The Home Depot, Inc. (NYSE:HD) Q3 2023 Earnings Call Transcript

The Home Depot, Inc. (NYSE:HD) Q3 2023 Earnings Call Transcript November 14, 2023

The Home Depot, Inc. misses on earnings expectations. Reported EPS is $3.81 EPS, expectations were $3.82.

Operator: Greetings and welcome to The Home Depot Third Quarter 2023 Earnings Conference Call. [Operator Instructions]. It is now my pleasure to introduce your host, Isabel Janci. Please go ahead.

Isabel Janci: Thank you, Christine, and good morning, everyone. Welcome to The Home Depot’s Third Quarter 2023 Earnings Call. Joining us on our call today are Ted Decker, Chair, President and CEO; Ann-Marie Campbell, Senior Executive Vice President; Billy Bastek, Executive Vice President of Merchandising; and Richard McPhail, Executive Vice President and Chief Financial Officer. Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors. [Operator Instructions]. If we are unable to get to your question during the call, please call our Investor Relations department at 770-384-2387. Before I turn the call over to Ted, let me remind you that today’s press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to the factors identified in the release and in our filings with the Securities and Exchange Commission. Today’s presentation will also include certain non-GAAP measures. Reconciliation of these measures is provided on our website. Now let me turn the call over to Ted.

Edward Decker: Thank you, Isabel, and good morning, everyone. Sales for the third quarter were $37.7 billion, down 3% from the same period last year. Comp sales declined 3.1% from the same period last year and our U.S. stores had negative comps of 3.5%. Diluted earnings per share were $3.81 in the third quarter compared to $4.24 in the third quarter last year. The third quarter was in line with our expectations. Similar to the second quarter, we saw continued customer engagement with smaller projects and experienced pressure in certain big-ticket discretionary categories. In addition, lumber and copper and wire deflation and storm-related overlaps negatively impacted results in the quarter. Billy will discuss these and other business trends shortly.

During the third quarter, our Pro customer outperformed our DIY customer. While internal and external surveys suggest that Pro backlogs are lower than they were a year ago, they are still healthy and elevated relative to historical norms. There is only 1 quarter left in the year, we believe the endpoints for our previous guidance range are no longer likely outcomes. As a result, and as we announced in this morning’s press release, we narrowed our guidance range for fiscal 2023. Richard will take you through the details in a moment. As we’ve discussed, this year reflects a period of moderation. However, we are confident in our ability to navigate through this unique environment. We remain very excited about our strategic initiatives and are committed to investing in the business to deliver the best interconnected shopping experience, capture wallet share with the Pro and grow our store footprint.

As we discussed at the investor conference in June, we continue to invest and focus on creating a frictionless interconnected shopping experience for our customers. We are pleased with the progress we are making. homedepot.com is one of the largest retail websites in the United States, and our digital app is one of the most highly rated in all of retail. And yet, we believe there is still opportunity to reduce pain points across the shopping journey. Our teams are identifying areas of improvement like better communication throughout the shopping journey and an easier returns process and the ability to seamlessly and intuitively make changes to an order once placed. For our Pros, we’re investing in a multitude of initiatives. We remain focused on building out our unique ecosystem of products and services.

As a result, we are evolving our organizational structure and recently elevated Ann-Marie Campbell to Senior Executive Vice President, better aligning our outside sales and service business in the global stores organization. Pro is one of our biggest growth opportunities, and this organizational change will allow us to better serve them by leveraging our full ecosystem of expertise, product assortment, fulfillment and operations. Our merchants, store MET teams, supplier partners and supply chain teams did an outstanding job delivering value and service to our customers throughout the quarter, and I’d like to close by thanking them for their dedication and hard work. In addition, the Home Depot is proud to have tens of thousands of veterans, service members and military spouses and orange aprons.

Last week, we announced The Home Depot Foundation surpassed the goal of $500 million invested in veterans causes and also increased the total commitment to $750 million by 2030. And with that, I’d like to turn the call over to Anne.

Ann-Marie Campbell: Thanks, Ted, and good morning, everyone. Let me start by saying that I’m very excited about my new role and the alignment this will create between the outside sales and services business and the global store organization. As you heard at our investor conference in June, capturing a greater share of the Pro’s wallet is one of our largest growth opportunities. It represents roughly $475 billion in addressable market, and today, we have relatively little share. The beauty of The Home Depot is that we have unique competitive advantages. Our convenience stores, our leading brands, our engaged associates, our expansive fulfillment options that are unmatched and that can be leveraged for the benefit of our customers.

