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Investment Overview for Home Depot (NYSE:HD)
Home Depot EBITDA Margin: Home Depot's EBITDA margin decdeclined from 13.5% in 2007 to 10.6% in 2008 due to increasing expenses, declining sales and competition from Lowe’s. From 2009-12, Home Depot improved margins to 14.7% 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 marginally 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 a 15 to 20% upside to our current price estimate.
Home Depot is the world’s biggest retailer of home improvement products. Home Depot has grown to 2,244 stores spanning across the US, Canada, Mexico and China. 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, while it is trying to increase its presence in China. Due to its large number of stores, Home Depot's sales are approximately one-and-a-half times those of its closest competitor Lowe’s.
Home Depot's business is vulnerable to the housing market, and the 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 and Hardware and Seasonal products divisions are more valuable than Home Depot's other divisions for the following reasons:
Plumbing, Electrical & Kitchen have a larger total market than the Hardware & Seasonal, Paint & Flooring markets
The Plumbing, Electrical, Kitchen and Appliances 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 important 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 carry out repair projects. Home Depot occupies a much higher market share in the Seasonal & Hardware Tools category, compared to the Plumbing, Electrical and Kitchen division.
Smaller market size but greater market share than the Building Materials, Lumber & Millwork segment
Though the Building Materials, Lumber & Millwork market is twice the size of the Plumbing, Electrical & Kitchen market, 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 14% and in Seasonal & Hardware Tools is close to 50%.
Consistently outpacing Lowe's in terms of comps
Q1 2012 was the 12th straight quarter that 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 December 2011, Lowe's 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 have struggled 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.
Home Depot has also been gradually remodeling its stores from the earlier 'warehouse' oriented style to a more customer friendly one. It is also increasingly trying to leverage technology through handheld devices like tablets and 'First Phone' mobile devices for more efficient inventory look-up, to increase employees' face time with the customers. It has also recently introduced the Paypal payment facility.
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 the online strategies, including small acquisitions and improvements in the web experience for its 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 4.6% in 2012. This helped Home Depot improve its margins through operating expense leverage during 2010-12. Going forward, we expect comps to continue to improve at 3-4%, as sales recover over the 2013-14 period. 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 the overall margins to further improve as the company continues its supply-chain improvements.
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. 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 recent 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 are 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 (represent 28% of the U.S. population and account 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.
Trefis Forecast Rationale for Number of Home Depot's International Stores
This is the number of Home Depot's retail stores in Canada, Mexico and China. These stores are similar to Home Depot's U.S. stores in their product range and operations.
Home Depot store count in Canada increased from 165 in 2007 to 180 in 2012. Home Depot started its Mexican operations in 2001 and since then it has grown to reach 100 stores at the end of 2012. Home Depot has become one of the largest retailer chains in Mexico. Home Depot entered China in 2006 by acquiring The Home Way, a local home improvement retailer. In 2012, however, the company sold most of its stores in China as part of its general rollback in the country.
We expect Home Depot to keep expanding in geographies outside the U.S., especially in attractive markets such as Mexico, where its penetration is still very low. From 240 in 2007 to 280 in 2012, the store count could exceed 300 by the end of the Trefis forecast period.
Trefis considered the following factors for its forecast
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- Home Depot's wider international footprint compared to Lowe's
- Home Depot is ahead of Lowe's in its global expansion outside the US and Canada. By the end of 2012 it had 100 stores in Mexico, apart from the 180 in Canada. In comparison Lowe's ventured outside the US and Canada in 2010 only. We estimate Home Depot's store count outside the US to cross 320 by the end of the Trefis forecast period, contributing revenues of around $8.2 billion. In comparison, as Lowe's expands further outside the U.S., we estimate it to cross $3 billion of annual revenues by the end of the Trefis forecast period. This would imply a store count of 90 outside the U.S.
- Lowe’s provides stiff competition to Home Depot in the U.S. market. International stores help Home Depot offset growing competition from Lowe’s in the US.
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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