11 May 2009

HD: Look Ahead to April 2009 Quarterly Results

The GCFR Overall Gauge of The Home Depot, Inc. (NYSE: HD) slipped from 35 to 34 of the 100 possible points in the fourth quarter of fiscal 2008, which ended on 1 February 2009.  Our initial and updated analysis reports explained in some detail how this score was attained. 

We have now modeled Home Depot's Income Statement for the quarter that ended on 3 May 2009.  The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data that the company is scheduled to announce on 19 May 2009.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we present some background information.

The Home Depot, Inc. (NYSE: HD) is the largest retailer of do-it-yourself merchandise, which includes building materials, home improvement supplies, and lawn and garden products.  The company competes fiercely with Lowe's (NYSE: LOW) and a multitude of smaller hardware and lumber retailers

Investors with large stakes in Home Depot include RBS Partners, L.P., and Berkshire Hathaway (NYSE: BRK.A).  RBS is associated with Edward Lampert, Chairman of Sears Holdings (NASDAQ: SHLD).  Investing guru Warren Buffett, of course, runs Berkshire.

In January 2009, Home Depot announced it would discontinue its EXPO Design Center business.  The EXPO stores "offer[ed] products and services primarily related to design and renovation projects."  To account for store closure-related asset impairments, severance pay, and other related expenses, Home Depot recorded a pre-tax charge of $387 million.  Additional charges totaling $142 million are anticipated.

The Expo shutdown came on top of a decision in May 2008 to forgo 50 or so planned stores in the U.S. and to close 15 existing stores.  Home Depot recorded pretax charges of $586 million in conjunction with these two actions.

After Frank Blake replaced Robert Nardelli (who will soon exit Chrysler) as Chairman and CEO in early 2007, Home Depot sold HD Supply, which serves professional contractors, to a consortium of private equity firms.   As part of the sale, Home Depot invested $325 million for a 12.5 percent equity stake in HD Supply.  In fiscal 2008,  Home Depot recorded a $163 million pre-tax charge to reflect the reduced market value of the HD Supply investment.  It should also be noted that Home Depot has guaranteed $1.0 billion of HD Supply debt.

Home Depot repurchased $10.7 billion of its own shares after the sale of HD Supply.

The quarter that ended on 1 February 2009 was the one that included the $387 million charge related to store closings and the $163 million charge due to the reduced value of the investment in HD Supply.  In this quarter,  Revenue dropped 17.3 percent and Same-store sales were down 13 percent.  Despite these difficulties, Home Depot only lost $0.03 per share in the quarter and Cash Flow from Operations was over $700 million.

When Home Depot reported fiscal 2008's fourth-quarter results, it provided the following guidance for fiscal 2009:

2009 Financial Outlook (based on GAAP)
    • Total sales: decline of approximately 9 percent
    • Comparable store sales: high single digit negative
    • Gross margin: flat to slight expansion
    • Total expenses as a percent of sales: flat year over year
    • Includes approximately $132 million of expense in fiscal 2009 related to the fourth quarter fiscal 2008 business rationalization charge
    • Operating Margin: flat to slightly up
    • Tax rate: 36 percent
    • EPS from continuing operations: decline of approximately 7 percent
    • Capital expenditures: approximately $1 billion
    • New stores: 12 net new
    • Depreciation and amortization expense: approximately $1.9 billion
Other Key Items Related to 2009 Financial Outlook
  • For fiscal 2008, the EXPO, THD Design Center, Yardbirds and HD Bath businesses had sales of $927 million and a net operating loss of $43 million.
  • Assumes no further share repurchases in 2009.
  • Does not include potential sales lift due to the economic stimulus package.

Because Home Depot's Revenue in fiscal 2008 was $71.3 billion, the guidance for fiscal 2009 is (1 - 0.09) * $71.3 billion = $64.9 billion.  In the last five fiscal years, the first quarter contributed an average of 24.2 percent of the annual Revenue.  Given this information, we will set our target for Revenue in the first quarter of the current year at 0.242 * $64.9 billion = $15.7 billion.  This works out to be a 12.3 percent drop from the first quarter of 2008.

Home Depot's Gross Margin as a percentage of Revenue was 33.65 percent in 2008.  For the first quarter of the new year, we will look for a modest improvement to 34 percent.  Given our Revenue estimate, we forecast a Cost of Goods Sold (CGS) of (1-0.34) * $15.7 billion = $10.4 billion.

We will assume that one-quarter of the $1.9 billion figure -- $475 million -- cited for Depreciation and amortization expenses in the 2009 will apply to the first quarter.

Sales, General, and Administrative (SG&A) expenses were 24 percent of Revenue in 2008.  This suggests that SG&A will be about 0.24 * $15.7 billion = $3.8 billion.

As for Other Operating Expenses, Home Depot stated that 2009 would include charges totaling $132 million for "business rationalization."  These charges are related to last year's restructuring initiatives.  We have assumed that 50 percent of the charge will be incurred in the first quarter.

Given the estimates above for Revenue and Operating Expenses, we're projecting that Home Depot's Operating Income, as we define it, will be $1.03 billion in the first quarter.  This figure is 41 percent greater than in the April 2008 quarter, but the earlier period included a $543 million special charge.  If the latter charge were to be excluded, Operating Income would be down 19 percent.

Net interest and other non-expenses were about $150 million per quarter last year.  We have set this figure as our target for the current quarter.

An effective income tax rate of 36 percent, per the guidance, would lead to Net Income of $562 million ($0.33/share) for the quarter. 

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.


Full disclosure: Long HD at time of writing.

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