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Investment Overview for Home Depot (NYSE:HD)
Home Depot EBITDA Margin: Home Depot's EBITDA margin declined from 13.5% in 2007 to 10.6% in 2008 due to increasing expenses, declining sales and competition from Lowe’s. From 2009-13, Home Depot improved margins to 15.8% by streamlining its operations, supply chain, and cutting down heavily on its SG&A expenses. Margins were also aided due to the 3-4% growth in same store sales. Going forward, we expect the margins to continue to slightly increase to just above the 14% mark over the Trefis forecast period with further operating leverage as comps improve. However, if the comps stay flat and there is limited or no operating leverage, margins could decline and there could be a 15% downside to our current price estimate. On the other hand, if the housing market and home improvement industry recovers sooner, and comps improve better than expected at 4-5% over the next few years, there could be a 15 to 20% upside to our current price estimate.
Home Depot is the world’s largest retailer of home improvement products. Home Depot has grown to 2,263 stores spanning across the US, Canada, and Mexico. It offers a wide range of home improvement products and installation services to individual home owners as well as professional builders. In addition to the physical stores, consumers can buy these products through the company’s dedicated website.
Home Depot has deep penetration in the US, Canada, and Mexico. Due to its large number of stores, Home Depot's sales are nearly one-and-a-half times those of its closest competitor, Lowe’s.
Home Depot's business is vulnerable to the housing market, and the housing slowdown has widely affected its sales. In fact, Home Depot had to close down its EXPO and HD supply businesses as their sales were badly impacted during the housing market downturn, making these businesses highly unprofitable.
The Plumbing, Electrical & Kitchen division, and the Hardware and Seasonal products division are more valuable than Home Depot's other divisions for the following reasons:
Plumbing, Electrical & Kitchen has a larger total market than the Hardware & Seasonal, Paint & Flooring markets
The Plumbing, Electrical and Kitchen market size is more than double the Hardware & Seasonal market and Paint & Flooring market combined. Consumers are more likely to buy home plumbing, electrical, and kitchen products owing to their importance in their daily lives. For example, products like electrical lights, kitchen appliances, water pipes, wash basins, toilets, and showers are basic requirements for every household. These products become necessary for consumers to fix when they break. Home Depot occupies a much higher market share in the Hardware & Seasonal tools category, compared to the Plumbing, Electrical and Kitchen division.
Sears is the leading U.S. appliance retailer, but has been losing market share to Home Depot in the last few years. Home Depot's market share in appliances improved by 1.7% in 2013, and could further grow while Sears continues to struggle. Around 78% of Home Depot's stores are within 10 miles of a Sears location.
Smaller market size but greater market share than the Building Materials, Lumber & Millwork segment
Though the Building Materials, Lumber & Millwork market is more than 1.5 times the size of the Plumbing, Electrical & Kitchen market ($240 Billion v. $150 Billion), it is a very fragmented market and Home Depot currently captures only around 6% of it. In comparison, Home Depot's share in Plumbing, Electrical & Kitchen goods is about 15% and in Hardware & Seasonal Tools it is close to 50% -- although the Plumbing market is three times larger ($150 Billion for Plumbing v. $44 Billion for Hardware).
Consistently outpacing Lowe's in terms of comps
In 2013, Home Depot outpaced Lowe's in terms of same store sales growth due to significant improvements in service levels and efficiency as well as a more successful pricing strategy. We expect this trend to continue. In late 2011, Lowe's had decided to move away from promotions to everyday low prices to establish itself as the retailer offering the most competitive prices. However, Lowe's sales continue to struggle more than they already would have in a depressed housing market as customers continued to seek discounts, particularly for discretionary and big-ticket purchases. Home Depot has been grabbing market share from Lowe's due to better pricing models. Transactions over $900 now contribute around 20% of all U.S. sales for Home Depot, growing twice as fast as transactions below $50 in Q4 2013.
Following the recession, Home Depot focused on cost-cutting and improving customer service, whereas Lowe's opted for promotional sales and kept opening new stores, which produced diminishing returns. Since mid-2009, Home Depot's quarterly comparable sales growth rates have consistently outpaced Lowe's. Comparable store sales for Home Depot grew by 6.8% in 2013, the highest level since 1999.
Emerging competition from online retailers
Online retail has been an emerging threat to the market share of brick and mortar home improvement retailers like Home Depot and Lowe's. For this reason both companies have made significant investments in online strategies, including small acquisitions and improvements in the web experience for their customers.
Improving same store sales could provide operating leverage
As a result of the gradual market recovery, Home Depot's same store sales growth (comps) has gradually improved from 2.9% in 2010 to 6.8% in 2013. This helped Home Depot improve its margins through operating expense leverage during 2010-13. Going forward, we expect comps to continue to improve at 3.5-4.5%, as sales rise. This should bring in further operating expense leverage, thereby pushing up margins.
Home Depot's supply chain improvements
Home Depot has been focusing on supply-chain improvements through its central distribution system. We expect overall margins to further improve as the company continues its supply-chain improvements. Rapid Deployment Centers (RDC) aim to aggregate product needs for multiple stores to a single purchase order, and then rapidly allocate and deploy inventory to individual stores upon arrival at the RDC. This move aims to simplify the ordering process and improve inventory management. Home Depot has 18 fully mechanized RDCs in the U.S.
Do it Yourself (DIY) activity will drive the home improvement industry growth in the near future
Until the housing market situation in the US improves, more buying action is anticipated from DIY customers. Repair & maintenance of small house projects will dominate DIY activity. The North American Retail Hardware Association (NRHA) forecasts that plumbing & electrical products will be a major part of consumer spending in the near future. The spending will come mainly from DIY consumers who will demand more selection, information, & service from the retailers.
Shift in consumer preferences will impact traditional range of home improvement products
A survey from NRHA suggests a change in the buying patterns among US home improvement consumers. People are no longer loyal to only products made in the US. Consumer demand is driven more by price and quality. Consumers may find foreign products which may be better suited to their needs more appealing than products made in the US. Another observable trend is the shift in consumers toward buying green or eco-friendly products such as water saving flushes and electricity saving appliances.
Aging baby boomers will increase Do it For Me (DIFM) customers in the US
With the change in US demographics due to the aging of the 77 million baby boomers (representing 28% of the U.S. population and accounting for 77% of all financial assets), we expect an increase in Do it For Me (DIFM) customers. This is good for retailers such as Home Depot as they can reap additional revenue by providing installation services unlike in the case of Do it Yourself (DIY) customers.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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