HD Supply Holdings

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

HD Supply Holdings is a leading industrial distributor in North America, specializing in providing a wide array of maintenance, repair, and operating (MRO) products to diverse end-markets.

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

HD Supply Holdings (HDELY) is a B2B distributor of a wide variety of MRO products. They primarily cater to the institutional (e.g., healthcare, government, education) and industrial sectors, with revenues diversified across a range of product categories.

The company operates through three segments: Facilities Maintenance, Construction & Infrastructure, and Specialty Construction.

  • Facilities Maintenance: Offers a broad range of MRO products for maintenance, repair, and operations needs in buildings, including janitorial, safety, and lighting products.
  • Construction & Infrastructure: Provides specialized MRO products for the construction industry, including items used for waterworks, civil construction, and infrastructure projects.
  • Specialty Construction: Offers specialty MRO products for specific applications in infrastructure like waterworks, electrical, telecom and other types of construction.

It’s important to note that while HD Supply operates in fragmented industries, their position as a large distributor with a broad product catalog allows them to serve as a consolidated source for their customers’ MRO needs.

Competitive Landscape

  • Competition: HD Supply operates in a competitive landscape with various players, including regional distributors, e-commerce marketplaces, and direct manufacturers.
  • Differentiation: They try to differentiate themselves through their scale, broad product assortment, supply chain capabilities, and service-centric approach.

A key aspect is their focus on providing a customized value chain. For example, large enterprise customers look for an offering that handles all of their needs from sourcing to shipping to returns. HD Supply positions itself as a capable partner for handling this level of complexity. This type of partnership, alongside their private brand offerings and supply chain strength, allows them to act as a one stop shop and is a key part of their competitive strategy

  • Industry Trends: Growth in the MRO market is tied to GDP growth and construction activity. In emerging markets, infrastructure development will also play a significant role in future expansion.

Financial Overview

Revenue Distribution

  • Revenue Breakdown:
    • A large part of revenue comes from sales of MRO products.
    • The rest comes from the provision of services, such as supply chain management.
    • The Facilities Maintenance segment contributes a major share of total sales, followed by construction and specialty segments.
  • Geographic: Almost all of revenue is generated in the United States and Canada.

Margins

  • Gross margins are not remarkably high, ranging from about 33% to 35%
  • Operating margins usually range between 7% and 8%, which is low but not bad for a distribution business.

The nature of this business is high sales volume with relatively low margins. So, for any improvement in profitability, scale and volume matter a lot.

Profitability

  • Profits: The company manages to produce profits in normal environments

However, net income can fluctuate greatly based on the presence of non-recurring charges, restructuring, impairments, or unusual gains. It’s very difficult to determine a recurring income amount based on such results.

Moat Analysis: 2/5

  • Sources of Moat:

    • Scale: HD Supply’s scale does give it some advantage. Being a large player, they are better placed to absorb fixed expenses, and have buying power over suppliers.

    • Switching Costs: They have some switching costs, because large enterprises have to manage and integrate a wide range of suppliers and inventory management systems. By being a reliable partner who handles all the complexity of handling supply chain, they can enjoy some stickiness among their customers.

  • Weaknesses of Moat:

    • Replicability: The scale advantages can be replicated by other large players or through consolidation of smaller players.
  • Limited Differentiation: Although they have a wide range of products, most of them aren’t differentiated and are replaceable. This implies the company can’t sell products at a price premium in most cases and will compete on price most of the time.
  • Overall Moat Rating: 2/5. They have a narrow and eroding moat. There’s not enough protection from the entry of new competitors or aggressive pricing by rivals. Although the scale and some switching costs provide a base, the lack of a deeper moat means future excess returns are not guaranteed and will depend on market dynamics.

Risks to the Moat and Business Resilience

  • Increased Competition: Competition from smaller, nimbler distributors, as well as e-commerce platforms, could erode HD Supply’s market position. This will put pressure on the company’s margins.

    • Supply Chain Issues: Disruptions to the supply chain, either from a raw material shortage or logistical issue, could negatively impact revenues and profitability.
  • Customer Concentration: The loss of a key enterprise client would have an outsized effect on the company’s performance, given the high revenue concentration among a few big clients
  • Technological Disruption: Changes in technology could disrupt the market for their offerings, requiring them to adapt quickly. However, a lot of their products are commoditized and have been in use for a long time so this may not be an issue.
  • Industry Cyclicality: Downturns in the overall economy or construction sectors can affect HD Supply’s sales, and they are vulnerable to declines in revenues in these periods.

The company also faces risks such as price inflation in its supply chain, which increases costs and affects the ability to sell at a competitive price. These are the normal challenges for a distributor. Also, the company is undergoing a transition in its leadership, which may have an impact on the company’s strategic outlook, and how well these strategies will be executed.

Financial Understandability: 2/5

While the business model of HD Supply is relatively straightforward as a distributor, its detailed financial statements and the impact of accounting choices makes it only moderately easy to understand.

  • Straightforward Business: HD Supply buys products from manufacturers and resells it to enterprise customers. The model is easy to grasp.
  • Impact of Acquisitions: Acquisitions and divestitures can complicate financials, as you may have to analyze nonrecurring or pro forma accounting items.
  • Variety of Revenue Streams: Their different product offerings and customer base make it harder to precisely predict the direction of growth.

Balance Sheet Health: 4/5

  • Debt: The company is currently leveraged with debt at a debt-to-equity ratio of 2.3 in 2023. Though the leverage is high, they have been steadily decreasing it and have been successful in deleveraging.
  • Good Liquidity: The company has a healthy amount of cash on hand, suggesting adequate liquidity and flexibility to weather economic downturns.
  • Net debt: Although the company has positive cash from operations, it does have a negative value in its owners’ earnings, or free cash flow. This is due to their high capex. The company has made great improvements in profitability, and they will have to see if they are able to generate true positive cash flow from the business

The company has no debt maturities until 2027, which provides sufficient flexibility to manage its capital structure.

Recent Concerns & Management Outlook

During the most recent earnings call, management highlighted the strength of their operating model, which enables them to generate value from acquisitions. Also, management highlighted they will continue to strengthen the balance sheet by further deleveraging. However, they noted there will be some volatility in the markets and a slowdown in certain segments of the business.

Conclusion

HD Supply, while operating in a relatively stable industry, struggles to maintain a strong moat. Although it enjoys the benefit of its scale, the business faces fierce competition. That said, a continued improvement in the company’s earnings and deleveraging is promising. The business is easily understandable but the complexity of financials and the lack of a moat prevents it from achieving a top score.