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WIKI ANALYSIS
Home Depot (NYSE: HD) is the largest retailer of home improvement goods in the world. Home Depot sells everything you would need to build a home -- from tools to paint. At the end of FY2009, the company operated 2,244 stores throughout the U.S., Mexico, Canada, and China, [1] offering products and services to end consumers as well as to professional builders, tradesmen, and repairmen. Home Depot's 2009 revenue of $66.2 billion[2] is nearly one-and-a-half times that of its nearest competitor Lowe's, which had a revenue of $47.2 billion in 2009. [3]
Like all home improvement retailers, Home Depot is very vulnerable to interest rates and the continued housing market slowdown. The subprime mortgage crisis in the financial industry has also been a major factor behind Home Depot's struggles. In 2009, Home Depot's net sales decreased 7.2% to $66.2 billion as same store sales decreased 6.6% for the year.[2] Growing international operations in Canada, Mexico and China also buffer Home Depot's exposure to the domestic US market. In 2009, Home Depot opened 11 new stores, most of which were in foreign countries. [4]
Despite being the world's largest home improvement retailer, Home Depot still faces many risks from competitors and from outside factors. In January 2009, the company announced that it was shutting down its high-end decor EXPO business because it had not been performing well financially, especially in light of the economic downturn.
Company Overview
Home Depot started in 1978 and has since grown rapidly into one of the largest retailer in the U.S. reaching $1 billion in sales by 1986,[5] and a record $77 billion in net sales in the mid 2000s. Today, Home Depot operates in the US, Canada, Mexico and China.
Stores and Products
Home Depot provides a wide range of home building supplies (35,000 to 40,000 products per store) and services to its target customers. In 2009, the company operated 2,244 stores of which 88% were located in the United States and the other 12% in Canada, Mexico, and China.[1] Most retail outlets are big-box stores averaging around 125,000 square feet of retail space (100,000 sq ft enclosed sales floors and 25,000 sq ft of garden areas outside).
Business Segments
Home Depot operates under four different business segments: [6]
- Plumbing, Electrical and Kitchen (29.8% of net sales)
- Hardware and Seasonal (29.1% of net sales)
- Building Materials, Lumber and Millwork (21.9% of net sales)
- Paint and Flooring (19.2% of net sales)
Customers
Retail
Home Depot's retail operations generated $66 billion in revenue in 2009, a decrease of 7.2% compared to revenue in the previous year. The company caters to three main types of retail customers:[7]
- Do It Yourself Customers (DIY): Home Depot markets many of its products to home owners who tackle their own home improvement projects as non-professionals. In order to meet these customers' needs, the company employs staff with specific expertise (e.g., former plumbers in the bathroom remodel section, for instance). Home Depot also offers clinics and "how-to" workshops in order to attract DIY customers.
- Do It for Me Customers (DIFM): DIFM customers--often ones in the process of remodeling homes--purchase materials and then hire professionals to install them (e.g., home owner buys a new sink at Home Depot and then hires a professional plumber to install it). Home Depot matches DIFM customers with qualified professionals and arranges installation services for its products.
- Professional Customers: Home Depot targets professional contractors and repairmen through delivery services and extended credit programs. This category is the largest, with almost double the sales of the DIY customers.
Home Depot Exiting Its EXPO Business
In January 2009, Home Depot announced that it was shutting down its EXPO business, a high-end decor business. In addition, the company announced that it was also cutting its support staff. These decisions were strategic maneuvers by the company to reduce costs in light of the struggling economy. Both decisions resulted in a reduction of 7,000 jobs and the closing of 34 EXPO Design Center stores.[8]
Business Growth
FY 2009 (ended January 31, 2010)[2]
- Home Depot's net income increased 17.7% in 2009 from $2.3 billion in 2008 to $2.7 billion in 2009. The large increase can be attributed to reduced operating expenses, which were down 10.3% compared to the previous year, as a result of better inventory management and the closing of Home Depot's EXPO business.
- Net sales however dropped from $71 billion in 2008 to $66 billion in 2009, or a 7.2% decrease. This is reflected by the comparable store sale decrease of 6.6% for the year primarily due to pressures from the slowdown in the home improvement market, higher unemployment, and decreased consumer credit availability. In addition, store cannibalization caused a 1% decrease in comparable store sales.
- Operating margin for the year was 7.3% of net sales compared to 6.1% in 2008, a 120bps increase as a result of lower operating expenses. For the year, SG&A expenses fell 10.9% and as a result, operating income increase 10.2% to $4.8 billion.
