The Home Depot's CEO Presents at Goldman Sachs Twentieth Annual Global Retailing Conference (Transcript)

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The Home Depot, Inc. (HD) Goldman Sachs Twentieth Annual Global Retailing Conference September 11, 2013 11:20 AM ET

Executives

Frank Blake – Chairman and Chief Executive Officer

Marvin Ellison – Executive Vice President - U.S. Stores

Analysts

Matt J. Fassler – Goldman Sachs & Co.

Matt J. Fassler – Goldman Sachs & Co.

So good morning everyone. I’m Matthew Fassler from Goldman Sachs and it’s my pleasure as we continue here with the heart of the second day of our conference, terrific string of large cap companies, including back to back the two retailers of the Dow. So very excited about what we have here in the middle today. And I’m very excited to introduce to you members of the senior management team of The Home Depot.

Directly to my left Frank Blake, the Chairman and CEO. Frank has held that position for the past six years and had a wonderfully diverse career prior to that, which included public service, time at GE, practicing law, and other disciplines. Sitting to his left is Marvin Ellison, who is Executive Vice President of stores for Home Depot. He has been at the company since 2002 and prior to that spent time at Target and that was the bulk of the experience prior to that.

Diane Dayhoff is right there and Dan Aldridge also from the company and the Investor Relations effort. I will keep my introduction brief since this company needs very little, very sufficed to say that Home Depot is the largest home improvement retailer in the world. It is the second largest retailer in the U.S. It is a company that at the moment happens to be operating in a pretty good piece of the U.S. economy. But that being said has been in the midst of a very successful and remarkably successful multiyear recovery process both at the company level and at the macro level we've seen an overhaul to the company supply chain.

We've seen some of the best expense control that I've seen in retail over the years. They've kind of leverage the two complex with six or seven and the operating leverage has been fantastic. It's a company that's very much by way of our forecast on its way to achieving its 12% launch from operating margin goal early if anything.

With that happy to start our fireside chat and kick off our conversation.

I guess the first question I'd ask you, the industry had a breakout quarter of sorts in the second quarter. You had your best comp store sales growth since I believe the 1990s. Can you talk about what macro factors were visible to you in driving that performance, particularly the different elements of housing be it turnover, be it value, be it buyers versus renters, investors et cetera?

Frank Blake

Okay. First, thanks, Matt. It's always a pleasure to be here. Thank you all of you for taking time to listen. So for the second quarter there were some things that are put to one side that were not so much macro related, but more seasonal. So as you all know we were comping against a fairly weak second quarter of 2012 because of the way spring happened in 2012. We had an early spring in 2012 that shifted most of the sales into the first quarter, a late spring in 2013, which shifted seasonal sales into the second quarter. Putting that aside and then just talking more on the macro factors what I'd say is a couple of things that we believe were driving our business.

First housing price appreciation, while we can to first look at housing starts or housing turnover, in fact, that impacts a fairly small percentage of homes, starts at 6%. Housing prices on the other hand impact owners more broadly and we think both studies have shown this and it’s intuitively clear that when your house is under water you got negative equity, you are less likely to invest in it than as your home price as appreciated. Obviously in housing crash we went through a tremendous loss of home equity, somewhere around $6 trillion.

And what we saw in the first half of 2013 was a nice recovery in home prices in most of the major markets in the country and we think that supported some of the growth in the second quarter. Frankly also supported some of the growth in the first quarter when you normalize out the seasonal variations. And then as you said Matt, we have the more traditional things you look at such as transaction, housing turnover, which was positive in the quarter as well.

Matt J. Fassler – Goldman Sachs & Co.

Great. And what does those elements that might be more sustainable tell you Frank about the past of the business? And if you also think about the pieces of the business that shows signs of life, were there any of them have started to perk up, that had not been visible prior to that, and what kind of legacy do you think they have?

Frank Blake

Okay, so lot of parts to that question. I will start with just a general comment, because having participated in this conference for many years, we were joking. Diane and I before coming in here that I remember many of them where we'd start the conversation by saying private fixed residential investment in the United States has had a new 60 year low. We're surely at the low and then the next year, it would be, we'd hit a new 60 year low, surely we're at a low. We're now, so now we've actually seen it start to recover. It was recovering from a very distressed state of around 2.25% of GDP, it’s now slightly north of 3% of GDP. And at that rate, it is still below what had been the 60 year low before we entered this housing crisis in late 2006.

