ^[3] The National Association of Realtors (NAR) projects existing home sales and new home sales to grow at 6.4% and 33% in 2015 against low interest rates, stability in the job market, and improving consumer confidence. ((U.S. Economic Outlook: April 2015)) In spite of this, existing home sales in absolute numbers have not yet reached their pre-recession levels, which is indicative of potential in the years going forward, which bodes well for the home improvement industry.

Growing Online Business Could Drive Revenues

While macroeconomic fundamentals seem to be weaker in the quarter, a number of company-specific moves could offset some of the expected fall in revenues. 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. Although e-commerce currently accounts for a small percentage of total sales for the company, it has been registering double-digit growth rates in the past two years. ((Home Depot Earnings Review: Solid Growth On High Demand, Despite The Data Breach))

In light of better navigation and convenient search capabilities across the retailer’s product offerings, Home Depot could gain from this realm in the quarter and in the full year. For one, Home Depot’s vast network of 2,260+ stores inherently provides them with a competitive advantage to cater to customers who use the Buy Online, Pick-up In Store (BOPIS), Buy Online, Ship to Store (BOSS), and Buy Online, Return In Store (BORIS) programs. Furthermore, Home Depot initiated a pilot program in 2014, where they will deliver orders placed online directly to customers. In this respect, they opened two new direct fulfillment centers in Georgia and California last year, and will add another fulfillment center in the latter half of 2015. These fulfillment centers are expected to hone efficiency at Home Depot, with close to 90% of orders being delivered to customers across the U.S. in less than two days time. ((Home Depot’s (HD) CEO, Craig Menear on Q4 2014 Results – Earnings Call Transcript))

Launch Of New Products For Pro Customers Could Drive Ticket Sizes

Apart from a fast growing online business, Home Depot also initiated steps last year to better cater to Pro customers, who could pull up sales by driving up average ticket sizes. This is also indicative of Home Depot’s attempt to drive revenues through new avenues, rather than just through productivity increases. The retailer has indicated the launch of a number of brands and services to focus on sales to professional customers. This includes the launch of a new color center entailing the Behr, Glidden, and the Home Decorators Collection paint brands. Apart from offering a broader selection of products, the new center also aims at enhancing the customer experience by clearly outlining the different paint assortments to bring ease to the selection process. Furthermore, the retailer introduced new products in the tools category that have higher battery life and durability, which could guarantee more efficiency for pros. ^[4]

In conclusion, although we expect a slower start to the year against weaker macroeconomic fundamentals and harsh weather conditions choking off demand, we expect Home Depot to continue doing well over the next few quarters to post revenues increasing over 5% in the full year, predominantly guided by its online avenues and Pro customers. However, a major factor looming over Home Depot is the impact of the massive data breach, which 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. ^[5]

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1. Economic Growth Slows Sharply In Q1 2015: 5 Factors Slowing US GDP [↩]
2. January 2015 Existing-Home Sales [↩]
3. Existing-Home Sales Spike In March [↩]
4. Home Depot’s (HD) CEO, Craig Menear on Q4 2014 Results – Earnings Call Transcript [↩]
5. Home Depot Q3 2014 10-Q, SEC [↩]