Amazon has become the giant killer of the retail industry. Apart from hand-full of companies, the entire retail sector has been disrupted by Amazon. In my opinion, driven by the stellar Q2 performance by Home Depot (HD), I think it will be very difficult & expensive for Amazon to compete with HD. HD’s management has done a tremendous job in ensuring its moat continues to expand. Some of the reasons why it will be difficult to compete are:
- 90% of the US population lives with 10 miles of a Home Depot store. HD is taking advantage of its presence by introducing same or next day delivery to its customers
- Solid online presence – In Q2 online sales grew 26%. 47% of those orders were picked up in-store
- A well oiled supply chain to handle all kinds of items big and small
Below is a summary of the stellar Q2 results and some key insights shared by the management that helps us understand how they think about the business.
Summary
- In Q2 2018, Home Depot(HD) achieved record sales & net earnings
- Highest quarterly sales and net earnings in the company’s history.
- Sales for the second quarter were $30.5 billion, up 8.4% from last year.
- Comp* sales were up 8% from last year with U.S. comps of positive 8.1%.
- HD is investing in improving delivery times and in-store customer experience
- Opened first Market Delivery Operations or MDO facility. HD is working towards creating an infrastructure for same or next day delivery. In the second half of this year, HD plans to open additional facilities.
- HD is ahead of its initial plan of updating its stores. Year-to date, HD has implemented way-finding sign and store refresh package in over 500 stores. Also, it is continuing to make progress on the rollout of the redesigned front end areas and BOPIS (Buy Online, Pickup in Store) lockers.
- HD anticipates that current Macro environment will have negligible impact on its business
- Decrease in home affordability (due to increasing interest rates & existing home prices) will have negligible impact on HD financials.
- Given HD’s size and scale of operations, the tariff environment is manageable. So far, products that have been most impacted by tariffs are lumber and washing machines.
- HD is seeing inflation start to tick up in raw material and transportation costs but it is manageable.
Business performance during the first half of 2018
The year 2018 started slow for Home Depot. Delay in onset of Spring season across US and Canada forced customers to delay the outdoor projects. During Q1 earnings call, the management had talked about bathtub impact on sales depending upon when Spring breaks, where weak seasonal sales in the first quarter are counterbalanced by strength in the second quarter. Management was confident that it will be able to make up for the lost sales in second quarter and they proved to be right. Customers drove Q2 revenue and profits higher to a record in company’s history. Comps* in Q2 increased by 8% over last year. Sales were higher in every department – lumber, indoor garden, outdoor garden and electrical had double-digit comps in the quarter. Tools and appliances were above the company average. All other departments but lighting posted mid-to-high single-digit comps.
*Comparable Sales (Comps) is a measure that highlights the performance of existing locations and websites by measuring the change in sales for a period over the comparable, prior-period of equivalent length. Comparable sales includes sales at all locations, physical and online, open greater than 52 weeks (including remodel and relocation) and excluding closed stores. Comps is the most import performance measure for a retail company.
Home Depot also saw an impressive growth in online sales. Online sales in the quarter grew by 26%. 47% of those orders were picked up in store. Growth of pro sales again outpaced the growth of DIY customer. Professionals now account for 45% of total sales at Home Depot.
Will a decline in existing home sales negatively impact business?
An analyst on the call asked a question about the impact of declining home sales (due to increasing prices and interest rates) on Home Depot’s business. Short answer to this question is that management sees a negligible impact of this trend on its business. Management’s explanation of how they think about this issue is very informative. Below is a quote from the CFO Carol Tomé
“I think it’s so very important when you think about the affordability index, and we’ve talked to you about this in the past, right now the affordability index for the country is 144, and if you look at the historical average, it’s 127, so in the past we’ve said, well, if it gets to 127, that could be a watch-out for us. But as we’ve thought about it, we thought really you need to think about it on the margin, because if only 4% of housing units are turning in a year, that means 96% of homeowners are staying in their home and they don’t care about rising interest rates, and in fact they love rising home prices because their equity is worth more. So really, when you think about affordability, it’s the 96% of the housing units that are in place that are driving the home improvement spend and not so much the marginal turnover that the media tends to pay attention to.”
Click here to read more about how Home Affordability Index (HAI) is calculated.
How Home Depot is expanding its Competitive Advantage?
In today’s uber competitive world a company risks becoming outdated quickly if it stops to innovate and invest in the future. This is more true for a company in retail industry than in some other industries. Threat from the likes of Amazon is much higher. Home Depot is doing a commendable job in keeping its competitors at bay. Given its scale and the initiatives that are in pipeline I cannot envision Amazon or any other company successfully competing with Home Depot. Let’s take a look at some of the initiatives:
- HD is building an infrastructure to become the fastest and most efficient delivery player in the home improvement industry. They have now rolled out small parcel express delivery from stores via car and van in nearly all of our major markets in the U.S., with plans for further expansion.
- Professional customers represent that fastest growing customer category for HD. They have initiated a three-year program to build a dedicated B2B site for its pro customers
- HD is revamping all of its existing stores:
- Implementing new way-finding and sign package to improve store navigation
- General environmental clean-up, spiff the floors, add lighting, paint, remodel restrooms
- Installing iPad-sized electronic price signs and information on the appliance in the appliance departments
- Introducing new innovative products exclusive to Home Depot
Conclusion
Home Depot is well positioned to benefit from the improved customer sentiment and it should witness strong sales and earnings for the rest of the year. Given the number of key initiatives that are currently in progress, the company should be able to strengthen its moat or competitive advantage for years to come. Mr. Bezos this one will be a tough one to beat. Happy Investing!
Disclaimer: These are my personal views and are for educational purposes only. I am long HD. Please do your own research before making any investment decisions.