How Can A Change In Home Depot’s EBITDA Margins Impact Its Valuation?

Home improvement giant Home Depot (NYSE:HD) has successfully managed to improve its EBITDA margin year after year, on the back of higher sales and increased productivity. Moreover, as the sales grow, the company is able to leverage the fixed costs, and thus expand its margins. Further, while its largest expense – payroll – increases with the growth in sales, it occurs at a slower rate, which is another factor that has driven its operating margin expansion. According to our estimates, the adjusted EBITDA margins have increased from 15.9% in FY 2013 to 18% in FY 2016. Going forward, we expect the margins to continue to increase, reaching the 19.5% mark by the end of the Trefis forecast period, due to further operating leverage as comps improve.

We have a $187 price estimate for Home Depot, which is below the current market price.

Two of the major factors that may improve the margins have been highlighted below:

1. Improving Same-Store Sales

The company’s integration of its brick-and-mortar stores with its online channel has helped it immensely to remain popular with its customers and associates. Home Depot’s integrated retail strategy, which seamlessly connects online and offline channels, is making its stores more efficient, leading to higher revenues and profitability. The company has also observed improved customer satisfaction scores as it continues to invest in this initiative. The company has stated that 60% of all its sales, whether in-store or online, are influenced by a digital visit. HD’s online revenues have increased by approximately $1 billion in each of the last four years, with the online penetration reaching 6.4%, nearly double that of its nearest traditional competitor. The online channel has also been one of the driving factors behind the impressive growth rates the company has seen, contributing to 20% of HD’s growth over the past few years.

While Home Depot has made a considerable effort in developing its omnichannel strategy, the core of the Home Depot experience is its stores. Hence, the company has made a substantial investment to keep them relevant, by improving the speed and convenience of a customer’s shopping experience, besides investing in capabilities to drive productivity and ensuring the timely availability of its products.

The shift towards the online space will ensure increased digital revenues for Home Depot; meanwhile, its investments to keep its stores relevant will ensure sales growth from this avenue as well.

2. Supply Chain Enhancements

Home Depot’s supply chain has been an immense source of value creation for its customers and shareholders, and can be considered one of the best in the industry. This has been achieved by making a considerable investment, in terms of time and resources, over the past several years. Home Depot has centralized its inventory planning and replenishment function and continuously improved its forecasting and replenishment technology. This has helped it improve its product availability and inventory productivity at the same time. At the end of fiscal 2016, over 95% of Home Depot’s US store products were ordered through central inventory management. In order to ensure timely availability of its products, the company has implemented initiatives such as Project Sync, which has enabled Home Depot’s warehouse workers to more quickly receive inventory delivered to distribution centers and stores. The company intends to pass on the savings achieved through this to the customers in the form of lower prices, and is a key to achieving the operating margin target as these efforts would help to optimize its end-to-end supply chain network and improve its inventory, transportation, and distribution productivity.

However, the retail landscape is changing, with a consistent shift seen towards the online space. This would result in higher costs due to increased delivery and logistics expense. Moreover, the needs of its associates are also evolving, such as the requirement for flexible hours, higher wages and benefits, etc. These factors could result in a bump in the operating expenses. While the measures undertaken by Home Depot would ensure growth in the margins, higher levels of operating costs could result in a slower than expected growth in the EBITDA margins, reaching 18.5% by the end of 2024. This can result in a 5% downside to our valuation for Home Depot. On the other hand, if the housing market and home improvement industry continues to strengthen, and outpaces previously forecast growth estimates, it may result in the EBITDA margin touching 20.5% by the end of our forecast period. Such a scenario would boost HD’s valuation by over 5%.

We have created an interactive model that details how a change in the EBITDA margin can impact the valuation of Home Depot. You can modify the EBITDA margin driver to see how it can impact the valuation and price per share.

See complete analysis for Home Depot’s stock

Have more questions about Home Depot? See the links below.

• Improving Housing Trends Bode Well For Home Improvement Companies
• How Is Home Depot Keeping Its Stores Relevant Amid A Changing Retail Landscape?
• What Is Home Depot’s Growth Strategy For the Future?
• What Is Home Depot Doing To Ensure Continued Growth Online?

Notes:

Get Trefis Technology