- There was an 6.6% decrease in comparable store sales in 2009, compared to a decrease of 8.7% in 2008.
- Home Depot opened 11 net stores in 2009 and discontinued its EXPO and THD Design Center businesses.
Q1 2010 (ended May 2, 2010)[9]
- Home Depot's first quarter net income increased 41.1% to $725 million, up from $514 million a year earlier. The company attributes the gain to increasing consumer spending on home improvement as the economy rebounds from the recession. Home Depot also said government stimulus programs, including tax credits for home purchases and rebates for energy-efficient products, added to the gain, as did warmer weather.
- Net sales for the period increased 4.3% to $16.9 billion. Home Depot said that the number of individual transactions increased 4.2%. Comparable store sales increased 4.8% company-wide for the period, while the US comp increased 3.3% -- this was the first time the metric had increased since Q4 2005.
Trends and Forces
Housing Market Not Expected to Reach Bottom Until 2011 Means Home Depot Faces Tough Road Ahead For Sales Growth
In June 2009, Home Depot claimed that the worst of the housing market fallout had already passed.[10] However, the housing market has gotten steadily worse since then. In the first three months of 2010, foreclosure rates grew by the highest in 5 years, and increased 35% compared to the same period last year.[11] Despite housing prices being the lowest in 40 years and very low mortgage rates, many analysts are predicting that home prices will fall another 5%-8% from the lows of May 2009, and that the housing market won't reach the bottom until the first or second quarter of 2011.[12] Many are also saying that the housing market will stagnate due to the slumping US economy.[13]
Any indication that the housing market is not making a fast and full recovery is bad news for Home Depot's sales growth. A weak housing market means more foreclosures, which means that home construction declines. Home Depot's sales depend on new housing construction because it provides many home builders with the materials they need to build a home. A weak housing market and a slow economy also means that homeowners are less likely to spend money on home improvement projects. If a homeowner knows that his home is decreasing in value over time, he won't bother to repair it to increase its value until home prices start increasing. Additionally a weak US economy means that people are saving more rather than spending on discretionary goods or projects. As a result of the weak housing market, Home Depot's net sales fell by 7.2% in 2009.[2]
Not all is lost in the housing market however. When the US government gave a lucrative tax credit to home buyers, the number of pending home sales increased during the first four months of 2010.[14] Taking this a possible sign that the housing market was recovering, consumers spent more money on home improvement projects, and as a result Home Depot's sales increased by 4.3% in Q1 2010.[9] However, the tax credit expired and as a result, pending home sales in May fell to the lowest level in a year.[14]
Changes in Housing/Interest Rates Affect Homebuilders which Home Depot Relies On
- To read a more detailed discussion of how interest rates affect housing, see also Interest Rates.
In the past, a high correlation has existed between the rate of home purchases and buildings and interest rates. As interest rates fall, prospective home owners and builders can borrow money less expensively and therefore will be more likely to do so. When more homes are built and purchased, Home Depot's sales to homebuilders and re-modelers increase. On the flip side, when interest rates rise, borrowing becomes more expensive and the number of building and home improvement projects decline, resulting in fewer sales for Home Depot. In addition, higher interest rates make home refinancing, a major source of funds for home improvement projects, more expensive.
The collapse of the housing market, which was caused by subprime lending, has caused national home foreclosure rates have to go up dramatically, with the hardest hit places being the Southeast and Southwest. The US foreclosure rate had the biggest jump in five years in the first three months of 2010. According to RealtyTrac, the number of US homes taken over by banks increased 35% compared to a year ago. Additionally the number of homes facing foreclosure grew by 16% during the same period. In all, more than 900,000 households (or 1 in every 138 homes) received a foreclosure-related notice during the period. If the rate of foreclosures doesn't change, the housing market is on track to lose 1 million homes to bank repossessions in 2010.[11]
The more foreclosures there are, the more homes are on the market, which results in a decrease in demand for building new homes. Home Depot has struggled through the collapse of the housing marking, having annual decreases in revenue and net income since 2006. In addition, same store sales have been negative in 2007, 2008, and 2009 at -5.1%, -7.2%, and -6.6% respectively.[2] However, there were signs of a turnaround in early 2010 as the US government gave a tax credit to home buyers. In Q1 2010, Home Depot's net sales increased by 4.3%.[9]
It should be noted that housing booms do not always occur when interest rates are low. This is especially true in the case of a geographic area housing boom. There are many reasons for such booms (e.g., a company may move to an area, providing a boon through new jobs creation). Because Home Depot has widespread locations throughout the U.S., they are in position to take advantage of such booms.
