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Home Depot Beats, Raises Outlook

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The world's largest home improvement retailer, The Home Depot Inc.’s (HD - Free Report) adjusted earnings for the third quarter of fiscal 2012 came in at 74 cents per share, surging 23.3% from the prior-period earnings of 60 cents, primarily due to an improvement in comparable-sales and strong operating performance. Moreover, the company’s quarterly earnings modestly exceeded the Zacks Consensus Estimate of 70 cents a share.

Quarterly Details

During the reported quarter, net sales increased 4.6% to $18.130 billion compared with $17.326 billion in the prior-year quarter, primarily driven by increased number of customer transactions and average ticket size. Sales, at the company’s comparable stores, improved 4.2%, while comparable store sales in the U.S. stores grew 4.3%. Moreover, net sales for the quarter surpassed the Zacks Consensus Estimate of $17.910 billion.

During the quarter under review, gross profit increased 5.1% to $6.267 billion from $5.961 billion reported in the prior-year quarter. Consequently, gross profit margin expanded by 17 basis points (bps) to 34.57%.

Operating profit, during the reported quarter jumped 7.3% to $1.733 billion against $1.615 billion in the year-ago period. Operating margin expanded 24 bps to 9.56% compared with 9.32% in the prior-year quarter. The improvement in operating margin was primarily driven by elevated gross profit margin and effective cost management.

Balance Sheet and Cash Flow

Home Depot ended the quarter with cash and cash equivalents of $2.554 billion, long-term debt of $10.779 billion and shareholders’ equity of $17.738 billion. During the first nine months of fiscal 2012, the company generated $5.384 billion of cash from operations and deployed $3.330 billion towards share buyback, $1.312 billion for dividend payment, and $887 million for capital expenditures.

Revised Outlook for Fiscal 2012

Following solid third-quarter results, management raised its fiscal 2012 adjusted earnings guidance to $3.03 per share, a 23% rise from the previous year’s earnings of $2.47 and up from $2.95 forecasted earlier. Moreover, the company expects net sales to grow by 5.2% in fiscal 2012, up from the previously projected growth of 4.6%.

Our Recommendation

Home Depot is the leading player in the highly fragmented home-improvement industry. The company has reinvigorated itself with a shift in focus from new square footage growth to maximization of productivity through its existing store base.

In addition, the company has implemented significant changes to its store operations to make them simpler and customer-friendly, thereby drawing more customer traffic. We expect these initiatives to boost its top line.

Moreover, with the introduction of a new warehousing and transportation system, the company has been able to improve its supply chain while minimizing cost. This has also helped Home Depot improve its Central Automated Replenishment System to facilitate immediate refilling of stock while reducing investments in inventory.

Home Depot will remain focused on optimum capital allocation, which will further enable it to increase shareholders’ wealth. However, given the current economic environment, we believe that spending on big remodeling projects will likely remain under pressure in the near term.

This influenced us to keep our long-term recommendation on the stock at Neutral. Home Depot currently maintains a Zacks #2 Rank, which translates into a short-term Buy rating. Peer Lowe's Companies Inc. (LOW - Free Report) also holds a Zacks #2 Rank (short-term Buy rating).

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