Strong Economy Bodes Well For Home Depot In The Second Quarter

Home Depot (NYSE:HD) is scheduled to report its second quarter results on August 14, wherein a substantial rise in both revenues and earnings is expected. A strong economy, as well as the benefit to be received from the tax reform, had prompted Home Depot to provide an upbeat guidance for FY 2018. Sales growth of 6.7%, comparable same-store sales growth of 5%, EPS improvement of 28%, and a dividend hike of 16% for the year are being anticipated by the company. Digital sales can be expected to be the main revenue driver for the company, which has been witnessing heady growth. Continued investment toward its supply chain will ensure steady growth from this segment in the years to come, and may also pose a barrier to Amazon.

We have a $216 price estimate for Home Depot, which is higher than the current market price. The charts have been made using our new, interactive platform. You can click here for our interactive dashboard on Our Outlook For Home Depot In FY 2018 and to modify our driver assumptions to see what impact it will have on the company’s revenues, earnings, and price estimate.

Factors That May Have An Impact In FY 2018

1. Soft Housing Market: The strength of the housing market can be gauged by looking at the residential construction spending and existing home sales, both of which were down in June (latest available data). The permits authorized for privately-owned housing units were down 2.2% sequentially, and 3% below the June 2017 level. Meanwhile, privately-owned housing starts in June were lower by a massive 12.3% versus May, and 4.2% below the corresponding figure for last year. The rising cost of construction materials is probably one of the main factors which has resulted in reduced confidence among builders. Moreover, according to the National Association of Realtors, existing-home sales decreased for the third straight month in June, at a rate of 0.6% sequentially, and 2.2% versus June 2017.

2. Pro Sales Outpacing DIY (Do It Yourself) Sales: The company’s Pro-segment is a key driver of its growth, with Pro-sales outpacing the sales of the DIY segment. According to a senior executive, while pros account for just 3% of the customer base of Home Depot, they make up 40% of the sales. As a result, a focus on this segment is imperative for ensuring future growth. Home Depot has been increasing its investments to deepen its relationship with such customers, including enhanced associate tools in the stores and expanded delivery options. For example, in the case of the latter, the company has started two-hour and four-hour deliveries in some markets.

3. Interconnected Retail Strategy: Home Depot has made a concerted effort to focus on its integrated retail strategy, which seamlessly connects online and offline channels, making its stores more efficient. This has resulted in improved revenues and profitability, with the online space being a key driver of the impressive growth Home Depot has witnessed in recent times. In the first quarter, online traffic improved at a healthy rate, sales increased 20% versus Q1 2017, and 46% of online orders were picked up in-store. By focusing on an integrated channel strategy, Home Depot has been able to increase revenues per square foot, rather than generating revenues from new square footage. This has ensured that its existing store network is being effectively used to drive revenues.

4. Strong Macroeconomic Conditions: Unemployment is at its lowest since 2000, and wages are improving. Although interest rate hikes make mortgages more expensive, on the whole, it is indicative of a strong economy. In the second quarter (three months ended June), U.S. GDP grew at over 4%, which should result in robust growth for HD in the quarter. It was reported that building material and garden equipment sales increased 0.8% month-on-month and 6.2% year-on-year for the industry in June, which should be a positive sign for Home Depot. Strong macroeconomic conditions bode well for a company like Home Depot that is heavily reliant on the improvement of the economy.

5. Higher Transportation Costs: The company faced transportation headwinds in the first quarter which had an eight basis points negative impact on the gross margins. While Home Depot isn’t the only company facing higher transportation costs, the increasing shift toward the online space, as well as the addition of features such as same-day delivery, can result in a pressure on the gross margins through the financial year.

6. Supply Chain Investments: HD has stated its intention of investing roughly $1.2 billion into its supply chain over the next five years. Given the changing retail landscape, the company believes “a great customer experience depends on great supply chain capability.” Over the past decade, the company has made big strides in its upstream supply chain – moving product to the stores and direct fulfillment centers (DFCs) – and more recently, it has undertaken significant expenditure to build its downstream supply chain – delivering to customers directly. However, the home improvement giant feels there is still some way to go to fully leverage its upstream network, as well as build the fastest and most efficient delivery system. In this regard, some of the steps being undertaken by the company include adding 170 distribution facilities across the U.S. to reach 90% of the U.S. population in one day or less, opening 40 flatbed direct fulfillment centers to serve HD’s top 40 markets, and continuing the rollout of van and car delivery options in top urban markets in 2018.

See complete analysis for Home Depot’s stock