18 August 2009

HD: Income Statement Analysis for the July 2009 Quarter

The Home Depot, Inc. (NYSE: HD) earned $0.66 per share in the three months that ended 2 August 2009, which was the second quarter of fiscal 2009.  Earnings per share fell from $0.71 in the comparable period last year. 

Home Depot is the largest retailer of do-it-yourself merchandise, which includes building materials, home improvement supplies, and lawn and garden products.

This post examines Home Depot's Income Statement for the quarter and compares it to our "look-ahead" estimates.  Our target for Net Income in the latest quarter was $0.62 per share, $0.04 less than the actual amount.

In a second article, we will report Home Depot's scores as measured by the GCFR Financial Gauges.  The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

The principal sources for this post were the earnings announcement and the conference call transcript at SeekingAlpha.  Some background information about Home Depot and the business environment in which it is currently operating can be found in the look-ahead.

Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.

Revenue was 9.1 percent lower than in the second quarter of 2008, which was a little better (i.e., less worse) than the 9.7 percent contraction in the first quarter.  We thought Revenue would fall 10.4 percent in the second quarter, so Home Depot performed 1.4 percent better than we estimated. 

Comparable store sales for the second quarter were negative 8.5 percent, and comp sales for U.S. stores were negative 6.9 percent.

Sales to professional contractors, etc., have fallen more than sales to the general public.  Professionals accounted for about 32 percent of total sales in last year's second quarter, but only about 27 percent in the last three months.  The number of customer visits resulting in sales "tickets" over $900 has dropped more than the number of visits leading to small-purchase transactions.

The Cost of Goods Sold (CGS) was 66.5 percent of Revenue in the quarter, which translates into a Gross Margin of 33.5 percent. The margin improved 0.3 percent relative to last year's 33.2 percent because there were fewer markdowns and, to use the company's phrase, "favorable shrinkage performance."

We expected a more lucrative 34 percent Gross Margin.  A $20 million charge in the second quarter related to the closing of its Expo stores could explain part of the shortfall.

Depreciation and Amortization expenses were $16 million less than our target, which was computed using management's guidance to expect expenses of about $1.9 billion in the entirety of fiscal 2009.  It now appears that depreciation and amortization expenses will be closer to $1.75 billion, based on the first two quarters.

Sales, General, and Administrative expenses were 21.6 percent of Revenue, which was a little less than our 22.0 percent estimate. 

The results identified above led to a 10.2 percent decrease in Operating Income relative to the year-earlier quarter.  Our estimate for Operating Income was pretty close, but too low by 0.8 percent.   Better-than-expected Revenue, plus lower depreciation and SG&A, were enough to offset the lower-than-expected Gross Margin.

In the Non-Operating area, the net interest expense came within a whisker of the $160 million we anticipated.

A favorable settlement resulted in a $50 million tax benefit, which reduced the effective income tax rate to 33.3 percent.  The tax rate is usually around 36 percent.

Overall, Net Income was down 7.2 percent.  Our estimate was too low by 5.6 percent. The tax benefit, which we certainly didn't anticipate, explained most of the difference.

In summary, we should not forget that second-quarter Revenue was down significantly and that a one-time tax benefit boosted the bottom line by $0.03 per share.  But, Revenue did not fall as much as we expected (feared?), and there were a couple embryonic signs of a turnaround.  For example, the company claims:

 "total customer transactions were positive for the first time in two years." 


"We also had the largest gain in total market share that we have seen in five years."

The Gross Margin has held up, and operating costs seem to be under control.

Consumers, given the current weak economy, are expressing a renewed preference for outlets with the lowest prices -- or perceived to have the lowest prices.  We have certainly seen this preference over the past year with Wal-Mart Stores (NYSE: WMT).  We also believe that improved customer service helped lift Home Depot's market share.

Full disclosure: Long HD and WMT at time of writing.

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