Home Depot (HD -2.44%) reported third-quarter results before the market opened on Tuesday that impressed investors and shareholders alike. The stock price for the home improvement retail giant was up close to 6% on the day of the release.
The report revealed that several important metrics are heading in the right direction, including sales, operating profit margin, and earnings. One figure, in particular, could be the most important to come out of this quarter's numbers for Home Depot. That number is $20.5 billion and it refers to the value of inventories on hand heading into Q4.
Home Depot has secured enough supply
The coronavirus pandemic is causing supply chain disruptions worldwide. The interconnected nature of today's economy means it can be slowed down significantly if a lack of supplies or material in one section creates a bottleneck. As is becoming typical since the pandemic onset, a virus outbreak at one facility or port causes mandatory quarantines for those infected and their close contacts. That scenario is occurring several times over, which is hampering output and slowing shipping times.
Consumers see this when they go to their favorite stores and notice various items are out of stock. Sometimes shoppers might substitute another product for the one they came for. At other times, they may leave the store altogether and go to a competitor. Therein lies the importance of Home Depot's $20.5 billion in inventory currently on hand. The figure is 27% higher than at the same time last year, and the company has more en route. Here's management talking about the matter in the Q3 conference call:
[W]e've received most of the goods for the fourth quarter. But there is still product, and we have 95-odd ships in total parked outside L.A. Long Beach, and we track our containers on those ships and also getting onto the ports and off the port. So we're not too terribly concerned. There is a huge amounts of Q4, but there is Q4 products still working through the supply chain.
In other words, if demand remains elevated in the fourth quarter, Home Depot appears ready to fulfill that demand. That could play an even more significant part in generating strong Q4 results if competitors could not secure a sufficient supply of goods to sell.
Home Depot also does not want to take a hit by having too much supply
The other side of the supply equation is that Home Depot takes on additional risk by bringing in so much inventory. Sales have surged for the home-improvement retailer since the pandemic. Folks who were staying at home more often are considering more projects than ever. Rising home values have been putting fuel on that fire, encouraging homeowners to invest in their property.
Indeed, Home Depot's revenue increased by 19.9% in fiscal 2020 -- more than twice the compounded annual rate of growth it achieved in the last decade. Economies are gradually reopening, and there is no telling if consumers will maintain this elevated level of spending on home improvement. If there is a sudden stop of spending growth or even a reversal, Home Depot could be left with excess inventory that it would need to discount in order to sell.
Shareholders should feel confident knowing that this is not the case so far. Sales increased by 9.8% in Q3, and management said Q4 is off to an excellent start. Still, investors should keep this risk in mind, and that's why the $20.5 billion inventory figure could be the most important for Home Depot in Q3.