Home Depot Earnings Review: Solid Growth On High Demand, Despite The Data Breach

America’s largest home improvement retailer Home Depot (NYSE:HD) reported solid Q3 results on November 18, buoyed by improving macroeconomic conditions, home price appreciation and greater consumer demand. Revenues grew 5.4% year-on-year to $20.5 billion in the quarter, with strong comparable sales growth of 5.8% in U.S., despite the threat of a possible impact of the data breach. ^[1] Home Depot announced in September that a cyber attack targeted its payment terminals, which might have left around 56 million customers’ credit or debit card data exposed, bigger than the card and personal information theft at Target late last year. However, while Target suffered a 46% drop in profits in Q4 2013, when the news of the data breach at the retailer surfaced, Home Depot managed to escape the anticipated customer backlash and reaffirmed its previous guidance for the fiscal year ending January. The company could achieve its comparable sales growth target of roughly 5% in Q4, after a solid 5.2% growth this quarter, on the back of additional customer traffic during the holiday season and on Black Friday.

We have a price estimate of $93 for Home Depot’s stock, which is slightly above the current market price.

Our complete analysis for Home Depot’s stock

Home Improvement Sales Fueled By Higher Customer Spending

After a rough initial few months of the year, when the U.S. economy remained weak amid unusually cold weather conditions, sales for home improvement retailers have picked up. After only a 2.6% comparable sales growth in Q1 for Home Depot, higher consumer spending has boosted the retailer’s comps by 5.8% and 5.2% respectively in the second and third quarters. A conducive business environment, home price appreciation and holiday sales provide further opportunity for Home Depot to boost its full year top line growth.

Home Depot depends on home sales as new occupants spend on home improvement supplies and construction products and services. Following the first quarter, home sales have picked up in the U.S., with existing home sales reaching a seasonally adjusted annual rate (SAAR) of 5.17 million in September, the highest sales figure in over twelve months, and also higher than the overall adjusted figure of 5.07 million for 2013. ^[2] New home sales also rose to a SAAR of 467,000 in September, the highest in over a year. Increases in new and existing house purchases during the last few months could mean more business for Home Depot through the end of the year, as customers are likely to look to purchase home improvement goods and equipment.

Home sales, in turn, are impacted by the economic environment and general business activity, and through key indices such as unemployment rates, interest rates and home prices, we gauge trends in the housing market, and consequently, the home improvement market.

• Unemployment Rate Falls: Home sales are also impacted by the general business environment that affects job creation and incomes. The unemployment rate in the U.S., where over 87% of Home Depot’s stores are located, fell to a six-year low of 5.8% in October. ^[3] This bodes well for Home Depot as job creation would facilitate income growth and consequently also support home sales. In addition, with job stability, consumers might also look to increase spending on home improvement products.

• Home Prices Rise: Rising house prices are closely associated with consumer affordability. The U.S. housing industry has picked up from the lows of 2010-2011, but the growth rate this year has slowed down in comparison to last year. However, this might not be a serious cause for concern. Although slower than 2013 levels, home prices have grown by around 5% this year. ^[4] According to Home Depot, almost half the expected 4.6% growth in its full year comps this fiscal year is expected to come from home price appreciation, as customers invest more in their homes.

• Mortgage Rates To Rise: According to Freddie Mac, the average rate for a 30-year fixed-rate mortgage fell to below 4% in mid-October, and is below the January levels of 4.5%. ^[5] Potential home buyers have looked to take advantage of the lowered borrowing costs, boosting home sales. Lending rates are expected to rise going forward, fueled by the Federal Reserve’s announcement of reduction in bond purchases, which had kept the long-term interest rates low. ^[6] The rates haven’t risen as aggressively as they did mid-last year when the Fed first announced reduction in bond purchases. However, the average rate for a 30-year fixed-rate mortgage is expected to rise to 5.1% by the end of 2015, which could further prompt house purchases in the near term, consequently boosting home improvement sales.

Future Growth For Home Depot Could Come From Online Sales

Home Depot has gained from an extended reach in the interconnected retail market, with online sales growing 40% year-over-year this quarter. In addition to in-store sales, the retailer has been expanding its online sales platform in order to compete with companies such as Amazon, which also offers home improvement goods online. Amazon boasts of a superior online market expertise and could eat into the sales of traditional home improvement retail stores, especially as more and more customers switch to online portals to shop. Home Depot’s online sales now form almost 5% of the overall sales, up from less than 1% during 2010-2011, according to our estimates. ^[7] The retailer launched its “Buy Online Pickup In-Store” service, in effect substituting in-store sales with online sales. About 40% of the online sales this quarter culminated in-store.

In addition, in order to enhance delivery systems, Home Depot also started the development of three new direct fulfillment centers, the first of which opened in February 2014 near Atlanta, and the second opened in California during Q3. Each facility is able to hold approximately 100,000 product offerings available to be shipped directly to customers, along with the capability to ship most orders the same day they are received. Following the opening of the third fulfillment center next year, Home Depot will be able to reach 90% of the U.S. population within 48 hours with parcel delivery. With further expansion of the dot-com business and strengthening of delivery channels, Home Depot could expand its online customer base, going forward.

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1. Home Depot press release [↩]
2. “New and existing home sales, U.S.“, National Association of Home Builders [↩]
3. U.S. labor market tightens, but wages still anemic [↩]
4. The U.S. housing market in 10 charts, wsj.com [↩]
5. 30-year fixed-rate mortgages since 1971 [↩]
6. historical 30-year fixed-rate [↩]
7. Home Depot earnings transcript [↩]