Investors have some conflicting signals heading into Home Depot's (NYSE:HD) third-quarter earnings report next week.
On one hand, industry demand has soared through the pandemic, and the housing market is staying strong. On the other, warning lights are blinking on fundamental metrics like unemployment and economic growth trends. At the same time, Home Depot has had to face market share challenges from industry veterans like Lowe's (NYSE:LOW) and from new entrants like Wayfair (NYSE:W).
This good/bad situation sets up an important earnings report from the industry leader on Tuesday, Nov. 17, that should capture investors' attention. Let's take a look at a few key metrics to follow in that announcement.
Market share concerns
COVID-19 has scrambled demand trends and created more noise in the industry, but the general trajectory is up. Home Depot's last report showed a head-turning 25% year-over-year sales spike, which is huge for a business that generates $110 billion of annual revenue.
The home improvement chain trailed its smaller rival last month in revenue growth rate, though, and so investors will be watching Home Depot's report in conjunction with Lowe's on the following day for signs of more stable market share trends.
The business is also seeing new threats from e-commerce specialists like Wayfair, which recently pushed into home improvement niches like bathroom vanities. Wayfair announced a 67% third-quarter year-over-year sales increase in early October and it will be interesting to see how well Home Depot's digital division stacks up against that growth metric.
Profits and cash position
While Lowe's has overtaken Home Depot on growth over the last six months, the market leader is still on top when it comes to key financial metrics like profitability and cash flow. Operating income was $9.3 billion in the first half of 2020, equating to 14.1% of sales. Lowe's comparable metric is 12.7%.
But Lowe's has closed this gap over the last year thanks to improvements in its stocking and pricing trends both in stores and online. We'll find out this week whether Home Depot managed to pull back away from its smaller peer.
Home Depot could make news on the capital return front, given that management halted stock buybacks in the second quarter and chose instead to pay down debt. Another quarter of strong free cash flow might put executives in a better position to resume that spending even as the chain pays out just over 50% of annual earnings in dividends.
Shaky economic growth trends and the risks around further COVID-19 outbreaks might keep CEO Craig Menear and his team from issuing a short-term outlook again this week. But Home Depot's recent sales trends will say a lot about how well the market is holding up through challenges like high unemployment and the end of fiscal stimulus.
Normally, executives would issue a bullish outlook after sales jumped over the first three quarters of the year. But recessionary economic conditions today could convince Home Depot to take another cautious tone on the last quarter of 2020 even as it prepares to close out what is shaping up to be a record year for growth and earnings.