Home Depot: Strengths, Weaknesses, Opportunities, and Threats

Home Depot (NYSE:HD) is credited with having revolutionized the American home improvement industry. Since the recession, the company has witnessed phenomenal growth with the stock price growing by over 270% in the last five years alone. With services encompassing Do-It-Yourself (DIY), Do-It-For-Me (DIFM), and Professional (Pro) customers, Home Depot has managed to carve its way to being the industry leader with an ~27% share. In this note, we analyze Home Depot’s business using the SWOT analysis to assess Home Depot’s strengths, weaknesses, opportunities, and threats. Using this, we look at what might be in store for Home Depot going forward.

Source: NASDAQ

Strengths

– Leadership: Home Depot’s top strength lies in its leadership. In spite of being highly dependent on macroeconomic factors for success, the retailer managed to stand its ground during the recession. When revenues were declining at an annual rate of 7-8% between 2008 and 2010, Home Depot did not let EPS numbers dip below the $1.37 figure that was recorded in fiscal 2008. Home Depot’s focus on cost saving and productivity enhancing strategies under the leadership of former CEO Frank Blake was instrumental in seeing the company through the global meltdown. Clearly, Home Depot has survived one of the worst economic situations and has a number of strategies up its sleeve that could safeguard it from tough economic conditions even going forward. Furthermore, current CEO, Craig A. Manear, with over 16 years of experience at the company, could very well continue executing the phenomenal leadership that has been seen previously.

– Productivity: Home Depot can be called the king of productivity. A comparison to arch-rival, Lowe’s, makes this clear. In spite of entering the home improvement market almost three decades after Lowe’s, Home Depot has managed to take the top spot. With a smaller store space than Lowe’s, Home Depot aims at maximizing revenue per square foot. This is evident when one looks at the metric in international stores — where Home Depot made ~$297 in average revenue per square foot, Lowe’s made ~$280, in fiscal 2014. Furthermore, Home Depot has continued to focus on productivity, both in-store and otherwise, rather than creating new revenues. This is evident in their initiatives regarding same-day delivery and in-store mobile technology. ^[1] Last but not the least, Home Depot’s mastery of productivity enhancement is also evident from their continued modernization of the supply chain, which, after starting as late as 2007 has already reached over 18 centers, as opposed to 15 at Lowe’s. ^[2]

– Diversification: Home Depot’s business has strength in terms of diversification, in terms of product portfolio, and operational areas. Home Depot’s business extends across a network of about 2,269 stores across the U.S., Canada, and Mexico. Their product portfolio ranges across kitchen, appliances, painting supplies, flooring supplies, building materials, plumbing, electrical, tools and hardware supplies, and more. Through this, Home Depot is able to adequately meet all home improvement demand under one roof, which gives it an edge over other competitors such as Wal-Mart and Costco. Furthermore, with a vast store network, Home Depot is able to capitalize on any skewed housing market recovery across the U.S. This has been key in Home Depot’s growth, outpacing that at Lowe’s recently since they were able to leverage the uneven housing market improvement in states like Florida and California.

Weaknesses

– Macroeconomic Conditions: One of the biggest drawbacks for Home Depot’s business is its high dependence on macroeconomic factors. With ~90% of stores located in the U.S., Home Depot’s success is highly correlated with the performance of the U.S. economy. This is evident if one looks at the company’s performance right through the recession, when revenues dipped 7-8%, and on the recovery, when revenues started growing at 4-5%. Although U.S. macroeconomic fundamentals seem to be strong for now, any discrepancy in the economy could directly hurt prospects for the retailer. In this situation, it could make sense for Home Depot to diversify its operations across other countries to hedge against risks associated with any particular market.

– High Debt Levels: The other source of concern at Home Depot is the company’s debt levels, with long-term debt standing at ~$16.9 billion (~15% increase y-o-y) in fiscal 2o14. This is much higher in comparison to the ~$10.1 billion (~6% decrease y-o-y) at Lowe’s. These high debt levels, coupled with future interest payments could exert a negative impact on Home Depot’s cash flows and profitability, along with constraining their ability to expand their footprint.

Opportunities

– International Expansion: Currently, Home Depot has a presence across the U.S., Canada, and Mexico. Since Frank Blake’s regime, Home Depot has focused on maximizing productivity and it has gained a lot from this. However, beyond a certain point, the company might reach some sort of a saturation when it comes to reaping benefits from productivity increases. In this case, it might make sense for Home Depot to expand its geographical footprint in order to create new sources of revenue. In 2004, Home Depot had moved to capitalize the growth opportunities in China under the leadership of Robert Nardelli. However, in 2012, the company shut down all its stores since its “do-it-yourself hardware approach” was not well received in the country against a cultural mismatch. However, even if not a good one, Home Depot could have learned valuable lessons from this experience that it could use in the future. ^[3]

– Macroeconomic Fundamentals and Dotcom Sales: Apart from international expansion, Home Depot has hardly reached its threshold in the U.S., with an increasing number of shoppers choosing online avenues for purchase. While the company’s online sales have been seeing double-digit growth across quarters, the dotcom avenue accounted for merely 5% of total sales in Q2 2015. In this case, Home Depot has immense potential to grow their revenues on this front, especially as the company continues to build its online interface and delivery capabilities. ^[4]

Threats

– Macroeconomic Factors: As mentioned earlier, Home Depot’s prospects are highly conditional on the performance of the U.S. economy. A number of near term factors could hamper the growth trajectory that Home Depot is otherwise poised to enjoy. Top on this, is an interest rate hike, that could reduce the level of activity in housing markets by pushing up mortgage rates. From 3.8% and 2.5% presently, 30-Year Fixed Rate and 1 Year Adjustable Rate are expected to go up to about 5% and 3.9% respectively, by Q4 2016. Apart from this, the company is also exposed to currency headwinds as the U.S. dollar continues to strengthen. This reduces the company’s revenues from operations in Canada and Mexico in dollar terms, and will adversely impact financials.

– Weather Related Issues: Apart from macroeconomic factors, sales for Home Depot could also be conditional on weather related factors. Normally, customers tend to postpone home improvement projects in light of bad weather, which is the top reason why Q1 tends to usually be the weakest quarter for Home Depot.

– Competition: Although Home Depot’s top competitor is Lowe’s in the home improvement domain, the retailer faces competition from a number of other players who also supply similar products. This includes names such as Amazon, Costco, Best Buy, and Wal-Mart. Clearly, more intense competition could lead to Home Depot having to offer products at more competitive prices or discounts, which could exert an impact on revenues.

In conclusion, in spite of potential threats, Home Depot could see better days, in light of strong business fundamentals and favorable macroeconomic conditions. For one, the NAR anticipates existing home sales to grow at 7% and 3.5% in 2015 and 2016, and new home sales to grow at 20% and 29.3%, over the same period. Given Home Depot’s high reliance on the U.S. housing market recovery, these numbers in themselves, could see the stock touching new heights.

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

Our complete analysis for Home Depot’s stock

Other Sources:

1. Home Depot Form-10K, SEC
2. U.S. Economic Outlook: October 2015

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