In the month of November, the Consumer Price Index, a widely used measure of inflation, jumped 6.8% from a year ago. Sparked by supply-chain disruptions and labor shortages across the economy, it was the highest increase in almost 40 years.
For a company like Home Depot (HD -1.83%) that has done extremely well during the pandemic, the threat of rising costs is a real challenge heading into the new year, having possibly negative implications ahead of what is traditionally a busy spring and summer for the business.
Continue reading to find out how this blue chip stock is dealing with the current situation.
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Lumber prices are going back up
A major commodity that has a meaningful impact on Home Depot's business is lumber. From April 2020 to May 2021, lumber prices skyrocketed to nearly $1,700 per thousand board feet, an all-time record. Prices came down over the following few months, but they shot up again from mid-November to mid-December, settling at just over $1,000 per thousand board feet today. This is still extremely high from a historical perspective.
"Lumber is a driver of projects throughout the business, and that certainly carries on," Chief Executive Officer Craig Menear highlighted on the company's third-quarter earnings call. During Home Depot's fiscal second quarter that ended Aug. 1 (when lumber prices were sky-high), the company posted record quarterly sales of $41.1 billion. The gross margin of 33.2%, while down slightly from previous quarters, was still very healthy and in line with past results.
This is a positive indicator of Home Depot's ability to handle the unpredictable price swings with a core commodity like lumber. As prices soared, unit sales fell. Even so, the business reported a historic quarter. Now, as lumber prices rise, especially ahead of the busy home-building and remodeling season in the spring and summer, don't be surprised if lumber unit sales start to drop again.
Nonetheless, other product categories like outdoor garden, appliances, and kitchen and bath should be strong. And thanks to a robust housing market, characterized by low interest rates, consumers are increasingly looking to undertake renovation projects to boost the value of their existing homes. This underlying trend supports demand for the products and services Home Depot offers.
"We have effectively managed inflationary environments in the past, and we feel good about our ability to continue managing through the current environment," said President and Chief Operating Officer Ted Decker on the latest conference call with Wall Street analysts.
Home Depot's success is undeniable
One of Home Depot's overarching objectives is to be the low-cost provider in the home improvement industry. This means that the business wants to lag competitors when raising prices and lead when reducing prices. Obviously, this negatively impacts profitability in the near term as the company is hesitant to pass higher costs on to consumers.
But if we look at Home Depot's historical performance, we see that this is definitely the right strategy to take. Over the past several years, while revenue has grown in the mid-single digits on a yearly basis, net income has soared as a result of expanding margins. In fiscal 2015, profit totaled $7 billion. Over the trailing-12-month period, it was almost $16 billion.
And the business is popular among contractors and other professionals, who account for roughly 45% of sales. Instead of immediately passing on higher input costs, which could alienate these high-value customers and push them to competitors, Home Depot understands that building long-term relationships with them is crucial to the success of the company. Sacrificing margin in unusual times like today to keep customers loyal is the right move.
The current economic environment is full of uncertainties with issues like the omicron coronavirus variant and tightening monetary policy receiving the bulk of investors' attention. When it comes to inflation in particular, I have no reason to believe that Home Depot won't be able to step up to whatever challenges 2022 brings.
