11 October 2009

HD: Look Ahead to October 2009 Quarterly Results

The GCFR Overall Gauge of Home Depot (NYSE: HD) inched up from 27 to 29 of the 100 possible points in early August, when the second quarter ended.  Our income statement, financial gauge, and gauge update analyses explained in some detail how the score was attained.

Home Depot earned $0.66 per share in the second quarter, down from $0.71 in the comparable period last year.  Revenue was 9.1 percent lower; sales to professional contractors were especially weak.  More encouragingly, the company claimed "total customer transactions were positive for the first time in two years" and "We also had the largest gain in total market share that we have seen in five years."

We have now modeled Home Depot's Income Statement for the quarter that will end on 1 November 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 17 November 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 tied to the ailing housing market, Home Depot consolidated operations and reduced capital outlays.  The first step was to relinquish 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 eighth 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 (NYSE: WMT) exemplar of efficiency.

Several famous investors have trimmed their earlier bets on Home Depot.  As of 30 June 2009, RBS Partners, L.P., associated with Edward Lampert, owned 9.9 million shares (down from 17.8 million shares three months earlier).  Mr. Lampert is Chairman of Sears Holdings (NASDAQ: SHLD).  Berkshire Hathaway (NYSE: BRK.A), run by investing legend Warren Buffett, owned 2.76 million shares (down from 3.7 million).  Soros Fund Management owned 190 thousand shares (down from 3.9 million).

After Frank Blake replaced Robert Nardelli (who subsequently served an ill-fated 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 third quarter.

When Home Depot reported its second quarter results, on 18 August 2009, it ...

... confirmed that it believes that fiscal 2009 sales will be down approximately 9 percent from fiscal 2008. Based on its year-to-date performance, the Company lifted its fiscal 2009 EPS guidance and now expects earnings per share from continuing operations to be flat to up 7 percent from last year. On an adjusted basis, the Company now expects earnings per share from continuing operations to decline by 15 to 20 percent.  [emphasis added]

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, Revenue in the third quarter has been 25.1 percent, on average, of the annual total.  We assume this seasonal patterm will remain in effect.  Therefore, our target for Revenue in the third quarter of the current year is 0.251 * $64.9 billion = $16.3 billion.  This figure is 8.4 percent less than Revenue in last year's third quarter.

Home Depot's Gross Margin as a percentage of Revenue has been 33 to 34 percent in recent quarters, and we expect a mid-range margin in the third quarter.  Given our Revenue estimate, we forecast a Cost of Goods Sold (CGS) of (1-0.335) * $16.3 billion = $10.8 billion.

Depreciation and amortization expenses in the last three quarters have averaged $435 million.  We are looking for a similar figure in the third quarter.

Sales, General, and Administrative (SG&A) expenses in the first half of 2009 were 22.75 percent of Revenue.  This expense in the third quarter is usually a little higher.  Our target is 23.5 percent for the current period.  To be precise, the expense should be about 0.235 * $16.3 billion = $3.8 billion.

Given the estimates above, we're projecting $1.2 billion for Home Depot's Operating Income in the third quarter.  This figure is 10 percent less than in the third quarter of 2008.

Our target for Net interest and other non-expenses is $165 million, roughly the same as in recent quarters.

An effective income tax rate of 36 percent, per the guidance, would lead to Net Income of $658 million ($0.39/share) for the quarter.  In the third quarter of 2008, Net income was $756 million ($0.45 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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