And that’s exactly what we aim to do. To do that, our new organizational structure will create stronger momentum with our teams to drive success with the Pro. Hector Padilla will focus on improving the experience for Pro’s shopping in our stores. His 29-year tenure and knowledge of our store operations and new Pro capabilities will be instrumental in achieving our goals. And Chip Devine, our Head of Outside Sales, brings nearly 30 years of distribution experience. He will work on building out capabilities to better serve more complex private needs. Ultimately, we must focus on removing friction within our operations, so our customers have a great experience every single time no matter how they choose to shop with us, whether in the aisles of our stores, picking a product at the store, receiving product at their job site with a sales associate or digitally.

We know that most of our Pros use many of these capabilities across our ecosystem when shopping with us. For us, we are building trust and a partnership that lasts for decades and across generations. This means we have to work hard to deliver a great experience regardless of their point of interaction. As you know, we have identified additional growth opportunities with the Pro, which requires us to invest in new capabilities and functionalities across the business. Think about the initiative we are undertaking with the complex Pro. This customer interacts differently. They are accustomed to interacting with their suppliers in a different way than our traditional business model. Pros working on complex projects want to reserve product, use trade credit and have products delivered to their job site in a staged manner.

While these capabilities exist in the market today, we are incorporating them in our full ecosystem to serve Pro customers in a way no one else can. I could not be more excited about the opportunity that lies ahead. And for the in-store experience, over the last several years, we have talked about the importance of in-stock, and ultimately, on-shelf availability or OSA. Having the right products in stock in the right quantity and on the shelf available for purchase is critical, and we’ve implemented several initiatives to help us do this more effectively and efficiently. In the past, we’ve talked about GSR or get stores right. GSR drives productivity by using our proprietary space allocation model coupled with our tenured field merchandising teams to determine which categories to invest in on a store-by-store basis.

More recently, we have talked to you about our rollout of Sidekick and computer vision. Using machine learning technology, computer vision helps our associates quickly find de-palletized product in the overhead and Sidekick helps direct associates to key bays where OSA is low or outs exist. Today, these tools have been deployed across all U.S. stores. And while early days, they have driven meaningful improvement in our on-shelf availability. The beauty of these initiatives is that they also drive productivity. They make it easier for associates to restock product, have a greater depth of high-velocity product and ensure we remain in stock with more products on the shelf and available for sale. As a result, we enable our associates to focus on the most important tasks and allocate more time to deliver a better shopping experience.

These are just a few examples of the many different types of initiatives that can drive significant value for our customers, our associates and our shareholders. Despite a challenging year, our amazing associates have remained engaged and ready to serve our customers, and I want to thank them for all they do. With that, let me turn the call over to Billy.

William Bastek: Thank you, Ann, and good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their ongoing commitment to serving our customers and communities. As you heard from Ted, during the third quarter, our sales were in line with our expectations. However, we did have some unfavorable impacts from core commodity deflation and storm-related overlaps. We saw the continuation of the trend that we have been observing throughout the year with softness in certain big-ticket, discretionary-type purchases. Instead of engaging in larger projects, customers continued to take on smaller projects. Turning to our department comp performance for the third quarter. Our Building Materials department posted a positive comp and 7 of our remaining 13 merchandising departments posted comps above the company average, including plumbing, appliances, hardware, outdoor garden, millwork, tools and paint.

During the third quarter, our comp transactions decreased 2.7% and comp average ticket decreased 0.3%. Excluding deflation from core commodities, we experienced comp average ticket growth, primarily driven by demand for new and innovative products. Deflation from core commodity categories negatively impacted our average ticket growth by approximately 60 basis points during the third quarter, driven by deflation in lumber and copper. During the third quarter, we continued to see a decline in lumber prices relative to a year ago. As an example, on average, framing lumber was approximately $420 per thousand board feet compared to approximately $545 in the third quarter of 2022, representing a decrease of over 20%. Big-ticket comp transactions or those over $1,000 were down 5.2% compared to the third quarter of last year.

We continue to see softer engagement in big-ticket discretionary categories like flooring, countertops and cabinets. However, we saw big ticket strength in Pro-heavy categories like roofing, insulation and portable power. Turning to total company online sales. Sales leveraging our digital platforms increased approximately 5% compared to the third quarter of last year. We continued to invest in the digital experience across our website and app and released a variety of enhancements in the third quarter. These range from simple improvements to help customers track orders to more complex things like updating our search and recommendation algorithms. For those customers that transacted with us online during the third quarter nearly half of our online orders were fulfilled through our stores.

During the third quarter, we hosted our Annual Labor Day appliance in Halloween events, and we’re pleased with the results. In appliances, we were encouraged with the customers’ engagement during the event. And 2023 was another record sales year for our Halloween program, both in-store and online, as our customers continued to add to their collection with our unique and exclusive product assortment. As we turn our attention to the fourth quarter, we intend to continue this momentum with our annual holiday, Black Friday and gift center events. In our gift center, we continued to lean into brands that matter most for our customers with our assortment of Milwaukee, RYOBI, Makita, DEWALT, RIDGID, Husky and more. We will have something for everyone, whether it’s our wide assortment of cordless RYOBI tools, DEWALT Atomic Drill and impact kits or our new Milwaukee M18 FORGE batteries.

