Home Depot’s Digital Sales To Drive Revenue Growth In The Third Quarter

Home Depot (NYSE:HD) is scheduled to report its third quarter earnings on November 13, wherein a 5% growth in sales and an over 23% improvement in earnings is expected. After a disappointing first quarter, due to colder than normal weather conditions, the home improvement retailer knocked one out of the park in Q2. Consequently, a better than expected first half performance prompted the company to up its full year guidance to 7% growth in sales and a diluted EPS of $9.42, versus a projected 6.7% revenue growth and an EPS of ~$9.33 earlier. The revenue increase has been driven by strength in the housing market and growth in its digital segment. Meanwhile, the earnings improvement has been a consequence of revenue growth, as well as the reduced effective tax rate, due to the lowering of the corporate tax effective January 2018. We expect these trends to continue in the short term, though higher than anticipated transportation costs may play a bit of a dampener. The company is undertaking significant investments in its supply chain to counter this, which should begin to show results in the medium term.

We have a $217 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 Estimating Home Depot’s Performance In Q3 And Its Fair Price 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 Impact Performance

1. Housing Market: Despite news regarding a weak housing market, reflected in the declining home sales figures, CEO Craig Menear stated that the company feels positive about the strength in the home improvement sector. The company has often stated that the housing stock in the country is old and in need of repair and renovation, which should help Home Depot. Moreover, unemployment is at its lowest level since 2000, and wages are improving. Although interest rate hikes make mortgages more expensive, on the whole, it is indicative of a strong economy. Strong macroeconomic conditions bode well for a company like Home Depot that is heavily reliant on the improvement of the economy.

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 45% of the sales. As a result, a focus on this segment is imperative for ensuring future growth. Pro-segment sales improved double-digits in the second quarter. 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. HD’s big-ticket transactions, those above $1,000, form 20% of their U.S. sales, and grew 10.6% in the second quarter.

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 second quarter, online traffic improved at a healthy rate, sales increased 26% versus Q2 2017, and 47% of online orders were picked up in-store. Moreover, in the digital space, the typical transaction ticket size is three times of that in a 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. Higher Ticket Size: A number of factors have resulted, and should continue to benefit, the average ticket size. Besides the aforementioned factors such as greater pro-sales and growth in digital sales, the focus on appliances, as well on innovation, are other factors driving this increase. Greater investment into appliances has resulted in share gains, with appliances garnering a higher than average ticket size. An example of innovation is the use of lithium technology in outdoor equipment, such as the lithium lawnmower, which is priced at $500, as compared to one that runs on gas, which typically costs between $200 and $300.

5. Higher Transportation Costs: The company faced transportation headwinds in the second quarter which had a 16 basis points negative impact on the gross margins, following on from the 8bps contraction from this in Q1. 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. Given these headwinds, the company expects gross margin to improve 41 bps this year, down slightly from the previous guidance of 44 bps.

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.

7. Reduced Tax Rate: Given the fact that Home Depot operates primarily in the U.S., its effective tax rate has been 35% or higher in the past few years. As a result of the decline in the corporate tax rate from 35% to 21%, effective January 2018, the company is expected to have a tax rate of 26%, which should be a key driver in the substantial improvement in the net income margin this year.

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