Home Depot Could Gain In Q3 Even If U.S. Economic Growth Slows

Several factors indicate a strong future for leading home improvement retailer, Home Depot (NYSE:HD), which is scheduled to announce its third quarter financial results on November 17. The retail heavyweight reported strong results last quarter, with sales increasing 4.3% year-on-year. This was aided by solid performance across all product categories. More than anything else, the revival in the U.S. economy and housing markets has ensured success for Home Depot so far, and there is little reason to believe that Q3 will be any different. Here is an analysis of what could work for Home Depot going into fiscal third quarter.

A Look At Macroeconomic Influences

As mentioned earlier, strong macroeconomic fundamentals in the U.S. economy and housing markets are key drivers of success for Home Depot. Let’s start by looking at how the U.S. has fared in this area in the last quarter.

— U.S. Economy: Real GDP growth in the U.S. has been recorded at 1.5% in Q3, which is lower than the 3.9% recorded last quarter. The slowdown in GDP growth has been attributed to businesses trying to rid themselves of stocked up inventory, rather than restocking. However, Home Depot may have little to worry about, since oil savings continued to steer consumer spending, which grew at 3.2% in the quarter. Furthermore, labor markets also remained upbeat in the quarter, with unemployment rates hitting historic lows at 5.2%. Economists anticipate the slowdown in growth to be a temporary phenomenon, and as the U.S. economy at large, and labor markets continue to remain upbeat, so could prospects for retailers, such as Home Depot.

— U.S. Housing Markets: More than the developments in the U.S. economy, the housing markets are more crucial for determining Home Depot’s performance. Now, housing markets have shown strong recovery in the first half of the year already. While existing home sales have undergone growth rates of about 6.3% and 8.4% over Q1 and Q2, respectively, new home sales have increased at 21.8% and 19.4% over the same period. Given that home improvement spending often happens with a lag, these number are already indicative of a promising quarter for Home Depot. Furthermore, Q3 also did not disappoint, with existing home sales increasing 8.3% and new home sales increasing 13.9%. The U.S. housing market is undergoing phenomenal recovery, and is yet to reach the potential it showed pre-recession. In this situation, there is much room for growth for the housing markets, and consequently for Home Depot, going forward.

Going Beyond Economic Factors

Apart from a favorable macroeconomic background, Home Depot could have much to gain predominantly based on their own strategies. In this, the company has directed resources to garner sales from their Pro customers, and through the company’s online avenues. Here are some factors, on the business side of things, that could work in the company’s favor in Q3.

— Home Depot has been focusing on catering to Pro customers, with the aim of driving big ticker purchases (transactions of over $900). Last quarter, big ticket purchases underwent a 6.3% increase year-on-year, and this could very well be sustained even in Q3. Recently, Home Depot acquired Interline Brands, which is a leading distributor of maintenance, repair, and operations (MRO). Home Depot hopes to leverage Interline’s expertise in this segment, to drive better organization and efficiency in MRO and installation, which could, in turn, attract more pro traffic.

— Apart from Pro customers, Home Depot has also been targeting the budding dotcom segment. In this, Home Depot planned to construct a total of three fulfillment centers, through which the they would provide same-day delivery for orders placed online. In Q3, the company’s third fulfillment center in Ohio is expected to be operational. Once again, higher efficiency and better capabilities could put Home Depot in a better position to leverage the opportunity present in this realm.

— Sales in Q3 could also be driven by a number of new product additions to Home Depot’s portfolio. This includes the 20-volt MAX sliding miter saw from DEWALT and the LED Smart Downlight. These products are supposed to be exclusive to Home Depot’s stores, and the ease in use and superior technology that these products display could benefit Home Depot in this quarter.

— Last, but not the least, there are a number of events such as Labor Day, Fall Cleanup, and Halloween Harvest, which could also benefit Home Depot’s store sales in the quarter.

In conclusion, while the U.S. economic growth seemed to have been slower than before, there are a number of other factors that are indicative of a strong quarter for Home Depot. Top on this list is the housing market recovery. Apart from this, Home Depot’s business fundamentals are also strong, in the sense that they have laid out appropriate strategies to target Pro and Dotcom customers to drive sales. These strategies, such as introducing products that are exclusive to Home Depot, along with interlinked capabilities, could give Home Depot an edge, not only over arch-rival Lowe’s but also over other players that offer home improvement products. Finally, even the slowdown in the U.S. economy is expected to be temporary, which is indicative of a bright future for the retailer.

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

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. U.S. Economic Outlook, November 2015
4. US Q3 gross domestic product up 1.5% vs 1.6% growth expected
   

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