So from our perspective we see housing recovering. We think it’s going to be a gradual recovery. So as we look into the back half of the year, we went through in our earnings call just a little while ago. We see the growth not as robust as it was in the first half, but that’s more explicable because of that set of individual elements within the Home Depot responding to storms, introducing new appliance plans and the like. But we continue to see good growth within the housing market adding say 2 to 2.5 points

In terms of what we see more specifically and there are number of categories that are now seeing growth that weren't seeing growth frankly when the market was in a crisis mode. Very obvious one that was called out for us in the second quarter was appliances. You see appliances starting to grow. I think the manufacturers would say that, that they are seeing growth certainly above what we’ve seen in the last few years. And we are also seeing that in some other larger ticket projects like flooring, like kitchens remodel switches, what you would expect as the market starts to recover.

Marvin Ellison

So Matt in addition to those categories, the Pro-consumer segment has also done really well to first and the second quarter. We sighted in the first quarter that pro actually outperformed consumer. In the second quarter consumer and pros were basically at parity. But even the smaller and the larger pro-customers and these are trace people and contractors, they showed a lot of strength in both quarters. So we hope that is sustainable, because it correlates directly to housing improvement and the improving in home values.

Matt J. Fassler – Goldman Sachs & Co.

Are there any businesses that still haven't kicked in, in where you take your businesses, project driven businesses that are still on the sidelines and any signs of life for any of those?

Frank Blake

No, actually if you look across our business and pretty much across our business, we were seeing a response to improving conditions. I mean, the rate of improvement obviously varies, but there aren’t any notable laggers for us. So there is a time when what happened in California or Florida was really important, either on the downside or on the upside, it sort of feels like the country is coming back into lot step a bit more uniformly, what are the regional differences and do they tell you anything about the forward?

Frank Blake

So, again, and Marvin might want to add some comments on this as well. But I would say is, if you look at 2012 one of the underlying sub-stories in 2012 was the recovery of the Florida markets and the California markets. As we go into 2013 and to take the second quarter as an example, the Florida and California markets did well, but they were largely in line with the rest of the business.

Matt J. Fassler – Goldman Sachs & Co.

Okay.

Marvin Ellison

Well, Matt, we’ve seen consistent. I mean, you look at second quarter, we saw strength in every major market. And it’s my job to convince Frank that’s because our strategy is working in all stores. But I think it’s also because you just see just broader macro improvement across the country. And those states and markets are still performing well, but you have other markets that were not the typical in obvious markets that were really in the – from a housing standpoint that had really strong performance in the second quarter also.

Matt J. Fassler – Goldman Sachs & Co.

I’ll direct this question explicitly to both of you. If you think about deliver model in the business, you now have a rising tide it seems and presumably either by virtue of traffic or by virtue of those bigger ticket transaction is being a little more labour intensive, you need to think about listing payroll.

As I mentioned in my intro, you had levered expenses remarkably well. When there was really very little pressure frankly to drive head count or drive payroll hours, how are you handling the higher demand from a service and payroll perspective?

Frank Blake

So I’ll make a general comment and then again I think this is something Marvin should comment on. First, I do think that one of the themes of Home Depot over the last several years has been the effort Marvin and his team have made what we call 60-40, which is redirecting testing hours, the customer facing hours, and improving the productivity within our stores. That same approach, thinking about how you make hours more productive is frankly as true in some of the higher touch categories. Matt, as you said, like a core categories and I give one example in flooring, where Marvin and his team haven taken a lot of the activity that perviously had been in-store in terms of building floors and doing measures and move that outside. And that’s actually freed up hours within the store for our flooring associates more directly to be involved in the selling process. But Marvin, do you want to comment?

Marvin Ellison

Yeah, Matt, just to remind you, about four years, we did an analysis of our payroll spend and we determined that 60% of all hourly payroll in the stores were focused on non-selling tires, unloading trucks, stocking shelves, conducting audits. And we made a process change. We reengineered the business, and as Frank noted, we called it a 60-40. The goal was simply to shift 60% of that payroll spend and we allocated to service and selling.

