Home Depot (HD) Analysis

In this article, we will look at Home Depot business from several angles. First the business and its prospects, the management and the prospects for the stock.

The Home Depot, Inc. is the world's largest home improvement retailer and the second largest retailer in the United States ("U.S."), based on Net Sales for the fiscal year ended January 29, 2006 ("fiscal 2005"). As of the end of fiscal 2005, we were operating 2,042 stores, most of which are The Home Depot® stores. The following is a description of our The Home Depot stores, Home Depot Supply and our other store formats.
The Home Depot stores sell a wide assortment of building materials, home improvement and lawn and garden products and provide a number of services. The Home Depot stores average approximately 105,000 square feet of enclosed space, with approximately 23,000 additional square feet of outside garden area. As of the end of fiscal 2005, we had 1,984 The Home Depot stores located throughout the U.S. (including the territories of Puerto Rico and the Virgin Islands), Canada and Mexico.

Home Depot derives its sales primarily from the U.S and Canada. It has stores in Mexico and has opened one store in China. Home Depot has primarily three sets of customers - the do it yourselves group, the do it for me group and the professional customers. Recent reduction in available Home Depot help is surely going to annoy the "Do it for Me" group. I was in a Home Depot store recently and got bounced from one person to the next ( even among the reduced help ) and my experience in Lowes was far better. The prices between the two stores are comparable. Even though Home Depot store is located closer to my house, now I prefer to go to Lowes and I am more of the "Do it Yourselves" group. Although the annual report doesnt break down each of these segments further, Bob Nardelli gives an overview in the business week interview. He says that 30% of the sales are through professional customers and he expects "Do it for Me" groups size to increase as baby boomers retire.

The second factor here is psychological factors that drive one to Home Depot. One is the Pavlovian factor where man is a creature of habit. Habit took me to Home Depot regularly as it was close to my house. However, recently my better experience in Lowes has shifted my habit to visit another store. Although Home Depot and Lowes are Coca Cola and Pepsi in the home improvement market, the similarities end right there. For once, I can buy the same brands I buy in Home Depot in Lowes as well. The differentiating factor here is customer experience - repeated lowsy experience in Home Depot stores can cause the Pavlovian distaste to develop in the customers.

Management - although home depot has increased its profits and margins in the past several years, it is not clear if management had any special role in making it happen. The company was setup to organically grow with increase in stores and the housing boom was in full bloom. Every new home owner had to buy a lawn mover, engine oil and other home improvement accessories. Location and proximity drove customers to the home depot locations. Although management is focussing on "Do it for me Group" - the baby boomers and on professional customers ( who make 30% of the revenues ) . In the business week interview, Nardelli also said that he takes responsibility to what happened in the share holders meeting and will revert back to the old format next year. In addition, he plans to expand the business by buyiing supply businesses. He also acknowledges Lowes as a good competitor. Overall, even though Lowes is slightly more expensive than Home Depot, it is not clear if it gives Home Depot consistent advantage over long periods of time. Lowes is growing faster but is smaller. The price for Lowes is also slightly higher compared to Home Depot. The management pay has also come under scrutiny as Bob Nardelli's pay package is about a couple of hundred million dollars and it is not clear it is tied to performance.

Balance sheet. The same store sales declined in Home Depot slightly year over year in 2005 compared to 2004. The net earnings while increasing by 16% in 2005 compared to 2004, the total earnings per share increased by about 20%. The increase was helped by stock buy backs. The earnings are expected to be double digits in 2006 compared to 2005. The operating margins and per ticket sales increased in Home Depot but Lowes has been doing even better of late. The share holders equity increased by about 14% ( lesser compared to per share earnings ) as the company booked more short term and long term debt. The operating cash flows declined year over year to pre-2004 levels. The capital expenditures for the company has been steady at around 3.5 - 4.0 billion dollars a year for the past three years.

Confluence of factors. Demographics is Home Depot's friend. The population of the U.S is expected to grow at around 3% a year for the forseeable future. This means that this population will continue to shop in Home Depot ( or Lowes ) stores. In the shorter term, the housing market slow down will probably keep a lid on the stock price. This will provide good buying opportunity for people with cash to deploy. One may also consider Lowes as an alternative to buy into this market. There is upside for both Home Depot and Lowes over a period of time, the market caps of both stocks being around 70 and 45 billion respectively.

Any person that owns the SP500 index fund will own Home Depot to the tune of about 0.65% of the portfolio. Lowes is not in the SP500 index.