FOOL PLATE SPECIAL
Home Depot reported earnings this morning. It met its profit estimates, but same-store sales were flat. More importantly, the company's returns on marginal capital continue to weaken significantly.
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Sales at Home Depot were $10.4 billion in the quarter. This is up 14.1% from last year's fourth quarter, but comparable-store sales were flat year-over-year, meaning growth basically came entirely on the backs of the company's new stores. Home Depot continued to blame weak lumber prices for its top-line malaise. A slowing economy did not help.
Net profits in the fourth quarter were $465 million, or $0.20 per share. After warning that it wouldn't meet its previous profit estimates twice in recent months, this figure met Wall Street's lowered expectations. Net income was down 19.5% year-over-year from last year's $578 million, representing the company's first bottom-line contraction in years.
Cracks still growing
Home Depot's core profitability has weakened considerably in recent quarters, and the fourth quarter showed that the troubling trends concerning marginal returns on invested capital have continued. The main problem is that the company's invested capital is growing at a much higher rate than Home Depot's sales or profits.
Though sales in the fourth quarter grew 14.1% year-over-year, the company's investments in property, plant & equipment grew at twice that rate at 27.8%. Home Depot now has $13.1 billion invested in its bricks and mortar, compared to $10.2 billion last year. In addition, the company's weighted average weekly sales per store decreased to $733,000 from $778,000 last year.
Given that same-store sales were roughly flat year-over-year, this means that Home Depot's newest stores are not as productive on a revenue basis as the company's existing stores. Whether it is due to increased competition from other stores like Lowe's (NYSE: LOW), new stores cannibalizing sales of other nearby Home Depot stores, or the company being forced to open stores in less-attractive locations, this trend is troubling. (For more on operating in the retail biz, check out our InDepth page.)
With net profit margins taking a nosedive, the company's return on assets and invested capital also continues to shrink. Annualized return on assets was only 8.8% in the fourth quarter, down from last year's 13.6%. Basically, it looks like the company's marginal invested capital (i.e., new stores) is not paying off.
The reasons for this decline in the company's returns are plain to see, if you know what to look for. The company is turning over its assets fewer times (remember the trend of assets growing much faster than sales), and the company's profit margin continues to weaken. Mix the two together and, voila!, returns on invested capital are eroding at an alarming rate. If the company continues to build stores that have a return on invested capital lower than Home Depot's cost of capital, the company could be in the unique position of growing earnings while at the same time destroying shareholder value.
Outlook
Home Depot said that it was comfortable with the current estimates of $0.26 per share for the coming quarter, which is slightly lower than the $0.27 per share the company earned in 2000's first quarter. Home Depot also said it will open another 200 stores this coming year, roughly on pace with last year's new-store rollout.
Paul Larson used to spend an oversized amount at Home Depot until he moved to rural Colorado, where the local True Value will have to do. He does not own shares in any retailer. You can view all of Paul's holdings online at fool.com. The Motley Fool is investors writing for investors.
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