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Home Depot's Exclusive and Innovative Products Keep Customers Coming Back

By Matthew Cochrane - Nov 2, 2017 at 9:09PM

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Home Depot understands that by making the product king, customers will keep coming back.

What does Lifeproof Vinyl Plank Flooring have to do with investing? Maybe more than you think.

The first thing you should know about Lifeproof Vinyl Plank Flooring is that it has all the benefits of vinyl flooring but looks like plank flooring. If that doesn't mean much to you, understand that it means the flooring is durable, relatively affordable, 100% waterproof, scratch-resistant, easy to install, and lightweight, but looks like beautiful hardwood flooring. And, oh yeah, it's available in over 40 patterns. Those are just some of the reasons Lifeproof took home the trophy from the Home Depot Inc. (HD -0.05%) 2017 Innovation Awards.

Other honorees included Stanley Black & Decker's Dewalt Max Flexvolt system, which features a battery that changes voltage when the tool is changed, and Petproof Carpet, which features lifetime stain resistance and extreme durability. What makes the Lifeproof Vinyl Plank Flooring and Petproof Carpet products even more impressive is that they, and several of the other product award winners, are only available at Home Depot locations.

Front of a Home Depot store.

Home Depot drives customer traffic with innovative and exclusive product launches. Image source: Home Depot Inc.

Where the product is king

Home Depot has proved to be one of the few bright spots in retail recently. While the overall sector has struggled, Home Depot has continued to turn in solid quarterly performances. When the company reported second-quarter earnings, its sales came in at $28.1 billion, a 6.2% increase year over year. To top it all off, operating expenses grew at a slower pace than revenue, allowing operating margin to expand to 15.9%, up from 15.3% the previous year.

Home Depot Metrics 2017 Q2 2016 Q2  Change
Net sales $28.11 billion $26.47 billion 6.2%
Diluted EPS $2.25 $1.97 14.2%
Operating margin 15.9% 15.3% 60 bps
Customer transactions 441.8 million 430.0 million 2.8%
Average ticket  $63.05 $60.87 3.6%

Data source: Home Depot.

While Home Depot had to do several things to achieve this magnitude of business success, management has made it a point to offer innovative products at good value points and, as much as possible, products that can only be purchased at Home Depot locations. Management believes this mix of exclusivity and innovation keeps customers coming through its doors.

At the 17th Annual Oppenheimer Consumer Conference this past June, transcribed by S&P Global Marketing Intelligence, Executive Vice President of Merchandising Edward Decker stated: "We firmly believe that product is king. We spend just an inordinate amount of time on product and innovation and value for the customer." He later added:

[W]e want to be No. 1 in product authority for home improvement. And it is the innovation and the value that we bring that I think differentiates and has differentiated Home Depot. ... When we talk about ticket and transactions and departments and comping, the whole store really is performing. And you can look at specific products in virtually every department. The pace of innovation and new product introduction is staggering.

Not only does the exclusive and innovative mix of products drive customer traffic through the store's doors, but management also maintains it is also able to charge premium pricing for the best products. At the same Oppenheimer conference, Decker insisted that "consumers see the value of product innovation." Decker says the retailer has experimented not only with premium pricing, but with super-premium pricing too, and the customer always pays up for innovation.

With this in mind, it's clearer how Home Depot is able to maintain its robust same-store-sales growth. Same-store sales were up 6.3% in the second quarter, driven by a healthy mix of higher average ticket sales (3.6%) and increased customer traffic (2.8%).

Working closely with partners

Of course, Home Depot could not achieve this level of innovation and exclusivity by itself. It needs to work with its suppliers to ensure that the products being offered meet the retailer's high expectations. In the company's first-quarter conference call, Decker said the company keeps a "huge focus on collaboration" with its suppliers. Decker believes Home Depot can continue to rely on its suppliers as long as Home Depot delivers two things: (1) launching a product better than any rival, and (2) delivering volume on a product.

Of course, these two points will often go hand in hand. A big product launch will almost inevitably lead to higher sales volume for that product. But Decker stated that as long as Home Depot can continue to come through on these two selling points, then investors could continue to expect a great relationship between the company and its many supply partners.

Hit a home run with this home retailer

Home Depot has a history of outsize returns, and over the past five years, the giant retailer has doubled the S&P 500's returns. While there are many moving parts to the company's success, nearly all retailers are judged on their same-store comparable sales. Revenue and earnings growth will necessarily flow from this one metric. This figure can only grow through two catalysts: increased customer traffic and higher average sales. Fortunately for investors, Home Depot seems to have found a winning formula for driving both of these numbers with one strategy. As long as Home Depot can continue to provide customers with innovative and exclusive products, it should continue to reward shareholders with market-beating returns for years to come.

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