For longtime Home Depot Inc. (HD 0.71%) investors, third-quarter 2018 was more of the same. Net sales rose to $26.3 billion, a 5.1% increase year over year, and diluted earnings per share (EPS) grew to $2.51, a 36.4% jump year over year, as reported by the company earlier this month. The strong top- and bottom-line growth was driven by a boost in comparable sales of 4.8%.
Shareholders are used to the giant home-improvement retailer realizing strong quarterly results, yet shares of Home Depot are now down about 7% year to date, trailing the S&P 500 index by about 10% over the same period. What gives? It might be a classic case of Wall Street failing to see the forest for the trees: It's so worried about next quarter's sales and margins that it's failing to see the long-term growth story play out in plain sight.
Questions taken from analysts during the third-quarter conference call centered on topics such as the housing cycle, tariffs, and hurricane-related costs and sales. While those are all important, sometimes it helps to take a step back and focus on the bigger picture. With that in mind, let's review management's comments during the conference call and consider how the company will be positioned in five years. Specifically, let's look at its efforts to grow e-commerce sales, invest in its logistics infrastructure, and improve the in-store experience for shoppers -- because I believe that Home Depot will offer the best and most robust omnichannel shopping experience in retail within five years.
One Home Depot: An interconnected shopping experience
Home Depot offers customers an interconnected shopping experience between the digital and physical realms, which it refers to as One Home Depot. In third-quarter 2018, online sales rose 28% over 2017's third-quarter totals -- heady growth, for sure. Yet its "Buy online, ship to store" and "Buy online, pick up in store" categories grew even faster, indicating that the company was creating a successful integrated shopping experience.
It's also adding more merchandise to its online retail space that customers won't find taking up valuable floor space in stores. This includes products in categories such as home decor, where the company made a key acquisition just last year to improve its offerings.
The virtual shopping experience also seems to be improving. Management credited the robust e-commerce growth to several factors, including improving its website's "search efficacy" and a more seamless online experience, both leading to higher sales conversion rates. CEO Craig Menear concluded:
All of these things have led to much better traffic. We had one of our strongest traffic quarters that we've seen in a number of years. Our absolute increase in visits was our single largest growth in the quarter in visits. And then it all resulted in the comp sales of 28%. And that's also due to increased conversion. So, we're getting people to engage into the site. The experience is getting to the right product. We're getting to the right close.
A supply chain second to none
Home Depot plans to spend $1.2 billon on improving its already-impressive supply chain infrastructure as part of a five-year plan that kicked off earlier this year. The company is motivated to stay on top of increasingly higher customer expectations for fast delivery options and satisfactory order fulfillments. During the conference call, Menear said that Home Depot could reach about 95% of the U.S. population with 2-day delivery. At the end of its five-year investment time table, the company believes it will be able to reach 90% of the U.S. population with same- or next-day delivery service. This capability will be combined with a longer tail of products available for such service, including big and bulky products frequently used in larger home-improvement projects.
In the conference call, Menear said the first of these new fulfillment centers was now being piloted and lessons were being learned that would be applied to the future logistical buildout. He also stated that the company has rolled out car and van delivery of store goods to 40% of the U.S. population, enabling same-day delivery for suitable items.
An improved in-store experience
The company isn't ignoring its roots, though, and is continuing to find ways to leverage technological innovations to improve the experience for in-store customers, too. Some of this is simple, like refreshing stores' looks and implementing new signage in stores, to help shoppers intuitively find what they are looking for. The company has now completed such projects in 700 store locations, ahead of the schedule it laid out for itself in late 2017.
Many of the discussed improvements involve freeing its sales associates from tedious tasks so they are more available to customers. In the conference call, Menear described one such innovation:
An example of this is the deployment of our new overhead management application. As you've heard [us] say before, customer service starts with being in stock. But beyond just having the product in stock, it has to be on the shelf for our customers to purchase, not stored in an overhead. Prior to the rollout of the overhead management application, the only way an associate could locate product in our overheads was to manually look for it. This new application on ... phones helps associates locate product in overheads quickly and accurately, saving them time, improving the customer experience, and enabling better inventory management.
Home Depot's long-term strategy looks strong
Home Depot continues to invest in whatever will make its customers most satisfied, a key characteristic to look for in any retailer. In five years' time, as these heavy investments come to fruition, the home-improvement retailer will have a more seamless online experience where customers can easily find what they are looking for and be presented with the pickup and delivery options that work best for them. When visiting the store, customers should find an improved sales floor layout and associates with more time to help the shopper. Connecting the two should be a world-class delivery infrastructure that can reach the vast majority of the United States with next-day delivery options. This sounds like a winning combination for investors willing to be patient.