Home Depot Gets With the PROgram

In what is becoming old hat for the giant home-improvement retailer, Home Depot Inc (HD -0.60%) posted another solid quarterly earnings report earlier this month. The company's revenue rose to $25 billion, an 8.1% increase year over year, and net earnings grew to $2.17 billion, a 10% increase year over year. The strong results were driven by positive comparable-store sales, which increased companywide by 7.9%.

Obviously, many factors go into Home Depot's success, but what keeps jumping out at me is the company's perpetual ability to draw in the "professional" customer. Home Depot's ability to attract this particular customer, one who, on average, has deeper pockets and visits the company's stores more frequently, is why it has continued to outperform the market, even while most brick-and-mortar retailers have struggled.

Here's a look at the company's most important numbers:

Data source: Home Depot Inc.

What is a Pro customer?

In its annual 10-K filing with the Securities and Exchange Commission, Home Depot defines its "Pro" customers as those who "are primarily professional renovators/remodelers, general contractors, handymen, property managers, building service contractors and specialty tradesmen, such as installers." In other words, these aren't DIY homeowners tackling weekend projects but, rather, people who depend on performing these types of jobs for their livelihood.

These customers make up a significant portion of the company's overall business. During the company's presentation at the Oppenheimer Consumer Conference this past summer, management stated that the Pro customer made up about 40% of all sales. Not only is that a huge percentage of Home Depot's customer base, but the Pro segment continues to grow faster than Home Depot's DIY customers. In the company's first-quarter conference call, management said that Pro sales were growing twice as fast as DIY sales, and this gap increased in the second quarter. This quarter, management stated Pro sales were again "outpacing" DIY sales growth.

Home Depot continues to surpass expectations by drawing the Pro customer. Image source: Getty Images.

Why Pro customers are so important

Pro customers, due to the nature of their jobs, tend to spend more money, more often, than other customers. These customers are usually working on big jobs like remodeling. In 2016's fourth-quarter conference call, CEO Craig Menear even made it a point to state that "We continue to see our Pro customer engage in bigger projects, in remodeling." With big jobs come big sales. It's no surprise then that purchases over $900 were up 12.1% year over year. These large transactions now make up about 22% of U.S. sales.

Drivers behind these big ticket sales, according to Executive Vice President of Merchandising Edward Decker in the third-quarter conference call, were things like flooring, roofing, carpet, and "several Pro heavy categories." A little later, Decker added that Pro-heavy categories "such as lumber, wire, insulation, gypsum and hand tools" saw double-digit growth during the quarter. With such an increase in large purchases, it's no wonder that Home Depot's average overall ticket increased 5.1% to $62.84.

How Home Depot wins business with the Pros

During the conference call, Home Depot's management gave two primary reasons why it was so successful with the Pro customer: offering the products they need at the right price and engaging this customer category more. Home Depot gives a lot of thought to selling exclusive and innovative products, and the company's 2015 acquisition of Interline Brands opened a whole new merchandise line for it to promote to Pro customers.

Interline Brands is one of the nation's leading suppliers and wholesale distributors for MRO (maintenance, repair, and operations). When Executive Vice President William Lennie explained the ongoing integration of Interline's business with Home Depot's, it quickly became clear the extent to which this acquisition was about catering to the Pro customer. Lennie said:

We really have two initiatives rolled out into the stores. The first one is Pro MRO, which gives the Pro customer shopping in our stores access to the Interline catalog, and we're seeing that engagement and those sales ramp week over week in a nice fashion right on target to where we'd expect them to be. Key categories for engagement with Pros are running in plumbing, electrical, HVAC and hardware. So it's right down the center of that in the core of the business.

Then the second initiative is our Pro purchase card, which I would really describe as a Pro access card. It gives the Interline customers access to shop our stores and with the swipe card have their purchases billed back on to their accounts.

Home Depot is finding new ways to engage with Pros as well. Its co-brand credit card is now offered to Pro customers. Its approval rate is 72%, while the average line of credit of $6,700. Home Depot is also finding ways to leverage its digital capabilities to attract more Pro customers. While Decker said Pro customers don't make purchases online, they often check inventory levels and prices online. He called it a "very interconnected shopping experience."

Hitting a home run

It's hard to pick any reasonable time frame where Home Depot did not beat the market. In the past five years, shares of Home Depot have risen 170% while the S&P 500 has returned 90%. Go back 10 years and the gap between the two widens considerably: Home Depot's stock increased 477% compared to the S&P 500's 77%. One of the primary catalysts for Home Depot's vast outperformance in recent years has been its phenomenal success in having Pro customers visit its stores more often and spend more money on purchases. Given the numbers we saw and the comments we heard from management after the company reported its latest earnings, this trend doesn't seem likely to change any time soon.