14 July 2009

HD: Look Ahead to July 2009 Quarterly Results

Home Depot (NYSE: HD) earned $0.30 per share in the three months that ended 3 May 2009, up from $0.21 last year.  While the quarterly EPS increase was appealing, the GCFR Overall Gauge dropped from 34 to 27 of the 100 possible points after a more comprehensive assessment.

Our initial and updated analysis reports examined the first quarter in some detail.  In summary, sales remained anemic.  The 9.7-percent decrease in Revenue was the product of a 2.6-percent decline in comparable store customer transactions and an 8.2-percent decline in the average customer "ticket."  Net Income would also have contracted, but the comparable period last year included large special charges.

The price of Home Depot shares increased 22 percent in the February/March/April quarter, from $21.53 to $26.32.  The contrarian Value gauge, registering its disapproval of the price surge in the face of weak operating performance, fell from 12 to 7 points.  The Growth gauge stood at zero.

[Because Home Depot has restructured substantially during the last few years, the gauge scores should be treated with an extra dose of skepticism.  GCFR compares current financial data with historic results, but the validity of these comparisons degrades after a significant reorganization.]

We have now modeled Home Depot's Income Statement for the quarter that will end on 2 August 2009.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company is scheduled to announce on 18 August 2009.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we set the stage with some background information about Home Depot and the business environment in which it is currently operating. Readers that keep close tabs on the company are invited to skip ahead

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 with Lowe's (NYSE: LOW) and a multitude of smaller hardware and lumber retailers

In response to the weak retailing environment, which is especially debilitating to those affected by the ailing housing market, Home Depot has taken substantial steps to consolidate operations and reduce capital outlays.  The first step was to terminate 50 planned stores in the U.S. and to close 15 existing stores.  The second step was to exit the EXPO Design Center and a few other peripheral businesses.  These actions led to asset impairment, severance, and other charges over $1.1 billion.

The company is also working to reduce inventory costs by streamlining distribution of products to stores.  New Rapid Deployment Centers -- the sixth opened recently  -- are key elements of this effort.  These regional warehouses receive mass deliveries from manufacturers and dole out the products to 100 or so area stores.  This distribution model is similar in form to Wal-Mart's exemplar of efficiency.

Several famous investors have placed big bets on Home Depot.  As of 31 March 2009, RBS Partners, L.P., associated with Edward Lampert, Chairman of Sears Holdings (NASDAQ: SHLD), owned 17.8 million shares.  Berkshire Hathaway (NYSE: BRK.A), run by investing legend Warren Buffett, owned 3.7 million shares.  Soros Fund Management owned 3.9 million shares.

After Frank Blake replaced Robert Nardelli (who subsequently served a term at Chrysler) as Chairman and CEO in early 2007, Home Depot sold HD Supply, which serves professional contractors, to a consortium of private equity firms.   Home Depot repurchased $10.7 billion of its own shares after the sale of HD Supply.

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 its HD Supply investment.  Home Depot has guaranteed $1.0 billion of HD Supply debt.

We are now ready to look ahead to 2009's second quarter.

When Home Depot reported its first quarter results, on 19 May 2009, it ...

"reaffirmed its guidance for fiscal 2009 of sales down 9 percent with negative comparable store sales in the high single digit area and earnings per share from continuing operations down 7 percent."

The company updated this guidance at its annual Investor and Analyst Conference, which was held on 10 June 2009.

"Today the Company is updating its FY2009 EPS guidance and now expects earnings per share from continuing operations to be flat to down 7 percent from last year. On an adjusted basis, the Company now expects earnings per share from continuing operations to decline by 20 to 26 percent. The Company previously announced its expectation that earnings per share from continuing operations in FY2009 would be down 7 percent from last year, and down 26 percent on an adjusted basis.

"The Company reaffirmed its sales, comparable store sales and gross margin guidance for the 2009 fiscal year. The Company still expects sales to decline by approximately 9 percent, comparable store sales to be high single digit negative and for gross margin expansion to be flat to slightly positive."

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 recent years, the second quarter contributed about 29 percent of the Revenue for the year.  We assume this seasonal pattern will remain in effect.  Therefore, our target for Revenue in the second quarter of the current year at 0.29 * $64.9 billion = $18.8 billion.  This figure is 10 percent less than Revenue in last year's second quarter.

Home Depot's Gross Margin as a percentage of Revenue has been about 34 percent in recent quarters, and we expect a similar margin in the second quarter.  Given our Revenue estimate, we forecast a Cost of Goods Sold (CGS) of (1-0.34) * $18.8 billion = $12.4 billion.

The company previously indicated that Depreciation and amortization expenses in the 2009 would be about $1.9 billion.  However, the $428 million charged in the first quarter was significantly less than the expected $475 million (25 percent of $1.9 billion).  We will split the difference and set our second-quarter target at $450 million.

Sales, General, and Administrative (SG&A) expenses in the first quarter were about 24 percent of Revenue.  This expense in the second quarter is usually 2 to 3 percentage points less in the second quarter than in the first.  Using the 2-percent delta, we will look for SG&A to be 22 percent of Revenue in the current quarter, or 0.22 * $18.8 billion = $4.1 billion.

Given the estimates above for Revenue and Operating Expenses, we're projecting that Home Depot's Operating Income, as we define it, will be $1.8 billion in the second quarter.  This figure is 11.5 percent less than in the second quarter of 2008.

Our target for Net interest and other non-expenses is $160 million, based on the results of recent quarters.

An effective income tax rate of 36 percent, per the guidance, would lead to Net Income of $1.06 billion ($0.62/share) for the quarter.  In the second quarter of 2008, Net income was $1.2 billion ($0.71 per share).

Please click here to see a full-sized, normalized depiction of the projected results next to Home Depot's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: Long HD and WMT at time of writing. 
No position in any other company mentioned.

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