The Home Depot, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Home Depot is the world’s largest home improvement retailer, selling a wide assortment of building materials, home improvement products, lawn and garden items, and related services through its stores and online platform.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: The Home Depot (HD) is a behemoth in the home improvement retail space, operating approximately 2,300 stores, primarily across North America, and also some international operations in Mexico and Canada. Their business model primarily revolves around providing a wide range of products and services to both Do-It-Yourself (DIY) consumers and professional contractors (Pro customers).

  • Revenue Distribution: HD primarily generates its revenue through the sale of merchandise, primarily split into categories such as Building Materials (Lumber, Millwork, and Plumbing), Decor, Hardwares, and other miscellaneous lines. They’ve also expanded into services such as installation and professional maintenance. Over the past several years sales have become more and more split between e-commerce and in-store as they continue to expand their online business model.
    • In the second quarter of fiscal 2024, their sales decreased by -2.0% versus the second quarter of fiscal 2023, due to sales decline in the U.S. which was -2.2%. They experienced strength in some regions, while a drop of demand in other regions.
  • Trends in the Industry:
  • The home improvement industry is sensitive to macroeconomic trends. The housing market has seen higher interest rates, thus slowing down new home builds. The consumer is still spending, but with less cash to spare, so bigger projects are done by higher paying pros, whereas smaller projects are done by consumers. DIY is slowing down while Pro is still good.
    • The industry is still fragmented, with local players making it harder to capture a bigger market share. However, these smaller companies have a limited online presence.
  • In-store is getting more and more tech-focused, as customers embrace new technology to help make their jobs more efficient.
  • Customers value convenience and personalized service more than ever.
  • Margins: The company generally operates with low single digit net profit margins but are able to generate good returns on equity and capital. Supply chain optimization has allowed some increase in gross margins. A large portion of the operating expense for home depot comes from employee compensation and store expenses.
    • For the second quarter of fiscal 2024 gross profit margin was 33.3% of net sales compared to 34.1% a year earlier.
    • Operating expenses have been decreasing as a percentage of sales, from 18.4% to 17.3% in the same time period as above.
  • Competitive Landscape: The home improvement market is quite competitive, with Lowe’s being the largest direct competitor to Home Depot, but they also face competition from smaller, specialized stores and online retailers. Home Depot’s scale and infrastructure offer a significant advantage, and they also have a more professional (Pro) leaning business model.
    • The company is trying to emphasize its position in both the DIY and the Pro segments. The pro segment is considered to be more recession resistant.
  • What Makes the Company Different?
    • Home Depot has been in business for many decades, and have built a large base of trust and reputation.
    • They have the first-mover advantage in terms of their delivery network in many areas.
    • They are actively improving their e-commerce offerings by optimizing the app.
    • They have been focusing on building out more fulfillment capabilities.
  • Other Relevant Info: Home Depot is a very big brand, and has high brand recognition. Also, their stores are usually very large and are located in well-trafficked areas, which help further enhance their competitive position.
  • The company is aggressively pursuing M&A strategies to quickly incorporate innovative business lines. They are spending more money on the supply chain to make the process more efficient.

Financial Overview:

  • Balance Sheet: HD has a very large balance sheet, with total assets of $76.53 billion (as of 2024-01-28) and total liabilities of $73.2 billion.
    • They have a negative equity of $4.46 billion and very low short term debt. However, they have over $40 billion in long-term debt.
    • They have close to 5 billion in goodwill and other intangible assets, showing the heavy spending and acquisition of other companies.
  • Income Statement: In the fiscal year 2024 ending January, they had total revenues of $157.4 billion, a gross profit of $52.7 billion, and a net earnings of $17.1 billion.
    • Their revenue fluctuates according to trends in the housing market, which has been suffering due to higher interest rates.
    • Their net income has been dropping due to decreased gross profit margins.
  • Cash Flow:
    • Home Depot is very cash-flow positive; they produce consistent cash from operations, and have substantial cash on hand and in short-term investments that they can freely allocate.
  • Capital Allocation: The company has been allocating a lot of cash into buybacks over the last 5 years, they have been using debt and the market value of shares to determine the appropriate amount.

Risks:

  • Economic Slowdowns: A major risk for Home Depot is sensitivity to economic slowdowns. When the economy dips, consumers tend to spend less on housing and home improvement, which negatively impacts HD’s financials.
  • Changes in Consumer Trends: Since the company is dependent on the consumer, they have to always be on top of changing consumer trends. They have to be on top of trends in home decor, technology, and the way people spend their money. As they are a relatively large company, it can be hard to change their course as a new trend emerges, they need to do a better job of forecasting.
  • Competition: There’s always a constant risk that new competitors and large tech giants entering the home improvement sector will make an impact, though they do face steep barriers to entry, and Home Depot also has economies of scale to keep competitors at bay.
  • Supply Chain Disruption: Companies are becoming more and more globalized, and that can create a risk for supply chain disruptions from natural disasters or international tensions. While the company has invested more in improving the supply chain, these disruptions can still impact operations and profitability.
  • Inflation: Inflation can create a lot of problems as it increases the price of input costs, and consumers may have less discretionary money to spend on nonessential items like home improvement. This can hurt profit margins and revenues.

Moat Analysis (3 / 5): Home Depot exhibits a narrow moat, not wide because of a combination of advantages, which helps it generate above-average returns on invested capital. The company enjoys scale advantages, especially in its distribution network and its numerous well-placed physical stores. Brand recognition and a track record for consistent profits also give the business an advantage. However, it lacks the strong switching costs of other industries.

  • There are switching costs for the Pro business, because they need a reliable supplier with a large distribution network. It is harder for them to switch to a competitor, because the competitor might not offer all of their needs, or might not have as good of a supply chain or network.
  • For DIY consumers, the brand does carry some pricing power, but since switching costs are very low, they also have a hard time creating an edge or moat.
  • There is also risk of losing their moat because of the changing industry, more and more consumers are willing to shop online, which means that other pure online retailers will benefit from this.
  • If a major competitor invests in a more efficient supply chain and network, it will lead to erosion of Home Depots’ moat.
  • They do have unique resources with their vast number of stores and strategic store placement.
  • Understandability (2/5): Although the general business model of Home Depot is quite easy to grasp—sell hardware, building materials, and related services—there are many layers of complexity involved when analyzing the company. Things like their pro customers versus DIY, complicated financials, various store locations and markets, make the company harder to analyze and understand for an average investor.
  • Balance Sheet Health (4/5): The company has a decent balance sheet. While they have a lot of liabilities, they are also very profitable and generate a lot of cash. Thus, they will be able to make their interest payments and not default.

Recent News and Management Discussion:

  • During the second quarter earnings call, management mentioned that customers continue to engage in larger projects which leads to higher customer ticket values. However, those are trending downward due to the macro economic environment.
  • In addition, there is a slowdown in discretionary spending. Home Depot is looking into ways to streamline the cost structure for more flexibility, while they also focus on efficiency gains.
  • Management are seeing strong demand from the professional (Pro) side and a decline from DIY customers.
  • Management is heavily focused on building and improving the online and interconnected shopping experience.
  • They are allocating capital effectively, balancing between investment and returning it to shareholders. They believe that their current debt is manageable and doesn’t affect business.
  • They have acquired a supply chain company called SRS to enhance their ability to deliver on their customer base.

The company seems to be making good moves in the right direction. However, the effects of external forces such as the housing market and inflation seem to be impacting their financial outlook. While the business is still quite profitable, growth has slowed and margins have been reduced. However, the company’s moat seems to be defensible and its financial strength should help weather any future downturns.