As so many brick-and-mortar retailers are shuttering locations, it's important to choose wisely when looking for potential investments in the retail sector. While Home Depot (HD 0.93%) has lagged the S&P 500 index over the past year, barely giving investors a positive return, I still believe the company promises market-beating returns over a long time horizon. The company's first-quarter results, though disappointing in some respects, reinforced this belief.
First-quarter net sales rose to $26.4 billion, a 5.7% increase year over year, and earnings per share (EPS) grew to $2.27, a 9.1% increase year over year. Meanwhile, comparable-store sales, one of the most important metrics used to evaluate retail companies, grew at a tepid 2.5% rate. The top- and bottom-line growth was driven by a 2% increase in average ticket size to $67.31 and a 3.8% increase in total customer transactions to 390 million.
Let's take a closer look at the three biggest takeaways from the quarter and see what else we can learn.
90% of Pro customers rent tools, but only 25% rent from Home Depot, a gap the retailer hopes to exploit in the quarters ahead. Image source: Home Depot
1. Bad news first: Long-term problems or short-term noise?
In Home Depot's latest conference call, management blamed lackluster same-store sales growth on two things: bad weather and lumber price depreciation. CEO Craig Menear said that February was the "second wettest on record" in the U.S. and that this "had a significant impact to our big ticket performance in the quarter." CFO Carol Tome added that 17 of the 19 domestic regions recorded negative comps in February, but that only two recorded negative comps for the quarter (both lapping large hurricane recovery sales from the prior year).
The second thing management called out was lumber price depreciation. In fact, the word "lumber" was used a whopping 35 times on the call. After going back through three years' worth of transcripts, I never found another call where it was mentioned more than eight times. Management stated that lumber price declines led to $200 million in lost sales growth this quarter and, if prices stay deflated, would result in a negative $800 million impact on sales for the full fiscal year.
Without the negative impacts from lumber prices and bad weather, Tome maintains that same-store sales would have seen a much more robust 4.5% increase, rather than the 2.5% the company experienced.
2. An interconnected digital and in-store shopping experience
Home Depot continues to work on providing a truly integrated customer experience that extends from its website to its stores, called One Home Depot. In Q1, online sales grew 23% over last year's first quarter. Home Depot is using its digital platform to expand its presence into additional categories it believes its customers would like to see, such as pool maintenance, HD Home, and work wear.
The company is also working hard to streamline the in-store experience and has invested heavily in this area. CEO Craig Menear stated:
During the quarter, we continued to make progress, enhancing this interconnected customer experience by investing in our stores, to improve our front-end checkout experience, continuing to roll out automated lockers, streamlining our customer service desk and simplifying tools for our associates. This is translated to reduce wait times and increase customer satisfaction ... . Not only do these front-end investments have customer service and productivity benefits, they're also helping us to optimize store layouts to maximize merchandising space productivity and high traffic event, in laid out areas.
Menear believes these efforts are working, saying that customer service checkout time satisfaction scores improved by 5 percentage points and that 54% of online orders are picked up in stores.
3. Leave it to the Pros
Another area where Home Depot has invested heavily is catering to its "Pro" customers -- think handymen, general contractors, professional renovators, property managers, and others whose professional livelihoods depend on maintenance and repair projects. Sales to pro customers once again out-paced sales to DIY customers, a trend that has continued for several consecutive quarters.
Home Depot is looking to increase its market share with Pro customers through two new initiatives. First, it is still rolling out its new website dedicated exclusively to the Pro customer. In Q1, Home Depot added 35,000 Pro customer accounts to the site, bringing its total to 135,000, a figure the company believes it can expand to one million by the end of the year. The website will make it easier for the Pro customer to find the materials and supplies they need -- in the quantity they want -- and find delivery options unique to their requirements.
The second way Home Depot is increasing its Pro customer engagement is through tool rental. Menear said that 90% of Pros rent tools, but only 1 in 4 rent tools from Home Depot. While this is dramatically improved from several years ago, when only 1 in 10 rented tools from the company, it still leaves a long runway of growth ahead in this area.
A sturdy foundation for a portfolio
Home Depot will always be subject to several macro-economic trends that will have the potential to derail its short-term earnings power. This includes weather and commodity prices, the two things that dinged the company's operations this past quarter. When one takes a longer view, though, it becomes clear that this home-improvement retail giant is on the correct side of several trends and has made the right investments to stay on top of potential e-commerce competitive threats as well as its primary rival, Lowe's Companies.
Based on Home Depot's 2019 full-year guidance, its shares trade at a P/E ratio of just under 20. For a company with solid earnings growth, even in a quarter when it was negatively affected by factors far outside its control, that seems like a reasonable valuation. It might be time for investors looking for a solid foundation for their own portfolios to consider adding some shares.
