Image: Home Depot’s third-quarter performance wasn’t bad. Inventories expanded, but management reiterated that its core customer remains resilient and engaged. Image Source: Home Depot
By Brian Nelson, CFA
On November 15, home improvement retailer The Home Depot (HD) reported strong third-quarter results that beat expectations on both the top and bottom line. Revenue advanced 5.6% in the period thanks to comparable sales growth of 4.3% and 4.5% comp expansion in the U.S. Net earnings came in at $4.24 per diluted share, showcasing 8.2% growth over the $3.92 per-share mark from last year. The firm noted that its core customer is still healthy, indicating that it has yet to feel a meaningful impact from what could be a painful decline in new residential construction given mortgage rate increases. Home Depot continues to be one of our favorite dividend growth ideas, yielding ~2.4% at the time of this writing.
Management noted on the conference call that it is pleased with the momentum behind both its Pro and DIY (“Do-It-Yourself”) customers and that engagement on the Home Depot app has increased while active users advanced–as the firm seeks to remove friction across the shopping experience. Home Depot’s comp average ticket increased 8.8% in the quarter, but this was offset by comp transactions, which fell 4.4%. We liked the pricing growth, but we’d like to see better performance with respect to the number of transactions. Home Depot noted, however, that its Pros (professional customers) tell them “their backlogs remain strong,” something we wanted to hear given the considerable uncertainty in the housing market these days given rate hikes.
Most of the average ticket increase in the quarter was driven by inflationary pressures across its business [building materials, lumber, copper (CPER)]. The executive team noted that it continues to monitor elasticities in its business, and at the moment, we think the firm has found a nice balance between driving average ticket prices higher while not pushing transactions too much lower, so that comps face too much pressure. The 4.3% comp in the third quarter was commendable, particularly given how difficult it is to walk the line between pricing expansion and volume declines in an inflationary economy. Management’s dedication to providing an interconnected shopping experience should help it navigate the uncertainty better, too.
Looking ahead, Home Depot affirmed its prior guidance for fiscal 2022, with comp sales growth targeted at ~3% for the year, and its annual operating margin to be ~15.4%, modestly below the 15.8% mark achieved in the third quarter. We like that the home improvement retailer continues to expect mid-single-digit growth in earnings per share on the year, which should help support dividend expansion. During the nine months ended October 30, 2022, free cash flow came in at ~$7.8 billion, a decline from the year-ago period but still respectable and in excess of cash dividends paid (~$5.9 billion) during the same time horizon. Here’s what management had to say about its core customer on the conference call (lightly edited):
“…we think our customer is still healthy. I mean, our customer tends to have a good job, growing wages, strong balance sheets. They own their home and have seen increased home equity. However, as Richard said in his prepared notes, I mean it is a unique environment, lots of cross-currents, inflation and rising interest rates, et cetera.
But given all that, our customer has remained resilient and engaged. As we said, both our Pro and DIY customers grew again in this past quarter. Project demand, in particular, is very strong. Our Pro sales are strong and our Pro intercepts with our customers indicate that their backlogs are still very healthy.
Customers are still spending lots of time at home. We’re not all back at work five days a week. These homes continue to age. And they’re worth 40% more than they were pre pandemic [over the last three years]. Now, I’m sure we’ll get into some housing questions and housing values may go down a bit, but we’re still going to be up meaningfully on a two-year basis…
…So, we are now seeing a dynamic of stay in place and improve your home. And that’s what our customers are telling us, and that’s what the Pros are telling us their customers are telling them.
During the quarter, Home Depot’s gross margin and operating margin were roughly flat on a year-over-year basis, as the company offset wage increases with efficiencies in its stores. The company opened three new stores in the period, including two in Mexico, and while inventories were up $5.1 billion on a year-over-year basis (or about 25%), we’re not too concerned by the situation as the inventory build at Home Depot has a degree of cost inflation to it and many products are of the non-perishable variety. Still, we’ll be monitoring its balance sheet closely in the coming quarters, as it holds a considerable amount of net debt on the books.
Concluding Thoughts
Home Depot’s third-quarter report was solid, all things considered. The firm offset weaker transactions with a higher average ticket to driven solid comp performance. Management noted that its core customer remains resilient, and while inventories have ballooned on a year-over-year basis, we’re less concerned about the inventory build as most of Home Depot’s inventory is of the non-perishable variety. We like the firm as an idea in the simulated Dividend Growth Newsletter portfolio, though we continue to pay attention to the health of its balance sheet, which includes a considerable net debt position.
Tickerized for holdings in the XHB.
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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson’s household owns shares in HON, DIS, HAS, NKE, and RSP. Some of the other securities written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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