And I’m happy to say that we’ll end this year achieving our goal. And so to put it in more specific terms the last four years we reallocated the equivalent of 12 full-time associates to the sales force to drive service without increasingly our payroll as a percent of sales. And so our goal now was to continue to create productivity and a more continuous productivity loop and understanding what our other parts of the business that we can reengineer as the customer starts to make decisions on more discretionary categories, we’ll shift our labour accordingly.

We work closely with the merchants to determine what categories they want to drive, where we want to increase market share, and we make the necessary labor investments. But we feel good about leverage. We feel good about our plan through 2015 to continue to build on this, and just to continue to find ways to provide service, but also meet our economic requirements of the business as well.

Matt J. Fassler – Goldman Sachs & Co.

So I want to talk on the merchandising front on two sets of items. The first is online. I think it was at your last Analyst Meeting that you introduced an elegantly simple matrix of where you thought you were exposed and where you though you had edge as related to e-commerce. And every company should follow your example, and think about the world that way, if not show us what they are thinking? Since then, what has your experience been in terms of where you in and whether it’s actually exposure from Amazon rather is online?

Frank Blake

So I’d say in broad terms and what Matt’s referencing is, we did basically a grid of where we feel that online competition has more – present more of a threat to us. So think about a core categories that are relatively easily shipped and aren’t time sensitive, so for example, lighting, decorative, hardware things like that.

And then other categories, so that would be the upper right hand quadrant. The lower left hand quadrant would be categories like emulsion and dry wall, where online doesn’t lend itself very well, shipping bulky commodities. In main that is still, we think an accurate descriptor of where we see competitive threats.

I would say the interesting thing looking at that chart is that we see more opportunities on our side to leverage our online presence as we get deeper into our Dot Com and interconnected efforts than we saw before.

Matt J. Fassler – Goldman Sachs & Co

What are some of those opportunities?

Frank Blake

So, for example, buy online pickup in-store, buy online ship to store have both been very successful programs for us about one out of every three now of our online transactions has actually fulfilled in the store. And that has created some interesting labor and product storage issues in the store, but it’s a great thing in terms of being able to take advantage of our online presence and translate that not only into sales that are convenient for the customer, but also obviously when the customers comes into the store he or she buys additional items when they are in the store.

Marvin Ellison

And, Matt, the only thing I will add to that is the online returns that take place in the store. So buy online return in-store is a huge advantage with 2,000 stores. I mean, we are in close proximity to most customers homes, and it’s just a better and a more convenient process for them rather than boxing it up and shipping it back to just take it to their near store to get a return. And we receive pretty consistent feedback, that’s a great process that we have and it gives us an advantage of our peer online competitor.

Matt J. Fassler – Goldman Sachs & Co.

Now historically there is a pro who prefer to do business locally rather than review, because relationships are convenience or what not. At moment think that your online ordering capabilities are substantially better than most of your local contract or your peers. Are you seeing the pro-customers responded off to the online capabilities here?

Marvin Ellison

We are seeing it pickup. I mean, there is an adoption period probably most effective way for pro to leverage online is to order product for early morning pickup. So buy online pickup in-store and that is specific for stock product. So if you think about our brick and mortar online, kind of interconnect the strategy, today is really three things, as buy online shift to stores, or you buying product that is an exclusive online product and shipping it to a local store, save your shipping charges and for bulky [ph] items or items you don’t want sitting on your front door step, it’s the way for you to just have it sent to your near store. Buy online pickup in-stores for stock items in the stores as you want to buy online and pick them up at your near store. And then as I mentioned buy online or return to store.

So if you are pro, you can leverage the buy online pickup in-store on the stock items, have it ready for you in the morning to pickup. We also just launched a new mobile app for pro-customers that has been very well received, that gives them the ability to have eReceipts to have the ability to have a specific list of your specific trace person like electrician or plumber and you buy the same products on a repetitive basis. You have your own personal list and you can check the in-stock position on any store in a geographic area. So, Matt, we are hoping that mobile app will continue to increase that adoption period.

Matt J. Fassler – Goldman Sachs & Co.

