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Why Home Depot's Second Quarter Was Better Than It Looked

Despite a rough second-quarter earnings report last month, Home Depot's (NYSE: HD) stock price has risen about 7.5% since Aug. 21 -- as if it were a high-flying growth stock -- while the S&P 500 index is up about 3.2% over the same period. In Q2, the giant home improvement retailer saw revenue rise to $30.8 billion, an increase of only 1.2% year over year, and earnings per share (EPS) grow to $3.19, a 3.9% increase over last year's second quarter.

On top of the tepid growth, the company lowered its 2019 full-year guidance from an approximate 5% same-store sales growth to only 4% growth in this key metric. It's only natural for investors to wonder why shares have shown so much strength in the wake of such mediocre results.

While any stock fluctuation over a short time is fairly meaningless, I believe a strong case can be made that Home Depot's shares are up precisely because the long-term picture is still intact. Allow me to explain.

Home Depot is refurbishing its store layouts and introducing pickup lockers to its stores. Image source: Home Depot.

What went wrong?

In the company's quarterly conference call, Home Depot's management credited two factors for the tepid growth: wet weather and lumber prices. CFO Carol Tome said weather squeezed comparable sales by about 0.5 percentage points, and lumber prices had a 1.1-percentage-point downward impact. As for the weather, management said that for some categories, once the weather improves, pent-up consumer demand is released and sales are made up in later weeks and months. For other categories, however, opportunities are lost forever, not just delayed.

Lumber price deflation also hurt Home Depot's quarter and was mentioned a whopping 23 times during the call. To illustrate just how much the lumber price decreases were hurting sales, management explained that a 4-foot-by-8-foot oriented strand board sold for about $8 in 2019's first quarter, more than 50% below 2018's prices. In Q2, the price dropped another 5% to an average of $7.60.

The nature of these factors, essentially bad weather and commodity price deflation, are far outside of Home Depot's control. The things that Home Depot could control in the quarter looked much better.

What went right?

Home Depot continues to invest heavily in removing friction from its omnichannel shopping experience, where the lines between online and in-store shopping are increasingly blurred. For stores, the company has concentrated on improving checkout times and ease of navigation. In this effort, the company has now:

  • Introduced pickup lockers for online orders in 1,100 locations.
  • Made front-end store improvements designed to get the customer in and out quicker in 400 store locations.
  • Incorporated digital price tags in the appliances department, allowing customers to see product reviews and ratings before making a large purchase.

As these improvements are implemented, Home Depot continues to see customer satisfaction scores increase in cleanliness, customer service, and checkout time.

On the digital front, the home improvement retailer has improved its site's search and functionality, resulting in higher traffic and better sales conversion. Of course, the biggest e-commerce hurdle is an effective logistics infrastructure. To this point, CEO Craig Menear stated:

During the quarter, we completed the retrofit of our Hagerstown [Maryland] facility into a parcel direct fulfillment center, which expands our one-day delivery capabilities on stock parcel goods from approximately 30% to approximately 50% of the U.S. population. We also drove productivity and cost out through our mechanization efforts in our upstream supply chain. We are on track with our plans to create the fastest, most efficient delivery network in home improvement and are pleased with the progress that we have made thus far.

Both the digital and physical improvements seem to be paying off, as online sales in Q2 increased 20% year over year. About 50% of online orders were picked up in stores, pointing to an effective omnichannel shopping experience.

What's the verdict?

There are numerous macroeconomic factors far outside of Home Depot's control, many of which can easily affect the company's share price -- over the short term. These factors can range from the housing market and interest rates to tariffs and weather. This quarter, commodity prices bit the company's performance. Next quarter, it could be tariffs or interest rates, things that are nearly impossible to know or predict.

These factors have always played a role in the company's stock price, and yet, over the last 10 years, Home Depot's stock is up more than 720% -- an undeniably incredible performance. With few exceptions, great businesses usually excel over the long term. Home Depot is making the right investments, thinking of the shopping experience across its mobile, digital, and physical channels.

Based on the company's full-year guidance, shares are trading at a forward P/E ratio of about 22.7. For a company investing heavily in its customer shopping experience even though it's already the top business in its industry, that doesn't seem to be too much of a premium. As a shareholder, I am happy to hold my shares through these short-term concerns, as long as the company continues to do so well with those things it can control.

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Matthew Cochrane owns shares of Home Depot. The Motley Fool has the following options: short February 2020 $205 calls on Home Depot and long January 2021 $120 calls on Home Depot. The Motley Fool recommends Home Depot. The Motley Fool has a disclosure policy.


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