The blood on the screen ran thick and fast for The Home Depot (NYSE: HD) after it released its Q4 2022 results on 21 February 2023. For the first time since the Covid pandemic, HD’s earnings beat consensus, yet the shares decline 7% after the results to close the day at $295.50.
We look at what the company has to say on its earnings call, to fathom if the market has overreacted.
Revenues and net income are up on a year ago – but only just
Revenues and income were both up on the corresponding quarter last year. At $3.30 per share, earnings beat market expectations of $3.28 per share.
Net income was $3.36 billion (compared to $3.35 billion in Q4 2021), on sales of $35.83 billion (compared to $35.72 billion in Q4 2021).
Earnings per share also increased 7.5% year-on-year to $16.69.
At $627, total sales per square foot of retail space is a new record for the company.
Operating margins are falling, and operating expenses are rising
Over the year, operating margins stand at around 15.3%, dragged by fourth-quarter operating margins of approximately 13.3%.
Over the year, operating expenses turned out to be around 18.3%. That’s a 13-basis point improvement from the previous year. However, interest and other expenses in the fourth quarter increased by $85 million to $408 million. The reason? The company’s debt position is now higher than it was a year ago.
As such, operating expenses in the fourth quarter has stretched to approximately 20% ─ an increase of 32 basis points on the same quarter in 2021.
HD increased its dividend and total return to shareholders
HD announced a quarterly dividend increase of 10% to $2.09. That equates to an annual dividend of $8.36 per share.
Over the fiscal year, HD has returned to shareholders:
- $7.8 billion in dividends
- $6.5 billion in share repurchases
CFO and Executive Vice President Richard McPhail confirmed that the board of directors “look to grow our dividend every year as we grow earnings.”
Dividends have now increased in each of the last 12 years.
Surely, so far, so good?
Revenues are up. Earnings are up. Okay, so margins are under a little pressure, but it’s still not disastrous. And the company has still been able to increase the dividend and total return to shareholders.
So, why the heavy hit to the share price?
The last four years have been great…
McPhail was quick to mention HD’s outstanding performance during the last four years, saying:
“From 2019 through 2022, we grew sales by $47.2 billion, a compound annual rate of 12.6%. During the first five quarters of this period, from the first quarter of 2020 through the first quarter of 2021, our sales were driven by significant ticket and transaction growth. This growth reflects factors unique to home improvement, as homeowners spent more time in their homes and took on more projects as they saw their homes significantly increase in value over that period.”
In this single paragraph, McPhail set us up for bad news. Worse though, his wording made it sound like it was the economy that drove exceptional performance, and not management – “growth reflects factors unique to home improvement”.
But the tide has turned rapidly…
McPhail led into the above commentary with a telling sentence:
“As we think about how 2023 might unfold, we think it’s helpful to look back on our performance since 2019.”
But, as we know, past performance is no guarantee of future returns. And the future doesn’t look very bright.
In setting targets for 2023, the company has considered how the home improvement market is changing:
- During the last few years, consumers’ spending on goods outstripped spending on services. This dynamic has reversed. Today, consumers are focused on creating experiences and traveling – a tidal wave of reaction to the restrictions placed upon them during the pandemic.
- The slowdown in the housing market has further restricted the consumer – who is now less able to borrow against the equity in their real estate.
And HD now expects a decline in earnings
With the shift from purchasing goods to spending on services, and assuming flat economic growth and consumer spending, HD expects 2023 to be a tough year. They are forecasting flat sales and a single-digit fall in earnings.
Inventories increased by $2.8 billion over the year to around $25 billion. Evidencing the rapidly declining market environment for HD, inventory turns are down to 4.3 times from 5.2 times last year.
Despite a 50% decrease in the cost of lumber in 2022, earnings will still be negatively impacted by inflation. If lumber prices stabilize at current levels, HD expects a hit of as much as 100 basis points to sales, and a significant impact on earnings.
Earnings will also be impacted by increased spending as the company strives to maintain customer loyalty through a challenging period. Ann-Marie Campbell, Executive Vice President, U.S. Stores and International Operations, said:
“We know that our associates are a key differentiator, and they are essential in helping us sustain the customer experience we strive for. In order to provide the best customer experience in home improvement, we must focus on cultivating the best associate experience in retail.
“So, what does this mean to us? This means not only investing in competitive wages and benefits, but also providing tools, training, and development opportunities that make working at The Home Depot an enjoyable and rewarding experience.”
Chairman, President, and Chief Executive Officer Ted Decker commented:
“The most important investment we can make is in our people, which is why we are announcing that we are increasing annualized compensation by approximately $1 billion for our frontline hourly associates. We believe this investment will position us favorably in the market, allowing us not only to attract the most qualified talent, but also retain the exceptional associate base that is already in place.”
The bottom line
Richard McPhail was asked if the investments that HD plan to make in 2023 would be scaled back if sales came in weaker than expected. The answer was an emphatic ‘no’. Spending isn’t penciled in, it’s been written in indelible ink. However, McPhail also said, “With respect to how we manage our P&L, we always operate with a degree of financial flexibility. And so, in any environment, we’re going to assess what that environment means for us and how we should manage the P&L.”
The bottom line is that we can expect flat revenues, weaker earnings, and maintenance of dividends.
But there is still a nagging feeling that HD are reacting to the market rather than being proactive in the market. Since 2019, the market has been more than kind to HD. The board has been able to take advantage and ride the tide to higher sales and profits.
The dividend yield is around 2.8%, and with a dividend payout of less than 45%, shareholders have a good degree of comfort that HD will be able to at least maintain their dividend during what could be a difficult period for the company.
However, with the shares trading at a PE ratio of around 18, those considering investing may benefit from holding back until the economic outlook is more certain