The other high level merchandising question I wanted to engage you on was private label. You’ve been in the private label private brand business for a while, but my sense is that you have, in fact, being consolidating your labels per say, can you talk about how that has come?

Frank Blake

First comment is we are a branded warehouse. We believe that brands are very important. They are very important to our pro-customers, they are very important to our consumers. So our efforts around our proprietary brands are more on the opportunistic side. We don’t plan to be turning over substantial portions of the store to private label brands.

Having said that, there are opportunities and just as you mentioned Matt, we are consolidating some of our brands. So we went through a period of time where almost every merchant had his or her own private label brand, we are really down to a handful of meaningful private brands and making more significant commitment in terms of the engineering around those brands, sourcing around those brands and the marketing around those brands whether it’s internal marketing to our associates or external market.

Matt J. Fassler – Goldman Sachs & Co.

Great. I wanted to talk for a moment about your – the drivers of your long-term margin assumptions. I have not asked you yet about supply chain that had sort of been the story for Home Depot, I would argue the most compelling part of the story really an enabler of so many other things that you’ve done well. Really Frank, since you took over the company, took over the CEO spot, how much more does this give you from an earnings or ROI perspective going forward?

Frank Blake

So we hopefully, fairly think, fairly clear as we set out our goals in 2015 for 12% operating profit and a 24% return on capital that, in fact, we are counting on the contributions on our supply chain. As you mentioned, we did a big effort around building out our, what we call our rapid deployment centers and those are all in place.

Our supply chain team is now going through the effort of optimizing those facilities and making sure that they are as productive as they can be. We are now also just launching at that, not the same magnitude as the RDCs, but we are building new direct fulfillment centers that will provide the stocking DC capabilities for basically our online business.

And so we have a lot of new capabilities that we are continuing to build out on our supply chain side. And I would say sort of an under appreciated element of the supply chain story has been all of the work around the central ordering what we call our automated replenishment system. And that's one that is just in continuing development as we get more and more sophisticated algorithms around how we do the ordering in our stores. It is the case that, if we have been sitting here five years ago, we would have set for a best while maybe get to 60% to 70% of the SKUs on central automated replenishment were up now over 95%

Marvin Ellison

That's right.

Matt J. Fassler – Goldman Sachs & Co.

As we think about the operating margin assumptions and the path that you gave us, I remember you have like three different stages of the housing recovery with some very specific terms that you essentially created to describe or what you thought that being with the contribution to GDP would be. Can you talk about where we were from a housing perspective at the time, you gave us that color and what stage do you think we are in now?

Frank Blake

Yeah. So when we laid this out, was in our Investor Conference in June, and I can’t remember exactly the additives, but I think we had moderate recovery sharp recovery. And we – where of the view we are in the moderate recovery phase and there are a set of variables that kind of determine where you are, one being household formation, so that's a positive.

We’re seeing household formation in the United States pickup, the other being housing turnover. So we’ve seen an improvement in housing turnover albeit from obviously very, very low levels. Housing price appreciation, so if you are doing kind of directional arrows, these are all positives. And then on credit availability, I would say, we are still in a constrained credit availability or world of constrained credit availability.

So that's been a moderating influence on the pace of recovery. So we still see, as I said a few minutes ago housing activity adding about give or take 250 basis points to our performance over and above GDP.

Matt J. Fassler – Goldman Sachs & Co.

And that was June 2012 just to be clear for that answer.

Frank Blake

Yes.

Matt J. Fassler – Goldman Sachs & Co.

Okay. So obviously we had this big pop in rates of late, mortgage rates are now double-digit percentage change up year-on-year. Can you talk about, I’m not going to ask you impact on housing, it’s kind of too abstract to your question. But has the consumer responded in any way to that reality?

Frank Blake

So I don't know in anyway, because we're just – we're a fraction of the overall consumer spend, what I would say as it relates to housing, so bringing it back to at least what we're more familiar with, as it relates to housing, I would say we're still at a point where although rates have obviously increased and home prices have increased from any historic perspective, housing affordability is still at very reasonable levels.

So we tend, I'd just suggest one way to look at this is as a consumer would look at it and really from a three-part perspective, what's the rate, what's the house price, and what's my credit availability? That kind of puts together the overall format.

