Home Depot Falling Apart

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With shares up nearly twice as much as the rest of the S&P 500 since its earnings news broke on Tuesday, it's time to take a gander at what Home Depot (NYSE: HD) had to say. Did the news really justify the five dozen articles that covered it?

Sales declined 3.5% year over year (comps fell 6.2%), pushing profits down 27%. Why such a big difference between the sales and earnings performance? Mainly because margins fell apart at the seams last quarter. Comparing this year's Q3 results to last year's, the biggest name in home improvement posted a 20-basis-point decline in gross margins (to 33.4%). But as selling, general, and administrative costs continued their inexorable rise despite the sales shortfall, with depreciation and amortization costs rising even faster, the decline snowballed into a 200-basis point decline in operating margins. In the end, the firm posted a 9.3% operating margin, its worst Q3 showing since October 2000 -- the middle of the Great Bubble Pop.

While Home Depot may not be glowing a brighter shade of orange, its Q3 numbers weren't as uniformly awful as they might sound.

That is, I don't think they were. We won't know for sure until the firm files its 10-Q and attached cash flow statement with the SEC, but I do at least see a glimmer of hope, and a whiff of cash carried by the cool autumn breeze blowing past HD's balance sheet.

Sales over the first three quarters of this fiscal year dropped 3.1% in comparison to where they were this time last year (when the firm's Home Depot Supply unit was still contributing to the till). Ex-HDS, Big Orange's inventories dropped only 8% and its accounts receivable fell a whopping 55%. The cash freed up as Home Depot refocuses its attention away from "buy now, pay later" professional builders, and back toward promptly paying Joe and Jane Homeowner, should do nice things for Big Orange's free cash flow.

The major worry I expressed in our pre-earnings Foolish Forecast also seems to have blown by. Last we heard from CEO Frank Blake, he was promising to "repurchase additional shares in the form of open market purchases, accelerated share repurchases and/or additional tender offers." With the share price in free-fall, though, and the housing market still echoing with poor earnings reports from homebuilders like NVR (NYSE: NVR), Centex (NYSE: CTX), and Lennar (NYSE: LEN), Blake has come to the realization that "it is prudent to take a cautious stance regarding the completion of the recapitalization until a more positive environment develops."

To which I say: Amen, brother. Keep that powder dry, 'cause it's still looking like rain out there.

(Speaking of which, tune in next week for our economic weather forecast on HD rival Lowe's (NYSE: LOW).)

Related orange Foolishness:

• Rich Duprey thought Home Depot was the best retail stock of 2007.
• The company failed again last quarter.
• Management is attempting to build a better Home Depot.