Home Depot (NYSE:HD), the nation’s largest home improvement retailer, is scheduled to release its Q4 earnings results on February 25. Compared to the previous quarters in 2013, the performance of the housing market was a bit disappointing in the fourth quarter so Home Depot may report only slightly higher year-over-year quarterly sales. On an annual basis, we expect the company to fall a bit short of its growth targets which were revised upwards at the end of Q3.
Home Depot certainly seems to have leveraged the increased demand for homes and home-related products well in 2013. Its total sales were up about 7.4% year-over-year in Q3 2013. Meanwhile, it has also done well to complement its top-line growth with key cost reduction strategies, thereby boosting the bottom-line. These will continue to benefit the company going forward and support its stock price which performed well all through Q4.
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Effect Of The Housing Market
The housing market recovery continued in October in the fourth quarter of 2013, spurred by strong consumer confidence and low mortgage rates but a slowdown occurred in November and December. New home sales rose were 463,000 in October, 445,000 in November and 414,000 in December. Sales of existing homes dipped compared to levels observed in Q2 and Q3. The reason that sales of new as well as existing homes are important for Home Depot is the spending on home improvement by new occupants. 
We believe that Home Depot’s stock price suffered in January and February because the housing data for November and December were released at this time and came in weak. However, this setback may just be temporary in nature. The U.S. has experienced an especially severe winter this time and we think that it may have been a major factor influencing the housing market activity in the fourth quarter as business activity levels dipped in general. It is safe to assume then that home improvement projects also got deferred. If so, we may see some pent-up demand resulting in a boost to Home Depot’s sales in the first couple of quarters in 2014.
Margins To Remain Strong With Cost Reduction Programs Leading The Way
Home Depot’s earnings in Q3 2013 kept improving from last year due to the company’s focus on reducing costs, including efforts to reduce complexity in the supply chain, improve distribution, and localize marketing and merchandising activities. Operating income as a percent of net sales was 11.78% for Q3 2013 compared to 9.56% for Q3 2012.
Home Depot’s gross margin was 34.92% for the third quarter, an increase from 34.56% in Q3 2012. Gross as well as operating margins are expected to have improved in Q4. ((Home Depot Q3 2013 8-K, SEC))
Notable Business Developments
Home Depot announced in December that it is planning to put in place infrastructure that will enable the same-day delivery of orders. The new systems will also allow the company to boost its online sales in general and perhaps capture a chunk of rival, Lowe’s’ customer base. The company said that it intends to spend around $300 million on building new fulfillment centers, a new warehouse management system and a new material handling system. Apart from providing same-day delivery, this will reduce the time it takes to fulfill online orders in general.
The latest initiative will likely strengthen Home Depot’s grip on the professional contractor segment which accounts for around 35% of its sales and includes those customers who wouldn’t mind paying a small premium to save an extra trip in the middle of a home improvement job. The first of these centers came up in Atlanta around two weeks back and the remaining two will come up over the next two years.((Home Depot Looks to Offer Same-Day Shipping, WSJ))
In the fourth quarter, Home Depot acquired online retailer Blinds.com. This company is the largest online window coverings retailer in the U.S. The terms of the deal weren’t disclosed. This acquisition follows Home Depot’s buyout of kitchen and storage supplier U.S. Home Systems Inc. and home services specialist Redbeacon in 2012. It is clear that the company is concentrating on acquiring specialist players in different segments to strengthen its offerings. 
What We Will Watch Out For
We are interested in knowing if our hypothesis about the cold U.S. weather dampening housing sales and home improvement sales is true. Therefore, we will look at sales numbers for the fourth quarter and watch out for the management’s comments in this regard.
We are also interested in knowing the management’s perspective on the benefits of the company’s fulfillment centers for its e-commerce business.
We have a Trefis price estimate of $77 for Home Depot’s stock, which we will revise once the company’s fourth quarter results are out.