17 May 2008

HD: Look Ahead to Fiscal 2008 First Quarter Results

On Tuesday, Home Depot will report its results for the quarter that ended 4 May 2008. This 13-week period was the first quarter of the company's 2008 fiscal year.

The Home Depot, Inc. (HD) is the largest retailer of do-it-yourself merchandise, which includes building materials, home improvement supplies, and lawn and garden products. New management sold the Home Depot Supply division, which served professional contractors, to a consortium of private equity firms on 31 August 2007. The price was $8.5 billion, or $1.8 billion less than the figure originally negotiated. Management then executed a $10.7 billion Dutch Auction tender offer for Home Depot shares.

We've modeled Home Depot's Income Statement for the latest quarter. The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data. Our estimates were derived from trends in the company's historical financial results and guidance provided by company management.

When reporting fiscal 2007's fourth-quarter and full-year results last February, Home Depot management issued the following guidance for fiscal 2008:
  • Total sales decline of 4 to 5 percent
  • Negative comps in the mid to high single digit range
  • Flat to slightly positive gross margin expansion
  • Operating margin decline of 170 to 210 basis points
  • Depreciation and amortization expense of approximately $1.9 billion
  • Income tax rate of 37.2 percent
  • Continuing operations earnings per share decline of 19 to 24 percent
  • Capital expenditures of $2.3 billion
  • 55 new store openings with 5 store relocations

This guidance was updated on 1 May 2008, when Home Depot announced "it will no longer pursue the opening of approximately 50 U.S. stores that have been in its new store pipeline, in some cases for more than 10 years." The company will also shutter 15 existing stores in the U.S.

Canceling plans for new stores will reduce the company's capital spending by about $1 billion over several years. However, the decision will result in a $400 million charge to current earnings because previously capitalized development costs will have to be written off.

Home Depot indicated that the closing of the 15 existing stores will lead to additional charges of $186 million. Of the $586 million total charge to earnings, the company plans to recognize $547 million in the first quarter. This charge will exacerbate the earnings decline that was predicted in the February's guidance and re-iterated in May.

Revenues were $18.5 billion in the April 2007 quarter, excluding the sales of the former Home Depot Supply business. If the company's guidance to expect a 4 to 5 percent decline was accurate, sales in the April 2008 quarter were probably between $17.6 and $17.8 billion. We will split the difference and set $17.7 billion as our estimate.

In the year-earlier quarter, Home Depot's Gross Margin as a percentage of Revenue was 33.8 percent, and the margin averaged 33.6 percent over the last four quarters. Given the company's guidance to expect "Flat to slightly positive gross margin expansion," a reasonable, if not slightly optimistic margin expectation for the April 2008 would be 34 percent. Therefore, given our Revenue estimate, the Cost of Goods Sold (CGS) in the first quarter should be about (1-.34) * $17.7 billion, or $11.7 billion.

Management indicated that Depreciation and amortization expenses will be about $1.9 billion for the year. If we divide this by four, an estimate for the quarter is $475 million.

Sales, General, and Administrative (SG&A) expenses as a percentage of Revenue have averaged 22 percent over the last four quarters. However, this ratio has been increasing, reaching 24.7 percent in the January 2008 quarter. For the first quarter estimate, we will assume 24 percent. Accordingly, we're expecting SG&A expenses to be 0.24 * $17.7 billion, or $4.25 billion.

In the Other Operating Expense category, we expect to see, at a minimum, the massive $547 million charge due to the reduction in new and existing stores.

Our estimates for Revenue and Operating Expenses would result in an Operating Income of $748 million, down 55 percent from the year-earlier quarter. The decline is 22.5 percent if we exclude the special charge.

Net interest and other expenses have been increasing. We will somewhat arbitrarily choose $200 million as our estimate for these expenses in the first quarter. This value would decrease pre-tax income to $548 million.

Management guided analysts to expect an income tax rate of 37.2 percent. This rate would suggest that provisions for income taxes will be $204 million, and Net Income will be $344 million ($0.20 per share, if the number of shares outstanding hasn't changed much from January). This figure is 64 percent below Net Income from continuing operations in the year-earlier quarter. On a per-share basis, earnings would be down 58 percent. Excluding the $547 million special charge, earnings per share would be down 15 percent (less than company guidance).

Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.

($ M)

4 May 2008
29 April 2007

Operating expenses

CGS (11682)


SG&A (4247) (4186)

Operating Income
Other income


Interest, etc.
Pretax income

Income tax

Net Income from
continuing operations

Discontinued operations

Net Income

Shares outstanding


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