23 February 2010

HD: Income Statement Analysis for the January 2010 Quarter

The Home Depot, Inc. (NYSE: HD) earned $0.20 per share in the fourth quarter of fiscal 2009, which ended 31 January 2010.  The company lost $0.03 in the same quarter of the previous year. 

The fourth-quarter results included a number of unusual items.  On a non-GAAP "adjusted" basis, which excludes write-downs and discontinued operations, earnings increased from $0.19 to $0.24 per share.

This post examines Home Depot's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Home Depot surpassed our EPS target of $0.17 by $0.03 per share on a GAAP basis on $0.07 per share on an adjusted basis.

The principal sources for the income statement analysis were the earnings announcement and the ensuing conference call (transcript available from Seeking Alpha).

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 various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Home Depot 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), cooperatives such as Ace and True Value, and a multitude of smaller hardware stores.  Additional background information about Home Depot and the business environment in which it is currently operating can be found in the look-ahead.

Pleasclick 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 of nearly $14.6 billion was only 0.3 percent lower than in the fourth quarter of 2008.  Revenue had been declining at 8 to 10 percent, so the flat performance will be considered an improvement.  Revenue exceeded our estimate by 5.6 percent.

For the fiscal year, Revenue fell 7.2 percent, which compares favorably to the company's guidance of a 9 percent decline.

Comparable (akin to same-store) sales in the fourth quarter increased 1.2 percent.  A sales rise at international stores (especially Canada) was strong enough to outweigh a 1.1 percent decline in the U.S.  The overall average sales per store rose 1.9 percent, but the average sale per transaction ("ticket") fell 1.7 percent.

The number of tickets over $900 decreased less than 1 percent, which Home Depot characterized as "a significant improvement" compared to earlier in 2009.  The company also indicated it "continue[s] to experience pressure in big ticket construction related categories such as dimensional lumber, concrete, gypsum, pneumatic tools and fasteners."

Market share in the U.S. rose over 1 percent in 2009.

The Cost of Goods Sold (CGS) was 65.6 percent of Revenue in the quarter, which translates into a Gross Margin of 34.4 percent.  The margin increased from 34.0 percent in the same quarter of the year earlier.  We had assumed the Gross Margin would not change.

Home Depot attributed the margin expansion to fewer mark downs and avoiding the re-occurrence of certain IT costs in Canada.

Depreciation and Amortization expenses were 5.9 percent lower than last year.  This item was 3 percent less than our target for the quarter.

Sales, General, and Administrative expenses were unchanged from January 2009 and were 26.6 percent of Revenue.  Our target was 26.3 percent, which was close, but we had assumed Revenue would be lower.  SG&A expenses, therefore, exceeded our estimate by 6.6 percent.

The various operating items combined to produce Operating Income of $727 million, a 173 percent gain over the $266 million in the year-earlier quarter.  On an adjusted basis, the increase a more modest 11.3 percent.

The improvement was mostly due to the Gross Margin's 40-basis point expansion, as mentioned above.

Operating Income exceeded our $633 million estimate by nearly 15 percent.  Better-than-expected Revenue gets the bulk of the credit.

In the Non-Operating area, Home Depot wrote off the remaining half, $163 million, of its ill-fated investment in HD Supply.  When Home Depot sold HD Supply, which serves professional contractors, to a consortium of private equity firms in 2007, it invested $325 million for a 12.5 percent equity stake in the business.

The net interest expense was $12 million less than we anticipated but 18 percent more than last year.

The effective income tax rate was only 25.9 percent, much less than the 36.5 percent we had assumed based on recent history.  The lower rate was due to "a $47 million benefit arising from global tax planning."

The quarter also included $41 million after-tax income on discontinued operations, which was primarily due to a settlement with HD Supply related to working capital.  This amount boosted bottom-line Net Income to $342 million ($0.20 per share).  The equivalent figures for the year-earlier quarter were losses.  Our estimate for the latest quarter was Net Income of $294 million ($0.17 per share).

In summary, Home Depot's results for the fourth quarter were better than we expected and would have been even more so had the company not written off the rest of its investment in HD Supply.  It should also be noted that the quarter included some substantial non-recurring benefits.  The company's Revenue guidance for the year had been a decline of 9 percent, and the actual decrease was 7.2 percent.  The Gross Margin improved modestly, and costs were generally well-controlled. 

Full disclosure: Long HD at time of writing.

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