HD Earnings Mixed, but We're Waiting for the 'Lowe's-down' on Wednesday

Home Depot (HD)  on Tuesday before the opening bell reported a mixed headline result with its third-quarter earnings. Sales of $27.2 billion (+3.5% year-over-year) came in light against the $27.53 billion consensus and adjusted earnings per share of $2.53 beat the consensus by one penny.

Looking at comparable sales, Home Depot saw a 3.6% increase at the company level against consensus expectations of 4.6% growth, while U.S. comps grew 3.8% against expectations of 4.7%. The pace of growth slowed as Home Depot moved through the quarter, with total company comps of 4.1% in August; 3.7% in September; and 3.1% in October with U.S. comps of 4.4% in August; 3.9% in September; and 3.3% in October.

"Our third quarter results reflected broad-based growth across our business, yet sales were below our expectations driven by the timing of certain benefits associated with our One Home Depot strategic investments," CEO Craig Menear said in the press release. "We are largely on track with these investments and have seen positive results, but some of the benefits anticipated for fiscal 2019 will take longer to realize than our initial assumptions." 

The chief executive went onto say that Home Depot is now updating its fiscal 2019 sales guidance, and is "reaffirming" its fiscal 2019 earnings-per-share guidance.

During the conference call, we got an example of how some of the One Home Depot strategic investments have progressed a bit slower than expected. For example, management spent some time discussing how some of the necessary unwinding of legacy IT systems have been more complicated than previously anticipated and that has delayed the rollout of some features. In total, management anticipated about a 100-basis point sales lift related to the investments, however, the early returns have been closer to 50 basis points.

Before we rush to judgement on execution, it's imperative to consider how some investments are performing above management's internal expectations. For example, management cited strength in homedepot.com, where online traffic growth was called "healthy" with strong conversion as online sales increased 22% year-over-year. Additionally, management discussed benefits related to their "interconnected experience" and from their digital platforms.

As we look further to the customer-experience perspective, more than half of online U.S. orders were picked up in store, and the rollout of automated lockers continue to make pickup easier and more convenient.

Taking a look at how Home Depot's many departments fared, comps in appliances, indoor garden, décor and storage, hardware, tools, outdoor garden, paint, and plumbing were above the company average. All other departments, except for electrical and lumber, were positive, but below the company average. Electrical came in flat due to light bulbs and deflation in copper, while lumber was challenged once again by commodity price deflation. In the third quarter, lumber reported a low single-digit negative comp, though there was some strong unit comp growth.

As for some other operating metrics, customer transactions were $400.9 million, up 1.5% year-over-year. Meanwhile, the average ticket increased 1.9% year-over-year to $66.36. Negatively impacting average ticket growth was the commodity deflation in lumber and copper -- a 80 basis point headwind in the quarter. Home Depot's sales per square foot came in at $449.17, increasing 3.5% year-over-year.

On the capital allocation front, management repurchased $1.25 billion worth of stock in the quarter, the same amount as the first and second quarter, thanks to a combination of open market transactions and an accelerated share repurchase program.

As for some general topics, management cited increased costs from tariffs and remains cautious about how tariffs could impact the consumer. On the housing market in general, Menear called the industry "healthy and stable" with the recent move in interest rates a creator of "support for that stability."

Looking at the rest of fiscal 2019, management now expects sales to increase 1.8% and comp sales to increase 3.5% (compared to 3.9% consensus expectations). These two figures were both negatively revised from prior expectations for 2.3% sales growth and comp sales growth of 4%. This comp guidance implies fourth quarter comp growth of roughly 5%, representing a solid acceleration from this quarter, but of course down from prior consensus expectations of 5.5%. When asked about its confidence in this 5% guide, management cited an absence or reversal of pressure of third quarter headwinds such as lumber deflation, foreign currency exchange, and event-timing shift. Bottom line expectations were held steady with management maintaining its earnings per share outlook of $10.03 (compared to $10.13 expectations). We'll get an initial look at 2020 guidance at Home Depot's Investor Day event in December.

When asked how the company knows the sales miss was driven by the initiatives taking longer than expected and not a slowing macro, management cited the broad-based growth it sees in the business with "great strength" in ticket transactions and big ticket transactions. "And when we look at what happens in discretionary spend categories, particularly at our high ticket discretionary spend," Menear said on the call, "we don't see anything there that concerns us at this point."

Home Improvement peer Lowe's Companies will report earnings Wednesday, and analysts will likely say it is taking share from Home Depot, if the quarter is good. And if the quarter fails to deliver, well there may be more talk of how a slowing macro has hurt the industry.

Though we are tempted to upgrade shares back to a One on this decline, we see a reason to wait at least until Wednesday. Home Improvement peer Lowe's Companies (LOW) will report earnings then, and analysts will likely say it is taking share from Home Depot, if the quarter is good. And if the quarter fails to deliver, well there may be more talk of how a slowing macro has hurt the industry.

Overall, the quarter was a disappointment with comps missing and sales coming in sluggish. While positioning matters and HD had a tough set up into the print with shares recording a new high yesterday, we expect shares will remain under pressure Tuesday due to the guidance revision.

After previously trimming shares around $234 in our Alert here, we are tempted to upgrade our rating to a One and repurchase what we sold higher on this decline, especially considering a roughly 5% pullback in a high-quality name like HD is incredibly rare. But we do see a reason to wait at least until Wednesday. Home Improvement peer Lowe's Companies will report earnings then and analysts will likely say they have taken share from Home Depot if the quarter is good. And if the quarter fails to deliver, well there may be more talk of how a slowing macro has hurt the industry. Even though management mentioned on the conference call how third-party data indicated they took "significant" share in the third quarter, we want to keep Lowe's squarely on our radar.