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Can Home Depot's (HD) Integrated Strategy Help Win Laurels?

Zacks Equity Research

Home Depot Inc.’s HD growth story has been robust over the years, owing to its efforts to provide an interconnected shopping experience to customers, with innovative products and improved productivity. Further, its efforts to simplify the Pro shopping experience and improve engagement through services like tool rental, delivery and the new B2B online experience have been aiding sales over the past several quarters.

These efforts are well reflected in the company’s record of positive earnings surprises for more than five years, with steady improvement in revenues and earnings per share. Apart from progress on investments, a favorable U.S. consumer backdrop and a steady housing market are supporting its growth trajectory. Consequently, the company is nearing financial goals outlined in December 2017.

Factors Supporting Growth

Home Depot is witnessing significant benefits from the execution of the “One Home Depot” investment plan, focused on delivering an interconnected shopping experience to customers. In-store investments under the plan mainly focus on easy customer navigation through the store aisles and increased speed to checkout. The company enhanced navigation through the introduction of a way-finding sign and store refresh package in more than 1,400 U.S. stores. These along with front-end store investments to optimize labor and merchandise space productivity led to improved customer satisfaction scores and conversion rates in stores.

Further, the introduction of digital price labels in the appliance department has enhanced store shopping experience as customers can now view the online ratings and reviews in the stores as well. Though physical stores are the keys to its business, the company identifies that many of in-store purchases are the result of online visits.

Additionally, nearly 50% of online orders in the United States are picked up from stores, reflecting the relevance of stores amid the growing popularity of e-commerce. The blended customer engagement across both channels forms the basis for the company’s integrated retail strategy that connects offline and online channels.

On the digital front, it is investing in its website and other applications to further enhance online customer experience. It is witnessing higher traffic, better conversion and continued sales growth in the digital business through improved search capabilities, site functionality, category presentation and product content.

Moreover, the company continues to roll out automated lockers in stores to make picking up of online orders easier and convenient. Currently, automated lockers are available in about 1,100 stores. Notably, stores with these lockers witnessed an increase of 250 basis points (bps) in checkout scores compared with stores without lockers.

The company is also making efforts to leverage the digital business to boost sales for new categories like HD Home pool and workwear. The investments across the digital and physical assets are likely to drive its productivity growth apart from boosting customer experience.

Furthermore, Home Depot’s Pro segment is a key growth driver, with Pro sales outpacing DIY (do-it-yourself) sales for the past several quarters. Strength in this business also places it in an advantageous position amid other home improvement peers like Lowe’s Companies Inc. LOW, Lumber Liquidators Holdings Inc. LL and Beacon Roofing Supply, Inc. BECN.

The company’s Pro segment is benefiting from its efforts to enhance service capabilities for the Pros. It is focused on simplifying the Pro shopping experience and expanding engagement through services like tool rental, delivery and the new B2B website. The B2B platform brings a more personalized experience to Pro customers based on customer feedback. The company expects to roll out the new Pro online experience to more than a million Pros by 2019.

Additionally, the company equipped store personnel with several tools to better understand Pro customers. The latest among these tools is the My View system, which enables associates to access customer data, allowing them to work proactively to better serve Pro customers.

Near-Term Hurdles

Though the company’s long-term growth prospects remain intact, we note that lumber prices have declined significantly in the past year, which partly hurt sales and comparable sales (comps) in the second quarter of fiscal 2019. Notably, lumber price deflation hurt comp growth by nearly $340 million (or more than 100 bps) in the fiscal second quarter. Moreover, the company expects lumber deflation to continue remaining a drag on the top line in the quarters ahead.

Moreover, it fears that potential impacts of the recently enacted tariffs on U.S. consumers might hurt sales performance. Considering these factors, the company slashed its sales and comps view for fiscal 2019. It now expects sales growth to be nearly 2.3% in fiscal 2019 compared with 3.3% rise stated earlier. Comps (for the comparable 52-week period) are now anticipated to rise 4% compared with 5% growth mentioned previously.

Further, the company’s margins look troubled, with gross margin contracting 20 bps in second-quarter fiscal 2019 due to impacts of changes in the mix of products sold and higher supply-chain costs. The increase in supply-chain costs mainly resulted from startup costs linked with the company’s One Home Depot supply-chain initiative. Additionally, operating expenses were nearly flat as impacts of the strategic investment plan-related costs were nearly offset by efficient expense management initiatives. Moreover, operating margin declined 20 bps mostly due to soft gross margin.

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