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Home Depot Is Leaving It to the Pros

By Matthew Cochrane - Aug 24, 2018 at 7:46PM

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What's the secret to Home Depot's success? Knowing who its most important customers are.

After a disappointing first quarter, at least partly caused by a cold winter that overstayed its welcome, Home Depot Inc. (HD -0.40%) seemingly bounced back in a big way in its second quarter. At least, the business performed well. Shares, as they have been all year, still seem largely stuck in neutral.

In the company's second quarter, sales grew to $30.5 billion, an 8.4% increase year over year, and diluted earnings per share (EPS) rose to $3.05, a 35.6% increase year over year. Comparable sales increased 8%, driven by 5% growth in the average ticket and a 3.1% rise in the number of customer transactions. While the stock market yawned in reaction to the quarterly results, long-term investors should be more than pleased. In addition, Home Depot raised its sales and earnings guidance for the remainder of 2018.

Home Depot storefront from parking lot.

Pro customers now make up 45% of Home Depot's total sales. Image source: Home Depot Inc.

There were lots of areas that stood out for driving these strong numbers, including the progress being made in its One Home Depot delivery infrastructure, new product partnerships, and the continued success of its interconnected shopping experience. But, after reviewing the company's conference call, I believe Home Depot's success with its professional customers, the "Pros," will be the biggest driver for the company going forward.

Home Depot Metrics Q2 2018 Q2 2017 Year-Over-Year Change
Net sales $30.5 billion $28.1 billion 8.4%
Diluted EPS $3.05 $2.25 35.6%
Customer transactions 455 million 442 million 3.1%
Average ticket $66.20 $63.05 5%

Data source: Home Depot Inc.

Why the Pro customers are so important

In its annual 10-K filing with the SEC, Home Depot describes its Pro customers as "primarily professional renovators/remodelers, general contractors, handymen, property managers, building service contractors and specialty tradesmen, such as installers." In other words, these are the Home Depot customers whose livelihoods virtually guarantee they will be making more frequent trips to the home improvement chain -- and spending more per trip than the average homeowner. After several consecutive quarters of growing faster than sales to DIY customers, sales to Pros now make up close to 45% of all Home Depot sales.

It makes sense, then, as sales to Pro customers grow, that Home Depot would see an increase in big-item sales. This quarter, management redefined its big-ticket sales as transactions over $1,000; they were previously defined as purchases over $900. These big-ticket items now account for 20% of all store sales and increased 10.6% over last year's second quarter. One of the reasons Executive VP of Merchandising Ted Decker gave for the rise in big-ticket sales was "strength with our Pro customers."

What's driving the sales to Pro customers? Decker provided some details:

In the second quarter, sales to our Pro customers grew double digits. Pro heavy categories like lumber, in-stock kitchens, power tools, windows, and concrete all recorded double-digit comps. As you heard ... our professional sales force is driving stronger relationships and a deeper level of engagement with our Pro customers, which in turn lead to higher sales. This partnership is particularly important with our MRO customers, where we saw strong mid-single-digit growth in the quarter.

The acquisition that is still paying off

The MRO category Decker refers to stands for customers in maintenance, repair, and operations fields. These are primarily maintenance and facilities staff at places like multifamily residences, hospitals, and college dorms. These customers obviously have numerous reasons to make recurring purchases to meet the demands of their professions.

In 2015, Home Depot acquired Interline Brands for $1.6 billion, in an effort to better capture this customer segment. The integration of the two brands now seems complete. The Home Depot's and Interline's sales forces can now cross-sell the two companies' inventories, and Interline account holders can charge Home Depot purchases to their accounts. That's helped contribute to the sales growth that the segment has seen lately.

More to come

Home Depot is still not done trying new ways to engage its Pro customers. During the conference call, management addressed progress on a new website being built exclusively for Pros designed "to build out all the tools and applications that our professional business customers need." Executives stressed that interviews and beta testing were still being done, but that, thus far, they were pleased with its progress. At other points in the conference call, management called out its professional sales force for being experts in their respective fields and driving Pro customer engagement.

Home Depot is still a buy

Home Depot has recognized that increasing its market share with Pro customers might be the secret to prolonged success in the home improvement retail space. To this end, it has dedicated resources to reach this valuable customer including training and hiring proficient salespersons, making acquisitions in the space, and building out a website specifically for this customer's unique needs.

It's true that Home Depot's shares are up an anemic 3% this year but, while the stock price has stalled, the business performance has not. After raising its 2018 full-year EPS guidance to $9.42, which would be a 29% increase from 2017's total, shares at today's price would have a P/E ratio of 20.8. Given the inherent growth in that projection, that seems like a fairly reasonable valuation.

Home Depot continues to evolve, keeping itself from falling victim to the retail apocalypse. In light of its growing share of overall revenue from Pro customers, a reasonable valuation, and shareholder-friendly management committed to buying back shares and raising its dividend, I don't believe the stock price will be stuck in neutral for long. For patient investors, this lull may well represent a decent buying opportunity that will yield market-beating results for a long time to come.

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