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Know the Home Depot (HD) Stock in and out Before You Invest

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The Home Depot Inc. (HD - Free Report) has been in investors’ good books, thanks to its robust surprise trend, with the fifth straight quarter of earnings and sales beat in second-quarter fiscal 2021. The continued demand for home improvement projects, the robust housing market and ongoing investments have kept the company’s business going in a tough environment. Growth in Pro and DIY customer categories as well as digital momentum also bodes well. Its “One Home Depot” investment plan positions it for long-term growth.

However, trends in the second quarter revealed year-over-year moderation in its comparable store sales (comps) growth due to the lapping of the high demand environment for home-improvement projects last year. A soft gross margin, stemming from increased penetration of lumber, has also been a drag.

Factors Supporting Growth

We are convinced with Home Depot’s execution of the “One Home Depot” investment plan, which focuses on expanding supply-chain facilities, technology investments and enhancement to the digital experience. Customers have been increasingly blending the physical and digital elements of shopping to enhance the shopping experience. This makes the interconnected One Home Depot strategy most relevant.

The interconnected retail strategy and underlying technology infrastructure have helped consistently boost web traffic for the past few quarters. Sales leveraging the digital platforms remained almost flat in the second quarter, as the company lapped digital sales growth of approximately 100% in the second quarter of last year. On a two-year stack basis, sales from digital platforms increased nearly 100%.

Another key component of delivering an interconnected experience is enhanced delivery and fulfillment options. Over the years, the company has created the fastest, most efficient delivery network in home improvement through options like buy online pickup in store (BOPIS) with convenient pickup lockers, buy online deliver from store with express car and van delivery, and curbside pickup.

In the first quarter of fiscal 2021, the company rolled out the mixed-cart selling from store capability, eliminating the friction for both customers and associates. It is also looking to enhance interconnected facilities in tool rental through the expansion of rent online pilot chain-wide. The capability is likely to enhance experiences for both Pro and DIY customers.

Home Depot’s Pro segment has been a key growth driver, with the Pro segment witnessing robust sales growth for the past several quarters. Management highlighted that consumers are focusing on larger projects, aiding growth in sales from the company’s Pro customers. Growth in Pro customers outpaced DIY customers for the second quarter in a row. On a two-year stack basis, growth in the company’s Pro and DIY customers was consistent and strong.

The company, which shares space with Lowe’s (LOW - Free Report) , Lumber Liquidators (LL - Free Report) and Builders FirstSource (BLDR - Free Report) , expects continued sales growth from Pros as project demand is strong and their backlogs are growing. It remains on track with investments to build a Pro ecosystem,  which includes professional-grade products, exclusive brands, enhanced delivery, credit, digital capabilities, field sales support, and HD rental. The company expects its differentiated Pro ecosystem to aid deeper engagement with Pro customers in the long term.

In the second quarter, the company entered a strategic big-box home-improvement exclusive relationship with LP Building Solutions, a provider of OSB panel boards. The company is also impressed with the momentum in its pro extra loyalty program. Pro extra members will now have access to the company’s B2B Pro online experience. The company will also roll out an innovative paint offering, BEHR DYNASTY, through its exclusive partnership with Behr.

Hurdles to Overcome

Though the company’s long-term growth prospects remain intact, its soft margins remain a hurdle. In second-quarter fiscal 2021, the gross margin contracted 80 basis points (bps), primarily driven by increased penetration of lumber products in the company’s sales mix. Lumber alone hurt the gross margin by 60 bps in the fiscal second quarter. The gross margin was also hurt by continued pressure from higher transportation costs, supply-chain investments and lapping a benefit from canceled events in the second quarter of last year.

Although the operating margin expanded 20 bps in the reported quarter, it was hurt by a gross margin decline as well as higher SG&A and other operating expenses. In the fiscal second quarter, total operating expense increased 2.2% year over year, while SG&A expenses rose 1.2%.

Home Depot also witnessed year-over-year moderation in U.S. comps growth in the fiscal second quarter. This was attributed to the lapping of the high demand environment for home-improvement projects in the year-ago quarter, particularly DIY projects.

Comps were adversely impacted by the reduced demand for DIY projects from year-ago levels, as consumers moved out of their homes, leaving some of the pandemic-induced habits. The company also witnessed single-digit negative comps in paint, hardware, and indoor and outdoor garden, which were some of the strongest performing departments in the year-ago quarter.