Home improvement retailer Home Depot (NYSE:HD) released its Q3 results on November 19. Earnings for the quarter stood at $1.4 billion compared to $947 million in Q3 2012, an increase of nearly 43%. Net earnings were propelled by top line growth with a steady recovery in the U.S. housing market driving consumer appetite for home improvement products. Net earnings for Q3 2012 included a non-recurring charge of $165 million as a result of the closure of seven stores in China. The company’s net sales for the quarter stood at $19.5 billion, an increase of about 7.4% over Q3 2012. 
Based on the solid performance and outlook for the balance of the year, Home Depot raised its sales expectations. It now expects sales to be up by approximately 5.6% year-over-year with a rise in comparable store sales of approximately 7%. At the end of the previous quarter, the company had estimated that sales would be around 4.5% higher year-over-year and comparable store sales would gain approximately 6%.
The key factors that drove the company’s performance were rising home prices and new home sales. Sales also increased on account of deals offered for Labor Day as well as commodity price inflation for products such as lumber and copper which increased the average ticket size.
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We have a Trefis price estimate of $71 for Home Depot’s stock, which we will revise shortly, now that the company’s third quarter results are out.
Housing Market Recovery Boosts Sales
The housing market recovery continued in the third quarter of 2013, spurred by strong consumer confidence and low mortgage rates. New home sales rose were 390,000 in July and 421,000 in August while the data for September is yet to be reported. Sales of existing homes continued to be strong year-over-year. The National Association of Realtors is expected to report existing home sales data for September shortly, which may provide further boost to Home Depot’s stock price. The reason that sales of new as well as existing homes benefit Home Depot is the spending on home improvement by new occupants. 
According to Frank Blake, Chairman and CEO of Home Depot, construction of new homes is a less significant driver of the company’s business than the turnover in existing house inventory and appreciation in home prices. He said that people feel good about investing in their homes when they are expecting appreciation in prices and that is expected to continue. This is why Home Depot is positive about its prospects despite slowing sales of newly built homes in the recent months following an uptick in long term mortgage rates. According to the company, while home prices have appreciated by about 10% year-over-year, they are still lower by around 25% from peak levels. This leaves a lot of scope for recovery. 
In the maintenance and repair categories, Home Depot continued to improve its sales of ladders, light bulbs, air circulation, wiring devices, pipes and fittings, fasteners and builder’s hardware. It also saw traction in categories such as counter-tops, floor tiles, window coverings, faucets, vanities, fixtures, and special order carpets.
Home Depot did well on event days such as Labor Day and fall clean-up events. These events drove sales of grills, storage, and soils and mulches. Total transactions grew by 4%, while average ticket sizes increased 3.2% for the quarter. The company claimed that its investments in the supply chain made over the past several years gave it the flexibility to respond quickly to spikes in demand by enabling efficient coordination among its merchants, stores and vendors.
Sales attributed to transactions amounting to less than $50 per transaction, representing approximately 20% of the company’s U.S. sales, rose by 3.1% for the third quarter. Sales for transactions over $900 per transaction. which also represent approximately 20% of Home Depot’s U.S. sales, rose by 10.3% in the third quarter. Growth in big ticket purchases was driven by continued strength in the company’s pro business that targets large customers, appliances, counter-tops and in-stock kitchens.
Margins Remain Strong
Home Depot’s gross margin was 34.9 % for the quarter, up from 34.56% in Q3 2012. The increase in gross margins was driven by the company’s U.S. business and was attributed to various factors.
Home Depot reported an improvement of approximately 17 basis points in gross margin due to the accretive impact of a businesses that it acquired in the first half of 2012. Margins improved by 22 basis points also due to higher productivity within the company’s supply chain. Better shrink performance led to an expansion of 2 basis points in gross margins. However, Home Depot also saw a contraction of 9 basis points in margins due to a change in the product mix. Overall, the U.S. business reported a 32 basis point increase in margins.
While the company expects a modest expansion in gross margins for the whole year, in the fourth quarter it expects margins to decrease by 15 basis points over the comparable quarter last year. This is primarily due to certain gross margin benefits recognized last year that are not expected to repeat this year.Notes: