17 November 2010

HD: Income Statement Analysis for the October 2010 Quarter

The Home Depot, Inc. (NYSE: HD) earned $0.51 per diluted share on a GAAP basis in the October-ending third quarter of fiscal 2010, up 24.5 percent from $0.41 in the same three months of last year. 

This post examines Home Depot's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings were $0.04 better than the $0.47 per share we had forecast.

The principal sources for this 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.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

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 has 2,244 retail stores, of which 88 percent are in U.S. states or territories.  Home Depot also operates in Canada, China, and Mexico.

Home Depot earned nearly $2.7 billion in fiscal 2009, which was nearly 18 percent more than in 2008.  Revenue slipped 7 percent to $66.2 billion.  (Fiscal 2009 ended on 31 January 2010.)

The market value of the company is currently a bit over $50 billion.

Home Depot competes with Lowe's (NYSE: LOW), cooperatives such as Ace and True Value, and a multitude of smaller hardware stores.  These rivals took advantage several years ago of lapses in Home Depot's customer service, which had deteriorated.  Frank Blake, who took over as Chairman and CEO in early 2007, has made improved customer service a high priority.  The company's current investments in technology upgrades are evidence that this effort continues.

A big drop in sales in 2008 affected most retailers, and stores dependent on the housing market were doubly challenged.  Home Depot chose to consolidate operations and reduce capital outlays.  The first step, announced in May 2008, was to relinquish 50 planned stores in the U.S. and to close 15 existing stores.  The second step, taken in January 2009, 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.

Additional 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 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 in the October quarter increased 1.4 percent, from $16.4 billion last year to $16.6 billion in the most recent three months.  Our estimate for the quarter, which was derived from the company's sales guidance for the fiscal year and from seasonal patterns, was spot-on.

Comparable (akin to same-store) sales in the third quarter grew 1.4 percent.  Encouragingly, the comparable stores growth rate got better in each month of the quarter.

The average sale per transaction ("ticket") was down 0.8 percent, and the number of tickets over $900 was down 3.4 percent.  These figures suggests that sales to contractors and other tradespeople remain somewhat weak.  Home Depot observed strength in sales of maintenance and repair products; the company concluded customers are willing to spend to maintain their homes, but discretionary renovations are still soft.

The Cost of Goods Sold increased to $10.9 billion (65.7 percent of Revenue) from $10.8 billion in the year-earlier quarter.  The latest amount translates into a Gross Margin of 34.3 percent, about 30 basis points more profitable than the 34.0-percent margin achieved in last year's third quarter.  Home Depot attributed the margin expansion to lower deferred interest, commodity price inflation, portfolio management, and the mix of merchandise sold.

The Gross Margin hit our target of 34.3 percent of Revenue.

Depreciation and Amortization charges of $400 million were 6.5 percent lower than last year.  This reduction was the result of the company having a smaller base of fixed assets. The Depreciation expense was 2.4 percent less than our $410 million target for the quarter.

At $3.84 billion, Sales, General, and Administrative expenses in the latest quarter were almost the same as last year's $3.87 billion.  As a percentage of Revenue, these expenses were trimmed from 23.7 percent to 23.1 percent.

SG&A expenses were 1.6 percent less than our $3.9 billion estimate. 

Subtracting the various operating expenses discussed above from Revenue yields Operating Income of $1.45 billion, up 14.6 percent from $1.26 billion in the year-earlier quarter.  The increase can be credited to Revenue growth, the better Gross Margin, and less burdensome Depreciation charges.

Operating Income was 4.7 percent better than our $1.38 billion estimate.  Lower-than-expected Depreciation and lower-than-expected SG&A expenses enabled Operating Income to beat our target.

The $142 million non-operating expense (mostly interest) was less than in recent quarters and $18 million less than we anticipated.  The interest expense was lower because the company had reduced its debt balance.

Pretax income was $1.31 billion, surpassing the $1.22 billion target we set.

The effective Income Tax Rate was 36.1 percent, a rate slightly less burdensome than the 36.5-percent rate we had assumed.  We wouldn't be surprised to learn the company had its best sales growth in lower tax jurisdictions.

This brought after-tax Net Income to $834 million, which was 21 percent better than the $689 million earned in last year's third quarter.  Our estimate was $776 million.

On a per-share basis, earnings increased from $0.41 to $0.51.  The latest number beat our estimate of $0.47 by a $0.04.  Lower-than-expected SG&A and interest expenses, coupled with a slightly lower tax rate, resulted in the positive surprise.

Full disclosure: Long HD at time of writing.

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