Competition
Home Depot vs. Lowe's[2][3]
Home Depot's only significant competition in the home improvement retail industry is Lowe's Companies (LOW). In 2009, Home Depot dominated in terms of sales revenue ($66.2 billion vs. $47.2 billion). Lowe's and Home Depot are by far the leaders of the home improvement retail industry, but together they comprise only 18% of the estimated $725 billion home improvement market (this includes pure product demand as well as installation labor demand). The rest is distributed between other "big-box" retailers such as Wal-Mart Stores (WMT), smaller hardware store chains, construction firms, and other small businesses.
Sales do not tell the whole Lowe's and Home Depot story. Lowe's has outpaced the market leader along key metrics of same stores sales growth and operating margin growth.
- Same Store Sales Growth: Lowe's has consistently been ahead of Home Depot in same store sales growth since 2004. Same store sales growth lends the best comparison of sales growth between the two companies by looking at the same stores year over year for both companies. By doing this it does not allow new store openings to affect the comparison. However, the collapse of the US housing bubble has leveled the playing field somewhat as both stores have suffered from lower product and service demands. In 2009, same store sales of Home Depot and Lowe's decreased by 6.6% and 6.7% respectively.
- Operating Margin: Lowe's had been behind Home Depot in terms of operating margins for several years until 2006 when Lowe's won a slight advantage over Home Depot. However, Home Depot surpassed Lowe's again in 2007 and has since maintained the lead. Home Depot's operating margin was 7.3% compared to Lowe's 6.0% mark in 2009.
- International Markets: Home Depot has 268 stores outside of the US (mostly in Canada and Mexico). On the other hand, at the end of 2009, Lowe's had a total of 16 stores outside the United States, all of which are in Canada. Lowe's hopes to pursue international expansion to catch up to Home Depot's global sales by opening new stores in Mexico -- the first of which were opened in Q1 2010.
One key driver of the difference in operating performance is Lowe's store environment, which is often noted to be more more customer friendly than Home Depot's. Consumers wanting less of a "warehouse style" home improvement retailer often choose Lowe's over Home Depot. This is especially true for the lucrative, growing DIFM customer base. Home Depot is taking steps to incrementally improve the customer experience by:
- Modernizing many of its stores to improve customer perception of Home Depot's physical locations.
- Introducing a 24-hour help hotline to improve customer service.
- Developing a new employee incentive program to improve customer service at Home Depot stores.
Smaller Competitors
Home Depot also faces competition from smaller independent mom & pop stores. Although these stores usually cannot match the prices of the industry giants Home Depot or Lowe's, they make up for higher prices with customer care, tradition, and perhaps convenience. In addition, the presence of Home Depot in some areas has even caused customers to boycott the giant firm and to shop at local businesses. The advantage that Home Depot has against these smaller competitors is that they stand a better chance at outlasting the economic downturn and in the mean time attracting old customers of fallen businesses.
One example of a small competitor is Builders FirstSource (BLDR), a company that makes and sells structural and related building products for residential new construction. The company is based in the United States and operates in the United States.
References
- ↑ 1.0 1.1 HD 2009 10-K "Properties" pg. 10-11
- ↑ 2.0 2.1 2.2 2.3 2.4 2.5 HD 2009 10-K "Selected Financial Data" pg. 18
- ↑ 3.0 3.1 LOW 2009 10-K, Exhibit 13, pg. 21
- ↑ HD 2009 10-K "Store Growth" pg. 3
- ↑ Funding Universe "Home Depot, Inc."
- ↑ HD 2009 10-K "Products" pg. 2
- ↑ HD 2009 10-K "Customers" pg. 2
- ↑ CNN Money "Home Depot cutting 7,000 jobs" 26 January 2009
- ↑ 9.0 9.1 9.2 HD Q1 2010 Report
- ↑ Motley Fool "Home Depot Calls a Bottom" 11 June 2009
- ↑ 11.0 11.1 MSNBC "Foreclosure rates surge, biggest jump in 5 years" 15 April 2010
- ↑ Tech Ticker "Housing Cheapest in 40 Years, But Buyers Don't Need to Rush In, Dan Alpert Says" 29 June 2010
- ↑ Seeking Alpha "1,000 Brokers Can't Be Wrong: Housing Market Headed for Stagnation" 1 June 2010
- ↑ 14.0 14.1 Washington Post "U.S. housing market remains fragile despite low mortgage rates" 2 July 2010
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