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Home Depot Needs Repairs

Investors have been left in the dark, wondering whether home-improvement giant Home Depot (NYSE: HD  ) will be able to regain its former glory. Yesterday's Q4 and year-end earnings announcement offered little insight, but recent developments suggest the company is finally turning over a new leaf.

The year 2006 wasn't pretty for Big Orange. Home Depot announced that it grew slower than the overall home-improvement market. That's a humbling development for a company used to years of category-killing and known for mercilessly driving smaller competitors out of business. Former CEO Bob Nardelli's strategy had involved growth in the do-it-for-me supplier business where contractors and other professionals help homeowners improve their homes. Unfortunately, this may have hurt the company's bread-and-butter, do-it-yourself retail store performance.

While overall financial performance has held up well, and certain metrics continue to outshine archrival Lowe's (NYSE: LOW  ) on a number of fronts, yesterday's earnings release revealed that cracks exist at the core retailing stores. Witness the 6.6% drop in fourth quarter same-store sales, and the 2.8% fall for the full year. Lowe's has proven more adept at growing its store base and improving profitability to match that of its larger orange rival. That's partly because Lowe's store base is smaller, and Home Depot's supply business is less profitable. Still the supply biz is growing as a percent of Home Depot's total sales, comprising more than 13% of total sales for fiscal 2006.

So where does the company go from here? Home Depot announced a renewed commitment to retailing during yesterday's earnings conference call, and it may end up selling or spinning off the DIFM supply business if it can't find a way to successfully integrate supply into the retail business. It conceded that supply is driving overall sales growth, so the key concern to investors is how long it will take to get the retail business moving in a positive direction again.

Management will offer more insight into its "business strategy and financial outlook for fiscal 2007" during its annual analyst conference, currently scheduled for Feb. 28. Don't expect a quick fix; in addition to the company's internal turmoil, the overall homebuilding industry remains in a funk, as new-home construction trends plummet at builders such as Centex (NYSE: CTX  ) , Toll Brothers (NYSE: TOL  ) , Pulte Homes (NYSE: PHM  ) , and KB Home (NYSE: KBH  ) . The industry could face more challenges as home "investors" begin to default on the subprime loans they took out in hopes of "flipping" homes at a quick profit.

Despite this, I'm hanging on tight, and I may even add to my position. After all, Home Depot still dominates its industry and throws off prodigious amounts of cash. This was one of the few areas Home Depot could brag about for 2006: During the year, it repurchased $6.7 billion in stock, and increased its dividend twice. We'll know more about Home Depot's future next week, but it will take patience for the company to refocus on retail and ride out home-improvement industry woes.

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Home Depot is a recommendation of Motley Fool Inside Value. Discover why the home retailer has built up a market-beating performance record with a free 30-day trial.

Fool contributor Ryan Fuhrmann is long shares of Home Depot but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.

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