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Bull Argument

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Dueling Fools

By Mike Trigg (TMF Tonto)

When Home Depot (NYSE: HD) was last featured in our Dueling Fools segment, Rick and Bill Barker (TMF Max) argued over the future of the home improvement retailer. Rick was bearish even back then but proceeded to lose the debate, making the 1984 Mondale-Ferraro defeat look like a close call.

That was more than a year ago and "my, how times have changed." Falling lumber prices and tough economic conditions are just two reasons Home Depot shares have fallen nearly 40% over the past year.

Home Depot is the leading home improvement retailer in the United States. As of last month, the company had 1,134 stores, ranging from its flagship Home Depot locations to EXPO Design Centers. The company boasts a dominant market share of 17%, nearly twice that of its nearest competitor. Plus over the past five years, sales and earnings have grown 28% and 25%, respectively.

Most of its customers are novice do-it-yourselfers. The company serves that segment with instructional classes and capable in-house personnel. The company also serves those that buy materials but outsource the project to a third party. Its remaining customers are professional contractors. Home Depot serves that segment by offering convenient hours and extending credit.

Barker pointed out the numbers below in his bull argument last year, but the results are so staggering it's worth updating and doing again. As you can see, Home Depot has consistently delivered sales and earnings growth over the years.

                              Return on
Year  Sales      Net Income    Equity  
1992  $5.1 billion $249 million  14.7%
1993   7.1          362          15.8
1994   9.2          457          16.3
1995  12.5          604          17.6
1996  15.5          731          14.7
1997  19.5          937          15.7
1998  24.1         1160          16.3
1999  30.2         1614          18.5
2000  38.4         2320          18.8
Much of Home Depot's recent success can be attributed to the once-budding economy. With gobs of cash going around, people were looking for places to spend, and homes were built, upgraded, and refurbished. That was music to Home Depot's ears, but it all came to an end once the economy slowed. The company has fallen on hard times of late (along with most other retailers), but the outlook remains bright, particularly considering its efforts to spur additional growth.

In addition to those growth initiatives, there are several economic indicators -- declining interest rates and increased mortgage activity -- that bode well for the future. The home improvement market is directly related to the impact interest rates have on spending. Recent cuts should spur additional growth, which means more housing-related expenditures.

What's more, when the Fool covered Home Depot's Q4 warning, LouAnn Lofton indicated that prior to the Fed's initial cuts, mortgage applications were up 20% in December year-over-year. One month earlier, that number declined 3%. Lofton went on to say that if homeowners were to refinance their mortgages with more favorable rates, some might use the money that had been saved on home improvements. (And remember, those statements preceded the Fed's second round of cuts.)

Home Depot is striving to maintain at least a 23% growth rate. With roughly $44 billion in trailing 12-month sales and its Home Depot stores already achieving a great deal of success, the company's long-term growth depends on its ability to identify and succeed in new markets. High on its list is international expansion. The company already has stores in Chile, Argentina, Puerto Rico, and Canada, but plans are on the way to attack new markets in South America, Asia, and Europe.

There's also the professional contractors. While only 18 of Home Depot's stores specifically target this segment, the company plans to expand its services to 500 stores by the end of this year. When all is said and done, the company plans on 80% of its stores catering to this segment.

The company has also launched its Villager's chain of hardware stores. These stores are essentially large convenience stores geared toward densely populated markets. Not only that, but the company's Internet retail and direct shipping sales model bode well for future growth.

Perhaps the most growth will come from Home Depot's EXPO Design centers for design and renovation projects, ranging from window treatments and patios to kitchens and baths. Currently, 24 EXPOs are operational with plans calling for another 200 by 2005. The company expects revenue contributions of up to $10 billion by 2006. In some instances, the company has placed a warehouse store next to an EXPO, essentially bundling two of its franchises.

Overall, it's hard to deny the growth vehicles that Home Depot has put into place. There's little debate about the company's past performance, but we should be more concerned with the future. The company has taken the necessary steps to ensure long-term growth. Meanwhile, struggling competitors have closed their stores, choosing profitability over market share. When the economic slowdown ends, Home Depot will surface a stronger company with more market share and additional revenue streams.

Mike Trigg spends his days offering readers what Gordon Gekko called "the most valuable commodity": information. Mike's holdings can be viewed in his personal profile. The Motley Fool is investors writing for investors.

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