We are maintaining our $33 per share fair value estimate after incorporating HD Supply’s (HDS) fiscal fourth-quarter results into our valuation model. The narrow-moat industrial distributor finished its fiscal year on a high note with fourth-quarter sales and earnings both topping prior-year actuals and consensus estimates. Fourth-quarter sales increased 3.2% to $1.634 billion (versus $1.629 billion consensus), while adjusted EPS increased $0.17 per share to $0.44 per share (versus $0.43 consensus). HD Supply’s sales growth trajectory for fiscal 2017 is off to a great start with preliminary February sales up more than 6% year over year. Still, the company’s shares edged lower after its earnings release, which we think was mainly due to the company’s soft first-quarter EBITDA guidance of $212.5 million at the midpoint versus $215 million last year.
All of HD Supply’s segments contributed to the company’s sales growth during the fourth quarter. Construction and Industrial sales were up 4.3%, Waterworks sales were up 3.4%, and Facilities sales were up 2.3% over the year-ago quarter. Consolidated EBITDA margin declined 20 basis points to 10.3% as Construction and Industrial margin expansion (up 100 basis points year over year) was more than offset by margin compression within the company’s other segments.
HD Supply’s free cash flow generation improved substantially in fiscal 2016, coming in at $432 million versus $336 million. The company made progress on reducing its leverage by paying down $200 million on its outstanding term B-1 loans ($639 million remains). Although HD Supply’s net leverage remains elevated at about 4 times fiscal 2016 EBITDA, we think the company will continue to utilize its growing free cash flow to pay down debt, and we estimate the firm will reach its target net debt/EBITDA ratio of below 3 times by early 2018.
Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.