Home Depot's Half-Hearted Hurrah

D-I-Y retailer Home Depot (NYSE: HD) has only gotten it half right with its plan to halt expansion and close underperforming stores. The other part that seems wrong is that it still plans on paying out dividends and doing share buybacks. That might set the retailer up for even more failure.

With a much larger store footprint than rival Lowe's (NYSE: LOW), it can afford to stop the planned development of the 50 or so stores it had in its new store pipeline. It has 2,258 stores to Lowe's 1,500. Taking a breather to allow the economy to catch up is a smart move. While Lowe's has said it was delaying the opening of 20 stores this year, it still has far to go to meet the saturation point that Home Depot enjoys -- or doesn't.

The Big Orange Box was suffering from cannibalization by existing stores. At times it seemed you were never more than a stone's throw from a Home Depot center. Starbucks (Nasdaq: SBUX) might be able to do that with coffee shops on every corner, but home improvement centers in a declining economy don't lend themselves to such proliferation. The way it handled the sale of its HD Supply business was another mistake.

Had Home Depot used that as a starting point for generating cash flow rather than an end point, I would have been hailing the decision along with the rest of Wall Street (shares rose more than 5% on the news). But paying out dividends and buying back shares boosts value at the expense of the underlying business.

It's a harsh thing to do -- cut dividends -- and most companies are loath to do so. It signifies a company in distress, and oftentimes the share price will get whacked as punishment. Yet Home Depot's 3% dividend yield is not so much a product of prudent fiscal policy as the result of fallen shares. It's not the hallmark of a return of invested capital, but instead the ruse of a weakened company.

Over the past two years, Home Depot has repurchased some 460 million shares worth more than $17 billion. Without that prop, the do-it-yourselfer's earnings per share would have dropped far more than the stated 13% drop. And the 19% to 24% decline in earnings from continuing operations that it has forecast for 2008 would also undoubtedly be much worse. It would have been better for Home Depot in the long run if it had conserved its cash and instituted the cost-cutting programs early.

Too many stores are still a disaster to walk into, and though CEO Frank Blake has promised to turn around the company's customer-service image, the process is apparently going to be a long and painfully slow one. The half-hearted plan Home Depot has outlined for the future will make the trip more torturous still.

Take a trip with these related Foolish articles:

• Another Failure for Home Depot
• Fool on the Street: Lowe's Plan for Improvement
• Stock of the Week: Home Depot