It's not often Home Depot (HD +2.42%) investors find themselves in this position, but shares in the home improvement retailer are actually trailing the S&P 500 index year-to-date. When the company reported its first-quarter earnings last week, its stock price dipped further, giving investors negative returns since the calendar turned to 2018. Is this a buying opportunity or a sign that the giant retailer is beginning to feel the pressure from competitors?
For the quarter, sales rose to $24.95 billion, a meager 4.4% increase year over year, while earnings per share (EPS) jumped to $2.08, a much stronger 24.6% increase year over year. This spike in EPS, however, was more due to tax benefits than a significant improvement in Home Depot's operations.
At first glance, investors might think the company has lost a step or two. After all, brick-and-mortar retailers are being increasingly pressured by online competitors, and Home Depot's fortunes also rest on the back of external factors, such as the U.S housing market. Yet, after reading through the transcript of the company's conference call with analysts, I think the underlying business is fine and that the company's second-quarter results will show strong improvement. Here's why...
Home Depot notched a decline in customer transactions due to cold weather, but it continues to show enduring strength with its Pro customers. Image source: Home Depot Inc.
Gardeners give Home Depot cold shoulder
The biggest reason for the store's lukewarm growth in the quarter was the unusually cold weather. "April was one of the coldest and snowiest months in more than 20 years," said CFO Carol Tome. But, as she noted, warm weather has finally returned, and consumers are now showing an appetite for outdoor decor and gardening products again.
This significantly impacted Home Depot in its first quarter -- which runs February through April -- because April is its second-biggest month (May is No. 1) for gardening sales. When there are 6 inches of snow on the ground, however, shoppers aren't looking for new patio furniture or flowers to plant.
For investors with a mindset longer than one quarter, this is news isn't particularly troubling because these losses of sales are not permanent, but rather just delayed until better weather arrives. Yet while the bad weather temporarily hit store foot traffic, there were several other signs that pointed to the company's healthy long-term outlook.
DIY-ers aren't the key
A better indicator of how Home Depot is faring would be how the company is doing with its most important customer: professionals. In the first quarter, while the number of customer transactions decreased 1.3% to 375.9 million -- which can plausibly be attributed to the quarter's bad weather and lack of gardening sales -- the average ticket price increased 5.8% to $66.02.
What Home Depot calls big ticket sales, defined as purchases over $900, were up 10%, driven by sales in flooring, appliances, and building materials. Who buys these types of materials the most? Pro customers, loosely defined as those who make purchases from Home Depot for a job, not a personal project. During the conference call, Menear said:
Part of the strength we saw in the business can be attributed to the health of our Pro customer, as Pro sales once again outpaced DIY sales in the quarter. Investments aimed at deepening our relationship with our Pro customers are yielding increased engagement, which translates to incremental spend. While still early, the combination of enhanced associate tools in the store and expanded delivery capabilities are gaining traction with the Pros.
Catering to top buyers
What keeps driving sales to Pro customers? For starters, the company continues to enhance the services it offers to these people. This quarter, the company rolled out two- and four-hour window delivery options for same-day car and van delivery in several markets, helping drive double-digit sales growth in delivered goods. Menear added that the delivery options are "attracting both incremental business with current customers and new customers."
Another positive that stood out was Home Depot's traction with its maintenance, repair, and operations (MRO) customers. These customers are professional maintenance personnel in charge of facilities such as multifamily residential complexes, hospitals, college dormitories, and prisons across the country. In 2015, Home Depot acquired Interline Brands for $1.6 billion, which specializes in catering to these specific customers.
Home Depot has made a concerted effort to integrate Interline with its stores, including carrying the same products and allowing Interline customers to use their accounts at Home Depot stores. Customers like these have constant needs as they work to maintain their facilities, creating an almost recurring revenue stream for Home Depot. This quarter, growth of Interline sales again outpaced the company's average sales growth.
Driving the lesson home
Home Depot's management seems convinced the dip in customer transactions was temporary, the result of a late-season cold snap. After looking under the hood and seeing the company's strong results with its Pro customers, I do not see any reason for long-term concern. Management maintained the company's full-year earnings guidance of $9.31, giving shares a forward P/E ratio of just a shade over 20. Given the company's long-term dominance and the important takeaways from the first quarter, shares seem more than reasonably priced. Investors could certainly do a lot worse than taking a closer look at one of the world's best retailers.
