Home Depot Q2 Earnings Review: Macroeconomic Fundamentals And Company Strategies Could Ensure Further Growth

Retail heavyweight, Home Depot (NYSE:HD) reported solid fiscal second quarter results yesterday, with sales undergoing a 4.3% increase year-on-year. The strong performance was guided by sales growth in all product categories, with transactions in the quarter reaching record highs. Home Depot has been one major beneficiary of the U.S. economic recovery, with the stock growing by over 300% in the last five years. In spite of this tremendous growth story, we believe there’s more to come for Home Depot. Here is an overview of the key take aways from the company’s Q2 earnings report and an analysis of what could ensure further growth for the company going forward.

A Snapshot of Macroeconomic Influences

Home Depot’s performance is heavily influenced by macroeconomic fundamentals, particularly in the U.S. This primarily includes the level of activity in the economy and the housing markets.

— U.S. economic growth: Home Depot’s performance is largely contingent on the U.S. economy since the majority of the retailer’s stores are located in the U.S. In Q2, the retailer benefited from a rebound in the U.S. economy, which posted a slower first quarter, and grew at about 2.3%. According to Trading Economics forecasts, the U.S. economy is expected to continue growing at about 2.5% and 3.2% over Q3 and Q4, which could ensure further sales growth for the home improvement sector. However, a note for caution is that these figures of growth may not be reason enough to celebrate, since the growth in Q1 and in Q2 was not only slower than what was experienced last year, but is also lower than the pace of the overall recovery. In spite of this, the U.S. economy is definitely in its growth phase, which could continue exerting a positive impact on the job market and people’s propensity to spend. The National Association of Realtors (NAR) expects economic growth, coupled with lower fuel prices, to fuel consumer spending (2.9% growth in Q2) even going forward. Housing furnishing and equipment spending has clearly reaped the benefit of this in the first half of the year, to see an approximate 6% increase, and could continue seeing this phenomenal growth even over the next few quarters.

— U.S. housing markets: In spite of a slower than anticipated recovery, Home Depot could continue to benefit from an upbeat housing market. Existing home sales and new home sales hit record highs earlier this year, with tax credits and a lower fee on FHA mortgages fueling this development. The NAR anticipates a 7% increase in existing and new home sales, with an estimated total of 5.8 million home sales in 2015. Furthermore, this figure is approximately 25% less than the total observed pre-recession, indicating that there is immense potential in the U.S. housing markets that could be uncovered. As the housing markets grow, so could home improvement spending, which could exert a positive influence on Home Depot’s sales figures going forward.

— Mortgage rates: Finally, there are mortgage rates, which are instrumental in driving the housing markets and consequently home improvement spending. The Federal Reserve is expected to pull up short-term interest rates as early as September. Against this, mortgage rates are also expected to climb, which could result in fewer buyers qualifying for a mortgage. The NAR anticipates mortgage rates to reach 4.3% – 4.5% by the year end, and go on to cross the 5% mark in 2016. While this could result in lesser activity in the housing markets in the medium term, the anticipation of higher rates could stir home buying activity in the short term. The higher buying activity in the short term could have a lagged effect on home improvement spending even over the next few years.

Company Specific Strategies To Drive Sales

Apart from promising macroeconomic fundamentals, Home Depot has indicated a number of strategies, which could ensure further growth to the business. A major part of this entails a focus on Pro customers and on the company’s online business.

— Pro Customers: Over the past few years, Home Depot has focused on building their brand among Pro customers, right from expanding their product portfolio to include products with higher Pro-penetration, to building fulfillment centers across the U.S. to ensure speedy delivery. The latest addition to this, is the new acquisition of Interline Brands, a leading distributor of maintenance, repair, and operations (MRO). In Home Depot’s Q2 earnings announcement, CEO, Craig Menear said that “Interline’s expertise in hospitality, multifamily, and institutional MRO, brings strong fulfillment and sales capability to The Home Depot and the residential MRO product market.” Apart from expanding their customer base, this acquisition is expected to bring in better organization in the MRO and installation department, which could help serve Pros better by driving efficiency. In Q2, big ticket purchases (transactions of over $900) increased 6.3% year-on-year. With further investments driving The Home Depot brand among Pros, the retailer could sustain these growth numbers even in the ensuing quarters.

— Online Business: Apart from Pro customers, Home Depot has seen unprecedented growth in its online business over the last few quarters. In Q2, the dotcom segment accounted for approximately 5% of sales. The retailer has worked to build this growth area, which could ensure sales growth going forward. This includes improvements to the company website, content, and the customer’s mobile experience, to ensure ease of use. Apart from this, the company’s third fulfillment center in Ohio is expected to be operational by Q3, which along with the other two fulfillment centers, are expected to allow Home Depot to provide fast delivery to close to 90% of their customers. Clearly, Home Depot’s strategy in this sphere is about driving ease of use, and with these improved capabilities, the retailer could benefit significantly in the full year from higher customer traffic.

— New Products: Q3 will also see the introduction of a number of new products that are expected to drive sales. This includes the 20-volt MAX sliding miter saw from DEWALT, which is expected to allow a higher degree of precision in cutting work apart from being lighter and more compact to handle. In addition to this, there is the LED Smart Downlight, which includes a color tuning system that can be controlled through mobile devices. This is supposed to be the “first of its kind” and “exclusive to The Home Depot.” While these new products are expected to drive Pro sales, Home Depot has a new lineup of carpets that are stain proof and more durable for their DIY customers. These new and innovative products, coupled with events such as Labor Day, Fall Cleanup, and Halloween Harvest, could see Home Depot touching greater heights in terms of sales going into Q3.

A Note On Breach Related Costs And Share Repurchases. 

In conclusion, Home Depot witnessed a strong quarter and while there are more reasons supporting growth in the future, there are some obstacles that the company has to deal with. One of these would be costs related to the massive data breach last year that left customer’s card details exposed. The management gave an update on this, giving a total of $132 million spent so far in breach-related expenses, net of insurance. The retailer indicated further expenses on this front even in the ensuing quarters. Apart from this, the company has revised its share repurchase numbers from $4.5 billion to $7 billion, of which, $3.9 billion worth of purchases are due to happen over Q3 and Q4.

Clearly, Home Depot has been reigning over the retail sector, posting strong earnings quarter after quarter. In spite of headwinds such as a stronger dollar, slower economic growth, and cost pressures from the data breach, we remain optimistic on the company’s prospects going forward backed by a strong product portfolio, upbeat housing markets, and company specific strategies to ensure returns to shareholders.

We have a price estimate of $120 for Home Depot’s stock, which is almost in line with the current market price.  We will be updating our model to account for the earnings release.

Our complete analysis for Home Depot’s stock

Key Metrics – Q2 2015

• Net Sales – up 4.3%
• Profits – up 4.5%
• No. of customer transactions – up 2.6%
• Average ticket size – up 1.7%
• Comparable store sales – up 4.2%
• Net earnings at $2.2 billion or $1.73 per diluted share (up 13.8%)

Revised FY 2015 Guidance

• Sales growth of 5.2 – 6% expected, based on year-to-date performance and Interline brands acquisition
• Comp sales growth at 4.1-4.9% expected
• Earnings per share expected at $5.31 to $5.36, based on new share repurchase announced

Sources:

1. The Home Depot (HD) Craig A. Menear on Q2 2015 Results – Earnings Call Transcript
2. Home Depot Announces Second Quarter Results; Raises Fiscal Year Results
3. Economic and Forecast Update (July 1, 2015)
4. United States| Economic Forecast | 2015-2050 Outlook

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