Home Depot Is Doing Everything Right

In this segment from the Market Foolery podcast, host Chris Hill and Bill Barker from Motley Fool Funds discuss the leading home improvement retailer, and there's practically nothing to find fault with in its first-quarter report: It beat on profit, its average tickets are up, and it's not trying to expand wildly beyond its current store footprint. Those gains are partly powered by factors beyond its control, of course. But it's capitalizing on the trends well. So is it still a buy at current levels? And what could slow it down?

Chris Hill: We have to start with Home Depot (HD -1.77%), which is the No. 1 home improvement chain in America, and they proved why once again with their first-quarter report. Their profits were higher than expected, their same-store sales were up 5.5%. Their average ticket order was up. Are they bulletproof right now? Is there anything that this company is -- if you're a bear, if god forbid, you're one of those poor souls out there who says, "I think I'm going to short Home Depot," do you have anything you can point to? Because this is one of those quarters that makes you understand why the stock is hitting an all-time high today.

Bill Barker: Yeah, I don't know what you have if you're a bear and you want to find fault here. The valuation isn't that high, and housing has a lot of room to go, probably, unless you have specific numbers that you're relying on that no one else is seeing, I don't know what you're seeing. The company is doing a very good job of simply growing what it has. It's not really growing stores at all. It has about the same number of stores -- depots, I suppose, rather than stores -- open that it had five or six years ago. So its guidance for comps and total sales growth are the same, right now around the 5% area. Then, it's buying back some shares, and it's improving margins, and it's all wound up with a low-teens to mid-teens growth rate.

Hill: You mentioned the share count, it's come down pretty substantially. I think it's almost been cut in half over the last 13 years or so. There's about 1.3 billion shares outstanding right now, in 2004, the stat I saw this morning, it was up around 2.7 billion. So it's really impressive that they are, on the one hand, methodically bringing down the share count, but they are also bringing that same day-in and day-out operational excellence to their stores themselves. And as you said, they're not growing their store count, which makes me think that this is an incredibly disciplined management team.

Barker: Right, the capital allocation equation here is, let's keep what we have, I'm sure they're closing down the store or two here or there, opening up one here or there. But they aren't in the "let's build another 100 stores across the country this year" model that a lot of other places are, whether it's McDonald's or AutoZone or plenty of other things. And they are really about the only game in retail right now that's working, Home Depot and Lowe's. So, it is the housing market. Let's not give management all the credit. We'll give them plenty of credit, but housing is a good place to be, and it is not getting disrupted on the retail side the way everything else is, including automotive parts. Automotive parts is a little bit better than clothing and books, things that have really been disrupted and are never coming back. But when you're going out on Sunday and fixing up your home, and you're going up to Home Depot or Lowe's, a local place, whatever --

Hill: Ace Hardware.

Barker: You're not waiting for Amazon for 48 hours to get you the stuff, because you're getting it right now. Actually, a lot of, 40% I think, of Home Depot's sales are to the professional contractor. That's also not being disrupted.

Hill: Yeah. And I think there's also something to the customer experience, in the same way that online shopping, regardless of what the online shopping destination is, they're hopefully providing greater convenience, I think that is, for a lot of people, part of the experience with Home Depot and Lowe's. They actually like it, it's an excuse to get out of the house, I actually want to go and compare the paint samples, that sort of thing, and kill a little time doing things that way.

Barker: I think it is, you're doing something. It feels like --

Hill: It feels good.

Barker: It feels like, I'm on a mission, I'm going to make my house better, I'm not just buying stuff. Maybe this is revealing something about me, but it's not that, you buy stuff and then it sits around the house. At Home Depot, you're buying something and then you're implementing it.

Hill: Putting it to use.

Barker: And then you're going to claim, later in the day, "I did a lot of stuff today, so I deserve some credit. I went to the store, and not only did I buy something, but I actually put those light bulbs in."

Hill: Speaking of light bulbs, what percentage of trips to any sort of home improvement store --

Barker: 100%.

Hill: Wait for it. Would you say involve you bringing something to the store that you need to replace? That, you haven't written something down, you haven't memorized it, but you're actually bringing in the light bulb, you're bringing in the screw, and you walk in and you're basically looking for an employee, saying, "See this thing I'm holding in my hand? Where can I find another one just like this?" What percentage?

Barker: Of me, or everybody?

Hill: You.

Barker: Close to 0%.

Hill: Really?

Barker: Yeah.

Hill: Oh, for me, it's at least, somewhere in the neighborhood of 50%.

Barker: No, I'm in the category of stereotypical men who go in and I'm not asking for directions on anything, it does not matter how long it takes me. It doesn't matter how many times I'm asked, "Can I help you?" No, I'm just looking, I'll find the specific screw that I'm looking for. I'm not saying that's a good thing. For you, it's much higher than zero?

Hill: It's much higher than zero. But that's also part of the Home Depot store, that's part of the turnaround for them, after Nardelli left, part of what management decided to do was, "Let's actually be helpful, let's train staff, let's, maybe not overstaff, but let's make sure our stores are properly staffed, so that when people come in, we have people who can help them, who can find exactly what they're looking for, and then they're going to come back." And I think that's a big part of the turnaround for Home Depot.

Barker: It is working, for them to be getting pretty consistent 5% comp improvements year to year, I think the two-year stack, the comp from a year ago plus the comp this year, it's more like 12% to 13% for Home Depot. That's really impressive, in a time of very little inflation to be getting 12% more sales out of the same square footage over the last two years, adjusting for inflation, you're talking about 8% or something like that. They have got everything going very well right now, and the bear case is dependent on the housing market currently being overheated, which it does not yet appear to be.