- Home Depot beat earnings estimates by $0.07 per share in Q4 FY 2015.
- Macroeconomic factors such as an improving housing market brought customers through Home Depot’s doors.
- Home Depot’s execution on strategies helped it set itself apart from competitors.
On 23 Feb 2015, home improvement retailer Home Depot (NYSE:HD) came out with its Q4 FY 2015 earnings announcement and held its conference call. Earnings per share in the fourth quarter came in at $1.17, beating estimates by $0.07 per share (6%). This also represents a 10% YoY increase over the $1.06 per share reported in Q4 FY 2014. Home Depot, and consequently its shareholders, had an excellent year. Let’s examine why.
Customers, confident from relatively good times on a macro scale, came into Home Depot, opened their wallets and spent hard earned money on company goods. In FY 2015, Home Depot’s same store sales expanded 5.6% with a 7.1% expansion in the United States alone. Moreover, customers spent more at a higher frequency. Home Depot’s transactions and tickets increased 4% and 2% YoY, respectively, in FY 2015. Home Depot’s management indicated that commodity deflation served as a drag on ticket expansion in the most recent quarter.
External and internal factors contributed to Home Depot’s impressive comps. First, the housing recovery served as a solid economic catalyst. Existing home sales increased an impressive 11% YoY in December, representing the “largest year-over-year gain since July 2013”, according to the National Association of Realtors.
Most importantly, solid execution contributed to Home Depot’s success in FY 2015. Home Depot touted its “interconnected retail” strategy, which focuses on the whole retailing experience for customers (both professionals and DIYs) in its brick and mortar stores as well as those using its various digital experiences. The use of fulfillment centers, serving as backup for store locations, enables more choices for the consumer both in terms of merchandise and delivery.
In the most recent earnings call, management repeatedly asserted that 40% of online orders were picked up in store locations. This gives Home Depot further opportunity to make additional sales. Moreover, this bodes well for company shareholders over the long-term in the face of the increasing tendency for consumers to buy products online.
Also, thoughtful merchandising via Home Depot’s assortment planning tools enabled the company to offer the right merchandise in a timely fashion and at the right price. This provided further enticements for consumer spending. Offering customers what they want remains the preeminent challenge in the retailing environment, and Home Depot proved effective in giving customers what they want.
Other fundamental issues
Home Depot saw its reported revenue, net income and free cash flow increase 6%, 11% and 16%, respectively, YoY. Prudent cost controls, combined with sales growth, resulted in expanded margins. Home Depot’s operating margins went from 12.6% in FY 2014 to 13.3% in FY 2015. Its profit margins expanded slightly to 7.9% in FY 2015 versus 7.6% in FY 2014.
Home Depot’s long-term debt balance increased 6.2% YoY in FY 2015. Its long-term debt to equity stands at a lofty 284% in FY 2015 versus 181% in FY 2014. This caused an 11% YoY increase in interest expense. However, times interest earned actually expanded to 12.8 in FY 2015 versus 12.6 in FY 2014. This still represents a decent margin of safety. Investors should worry if this ratio drops below five.
Shareholder friendliness exhibited
Home Depot believes in rewarding the shareholder both in terms of share buybacks and through more tangible means of dividends. With that said, management announced a 17% increase in its dividend in the most recent earnings announcement. Home Depot paid out a prudent 38% of its free cash flow in dividends in FY 2015. The company currently pays its shareholders $2.36 per share per year yielding 1.9% annually. Home Depot spent the same amount on share repurchases in FY 2015 as in FY 2014, according to its statement of cash flows.
Slightly lower growth expected in 2016
Home Depot’s management exhibited caution when looking ahead to FY 2016. They expect home price expansion to clock in at 3.5% versus 5.4% in FY 2015. They expect the economy to slow down a bit in FY 2016 with a GDP estimate of 2.1% versus 2.4% in 2015, according to Home Depot’s earnings call. At best, Home Depot expects same store sales to register at 4.5% in FY 2016 versus 5.6% in FY 2015 and revenue growth to come in at 6%, which is below the 6.4% growth rate experienced in FY 2015. Management expects to spend $5 billion on share repurchases, which is less than the $7 billion spent in FY 2015. One bright spot is that management expects capital spending of $1.64 billion on operating cash of $10 billion. This would translate into free cash flow growth of 6%.
Other long-term opportunities
Home Depot is doing research on the aging of housing on a macro scale. In the earnings call, management said that “65% of the homes in the United States are older than 30 years and there's external research that shows that spending on older homes is higher”. They believe that home owners spend more on older houses. Management hinted that if this percentage trends higher consumers could spend more at its stores. Moreover, Home Depot is also investing in fulfillment centers that will enhance its digital strategies. Interestingly, Home Depot will slowly unveil to its consumer base the opportunity to order online and have a product delivered from the store to the consumer’s house.
Home Depot seems to understand that it must adapt to the digital world to survive. The company executed well on this front in FY 2015. Home Depot’s capability to differentiate from other struggling retailers merits the attention of the long-term investor.