VALUATION HIGHLIGHTS

1. Home Depot constitutes 100% of the Trefis price estimate for Home Depot's stock.

WHAT HAS CHANGED?

1. HD Continues To See Strong Surge in Sales

Consumers spent aggressively on upgrading and remodeling their homes at a time when other budget categories, like vacations and away-from-home entertainment, slumped. Consequently, Home Depot's sales and net income jumped an impressive 19.9% and 14.4%, respectively, in fiscal 2020. Operating profit for 2020 landed at $18.3 billion, or 13.9% of sales, compared to $11.2 billion, or 14.4% a year ago, due to higher costs in areas like labor, fulfillment, and the e-commerce platform.

For its fourth quarter, sales came in at $32.3 billion, a 25% improvement over the year-ago quarter. That was on the back of comparable sales that climbed by nearly the same percentage. On the bottom line, net profit was 16% higher at $2.9 billion, or $2.65 per share. Those spending priorities might change just as dramatically over the current year as the pandemic winds down, management warned in their latest earnings report.

2. Higher Costs Accrued

While the pandemic is boosting sales for Home Depot, it’s also raising costs. Home Depot compensated its employees generously for their work during risky conditions. The company granted additional paid time off to all hourly workers with even more paid time off for those over 65 or at-risk. The company plans to invest ~$1B in annualized permanent compensation enhancements for frontline, hourly associates.

3. Home Depot's Online Sales Continue to Propel Overall Growth

Home Depot has made a concerted effort to focus on its integrated retail strategy, which seamlessly connects online and offline channels, making its stores more efficient. This has resulted in improved revenues and profitability, with the online space being a key driver of the impressive growth Home Depot has witnessed in recent times. Sales using digital platforms soared 86% in fiscal 2020 compared to the prior year and approximately 62% of online orders were fulfilled through a store. The penetration was 14.4% to the business. Moreover, in the digital space, the typical transaction ticket size is three times that in a store. By focusing on an integrated channel strategy, Home Depot has been able to increase revenues per square foot, rather than generating revenues from the new square footage. This has ensured that its existing store network is being effectively used to drive revenues.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Home Depot EBITDA Margin: From 2013-2019, Home Depot improved margins to about 18% by streamlining its operations, supply chain, and cutting down heavily on its SG&A expenses. Margins were also aided due to the substantial growth in same-store sales. However, the retailer saw a decline in margins to close to 17% in 2020, due to higher costs accrued due to the pandemic. Going forward, we expect the margins to continue to slightly increase and reach just over the 18% mark over the Trefis forecast period, with further operating leverage as comps improve. However, if the comps grow only modestly, and there is limited or no operating leverage, the margins would remain steady, causing a 5% downside to our current price estimate. On the other hand, if the housing market and home improvement industry continues to strengthen, and outpace previously forecast growth estimates, and comps improve better than expected, resulting in the margins reaching 20%, there could be an over 5% upside to our current price estimate.

BUSINESS SUMMARY

Home Depot is the world’s largest retailer of home improvement products. Home Depot has grown to 2,296 stores spanning across the U.S., Canada, and Mexico. It offers a wide range of home improvement products and installation services to individual homeowners 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 U.S., Canada, and Mexico.

Home Depot acquired HD Supply, a provider of maintenance, repair, and operations products in November 2020. This buyout is likely to boost the overall value of the business by adding new growth opportunities and pushing profit margins higher.

KEY TRENDS

Lowe's outpaced Home Depot For The First Time In Terms of Comps

Home Depot and Lowe's are the number one and two home improvement retailers in the U.S. Since 2013, Home Depot outpaced Lowe's in terms of same-store sales growth with better pricing. In 2018, comparable sales growth was recorded at 2.2% for Lowe's and 5.2% for Home Depot. A similar growth trend was witnessed in 2019, where Lowe's comps grew 2.6%, while Home Depot's comps grew 3.5%. However, Lowe's comparable sales of 26.1% managed to surpass Home Depot's comp sales of 19.7% in fiscal 2020.

Lowe's continues to reduce the gap with its largest competitor and gain market share in the fragmented home improvement industry, by improving sales through merchandising initiatives, enhancing profitability by improving store and operating capabilities, improving its digital penetration, and using its new loyalty program to attract more Pro customers.

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.

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.

Pro customer activity will drive home improvement industry growth in the near future

The pro segment is estimated at $120 billion a year, nearly as large as the do-it-yourself segment. A breakdown of Home Depot's comparable sales growth in the last few quarters shows a broader increase in the average ticket size as compared to a customer traffic increase. Transactions of $1000 or more have grown by high single-digit or double-digit percentages in the last few quarters. Pro sales continue to grow disproportionately faster than Home Depot's average, boosting its top line and leading to a market-beating growth in categories such as plywood, fencing, and industrial lighting.

Shift in consumer preferences will impact the traditional range of home improvement products

A survey from NRHA suggests a change in the buying patterns among U.S. home improvement consumers. People are no longer only loyal to products made in the U.S. Consumer demand is driven more by price and quality. Consumers may find foreign products, which may be better suited to their needs, and more appealing than products made in the U.S. Another observable trend is the shift in consumers toward buying green or eco-friendly products, such as water-saving flushes and electricity-saving appliances.