FOOL PLATE SPECIAL
Home Depot reported earnings today that bested Wall Street's estimates. However, there continue to be troubling trends in the company's financial efficiency at the store level, and one Fool thinks the stock may be worth considering as a short.
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Call me insane, but I've had an urge to short Home Depot (NYSE: HD) over the past few months. I love the stores -- and spent an oversized amount at them while remodeling my first humble abode -- but when I look at the financials and the deteriorating efficiency of each store, it makes me want to go to "the dark side" and short the stock. Before my email box gets filled with hate mail from the Home Depot faithful, let me reiterate: I love the stores! Living out in the boonies more than 200 miles from the nearest orange-clad warehouse, one of the things I miss most about the city is shopping at Home Depot. The service, the selection, and the low prices certainly add value for each customer who shops there. You won't get any argument from me about the quality of the shopping experience. Heck, one of my favorite Nascar drivers is Tony Stewart, driver of the #20 Home Depot Pontiac. The Peter Lynch mantra of "buy what you know and love" certainly has some merit, but sometimes companies can destroy shareholder value in the process of creating value for their customers. While I love Home Depot, I also liked to eat at Boston Chicken, and we all know what happened to that company. Why is Home Depot a potential short? Let's look at the company's earnings, just released this morning, for the most recent information. While Home Depot's earnings per share of $0.27 beat Street estimates by two cents, other information in the report revealed marked weakness at the individual store level. (For more on the retail business, visit our InDepth page on the subject.) The first number that should concern Home Depot shareholders is the weighted average weekly sales per store. For the third quarter in a row, this figure has dropped significantly year-over-year. In last year's first quarter, each Home Deport store averaged $892,000 in weekly sales. This year that figure is down to $807,000, a 9.5% drop. Company-wide, same-store sales dropped 3% year-over-year in the first quarter. Moreover, while the company was able to slightly increase its earnings in the first quarter from $629 million last year to $632 million this time around, sales growth far outpaced profit growth. Sales were up 9.8% year-over-year, meaning net profit margins went from 5.7% last year to 5.2% this time around. Though sales improved 9.8%, the total square footage of the company's stores increased by 23%. Assets invested in property, plant, and equipment jumped by a whopping 27.3%. Combine the slightly decreasing margins with the a store base that is not being utilized nearly as efficiently as it once was, and the company's return on invested capital is plummeting. If these figures were only from this quarter, one might be able to forgive them. However, the deteriorating trends have been present for the past several quarters and is probably the reason the stock has gone nowhere since late 1999. We've written about these problems in such previous articles as "Home Depot's Cracks Widen" and "Structural Problems at Home Depot." I've had my eye on Home Depot as a short for some time, and today's earnings gave me no reason to take the company off my short radar. Like I said, I love Home Depot. I really do. But at the same time I'm looking at a retailer with clearly deteriorating fundamentals at the store level trading at 45 times trailing earnings. At first blush Home Depot operates wonderful stores and is expanding like mad. But if one looks a little deeper at the company's financial underpinnings -- namely, marginal returns on invested capital -- the story is not nearly as rosy. I have not shorted the stock yet, but I continue to be tempted. Home Depot is planning to come to Paul Larson's corner of rural Colorado, and Paul is excited. Paul Larson currently owns no position in Home Depot. You can see Paul's complete stock holdings online. The Motley Fool is investors writing for investors.
The reason I think Home Depot is a good potential short is really quite simple. The company continues to expand at a rapid pace even while its existing stores are seeing a deterioration in their operating efficiency. Part of this may be due to increased competition from the likes of Lowe's (NYSE: LOW), but the more insidious problem is likely oversaturation and cannibalization of Home Depot stores in certain key markets.
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