Matt J. Fassler – Goldman Sachs & Co.

So there is a set of questions that we're asking all of our companies, like to tailor them to each company’s story. And the first relates to expectations for the environment, and the second half of the year relative to the environment that you experienced in the second quarter of the year, and I will just ask that out right to you.

Frank Blake

So we continue to see that housing is going to continue to recover that this will be a positive for us as we look at the back half. There is some specific things that we called out that are more or less unique to us or some to our space that decrement the rate of sales growth that we saw in the first half as we look at the second half, the most significant being were overlapping two seasons worth a very significant parking activity, so not only Hurricane Sandy and Isaac last year, but Hurricane Irene a year before and that's very significant commodity price inflation in our categories particularly lumber in 2012.

We don't expect that same degree of inflation and, in fact, we know it's not going to happen in 2013 in the back half. And then very specific to us, we introduced some new appliance brands in 2012, and so that improvement we're now overlapping, and so that kind of walks us down from where we exited at around 8% down to around 4%.

Matt J. Fassler – Goldman Sachs & Co.

Those appliance increases have legs do you think in other words cycle them you are done or is that a multiyear goal?

Frank Blake

Well, I would say the first general comment is appliances as a category is growing. So that's one of the categories that was hit fairly hard during the downturn, some of that related to obviously no new or very reduced rates of new homebuilding impacted our appliance vendors, but you are seeing some recovery in that durable category. And then the addition of brands for us helps us attack additional market segments that we weren't able to attack beforehand.

Matt J. Fassler - Goldman Sachs & Co.

Great. And 2014, do you feel like you have visibility at all to that?

Frank Blake

we will wait on 2014 till we lay out 2014.

Matt J. Fassler - Goldman Sachs & Co.

I would ask you about operating margin trajectory, but you have a long-term plan and you seem to be mapping to that, so I won't waste our time. Capital allocation actually an interesting one, you came to market last year, but I believe $3 billion in debt?

Frank Blake

3.25.

Matt J. Fassler – Goldman Sachs & Co.

And you've raised the buyback for the year a bit above what you had initially intended. I will ask you about general priorities for capital allocation. But I guess I'll ask you first, what drove the decision to come to market in size and do what you did here?

Frank Blake

Yeah. So there were two elements to the debt and one was, we have some debt that's coming due at the end of the year of 1.25 billion. So this was last week seemed like a good time to go out and address that. And then the additional $2 billion, we've tried to be very transparent over time in terms of what our capital allocation principles are.

One of them is, our leverage ratio of two times debt -to-EBITDA because of the performance of the business, we were significantly under that standard. And so we saw this as a good opportunity, again, we're not quite up at 2, but pretty close to 2 as you look out towards the end of the year.

Matt J. Fassler – Goldman Sachs & Co.

Great. I have some more questions, we also have roving mikes and we have the opportunity for those of you in the audience who are interested to raise your hands and step in. And so far we have no takers, and I’m going to keep going. Briefly on your Latin American operation, it's interesting Home Depot at the moment and time at different level of global exposure and aspirations, right now you've been very focused on the Southern Hemisphere Mexico couple of smaller operations in other geographies what do you see as the trajectory here?

Frank Blake

So first comment on our Mexican business, we love our Mexican business. It’s a great business. We have over 100 stores in Mexico. We started 11 years ago. We have had 39 quarters in a row of positive comp growth, so a great business. And then you go well what else and we're very pleased with our Canadian business, so we’ve had six quarters in a row of positive comp growth in Canada, we love our business in Canada give or take a 180 stores.

The issue for us in terms of international – other international opportunities is really reflected in the second quarter. So if you look at the second quarter for The Home Depot, in three months, we grew sales almost $2 billion. We grew sales in three months almost $2 billion. That's an enormous opportunity. We love our Mexican business. Our Mexican business by any measure has been a phenomenal success.

In 11 years that business is now give or take about a little north of $2 billion. So you go as you think about, as we think about it from a human resource perspective, capital allocation perspective, and all the rest where is our time and attention best spent, it’s best spent on improving the businesses that we now have.

Matt J. Fassler – Goldman Sachs & Co.

Great. We have one middle of the room first and then one up front.

Earnings Call Part 2:

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