These new M18 FORGE batteries will be a game changer for our Pro customer, providing the most powerful fastest-charging and longest life of any battery on the Milwaukee M18 platform. This quarter, I’m also excited to announce the addition of WAGO to our powerhouse assortment of Pro brands including Milwaukee, USG, Custom Building Products, Leviton and QEP to name a few. It is these strategic vendor relationships that make us the product authority in home improvement and the addition of WAGO will help extend our position. WAGO is one of the top requested most innovative Pro brands in the wire connector segment that features a releasable level log wire connector that speeds up installation and save space in tight applications. We recently launched a number of SKUs in our stores, which are exclusive to The Home Depot in the national big box retail channel.

Our merchandising organization remains focused on being our customers’ advocate for value. This means continuing to provide a broad assortment of best-in-class products that are in stock and available for our customers when they need it. We will also continue to lean into products that simplify the project, saving our customers time and money. That’s why I’m so excited about the innovation we continue to bring to the market. With that said, I’d like to turn the call over to Richard.

Richard McPhail: Thank you, Billy, and good morning, everyone. In the third quarter, total sales were $37.7 billion, a decrease of approximately $1.2 billion or 3% from last year. During the third quarter, our total company comps were negative 3.1% with comps of negative 2.1% in August, negative 3.4% in September and negative 3.7% in October. Comps in the U.S. were negative 3.5% for the quarter with comps of negative 2.5% in August, negative 3.8% in September and negative 4.1% in October. In local currency, Mexico and Canada posted comps above the company average. It is important to note that adjusting for storm-related overlaps and some seasonal shift, monthly comps were relatively consistent across the quarter. In the third quarter, our gross margin was 33.8%, a decrease of approximately 20 basis points from the third quarter last year, which was in line with our expectations.

During the third quarter, operating expense as a percent of sales increased approximately 120 basis points to 19.4% compared to the third quarter of 2022. Our operating expense performance during the third quarter reflects our previously executed compensation increases for hourly associates as well as deleverage from our top line results. Our operating margin for the third quarter was 14.3% compared to 15.8% in the third quarter of 2022. Interest and other expense for the third quarter increased by approximately $30 million to $438 million. In the third quarter, our effective tax rate was 23.3%, down from 24.4% in the third quarter of fiscal 2022. Our diluted earnings per share for the third quarter were $3.81, a decrease of 10.1% compared to the third quarter of 2022.

During the third quarter, we opened 7 new stores, bringing our total store count to 2,333. Retail selling square footage was approximately 242 million square feet. At the end of the quarter, merchandise inventories were $22.8 billion, down $2.9 billion or 11% compared to the third quarter of 2022. And inventory turns were 4.3x flat to 1 year ago. Turning to capital allocation. After investing in our business and paying our dividend, it is our intent to return excess cash to shareholders in the form of share repurchases. During the quarter, we invested approximately $670 million back into our business in the form of capital expenditures. And during the quarter, we paid approximately $2.1 billion in dividends to our shareholders, and we returned approximately $1.5 billion to shareholders in the form of share repurchases.

Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was approximately 38.7%, down from 43.3% in the third quarter of fiscal 2022. Now I will comment on our guidance for fiscal 2023. As you heard from Ted, with one quarter remaining in fiscal 2023, we no longer expect the end points of our previous guidance range as likely outcomes, and therefore, we are narrowing our guidance for 2023. We expect fiscal 2023 sales and comp sales to decline between 3% and 4%. We are targeting an operating margin between 14.2% and 14.1% for the year. Our effective tax rate is targeted at approximately 24.5%. We expect interest expense of approximately $1.8 billion. And we are anticipating between a 9% and 11% decline in diluted earnings per share compared to fiscal 2022.

In addition, as you heard from Ann, we continue to focus on driving productivity in the business. We have taken a number of actions that will help us realize the previously announced $500 million in annualized cost savings in 2024 and are fully confident that we will deliver on this commitment. We also remain focused on meeting the needs of our customers with our leading product authority in home improvement, strong in-stock levels and knowledgeable associates. We will continue to prudently invest to strengthen our competitive position and leverage our scale and low-cost position to outperform our market and deliver shareholder value. Thank you for your participation in today’s call. And Christine, we are now ready for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from the line of Simeon Gutman with Morgan Stanley.

Simeon Gutman: In thinking about inflections and when we might see one, looking at the spread maybe between DIY and Pro is the story of this quarter that maybe DIY has stabilized, but the Pro is getting a little bit worse? And then if that’s right, and feel free to correct if that’s wrong, would that mean that it could take a little longer than for the Pro sort of normalizing to play out? And actually, the overall comp could get a little worse before it gets better?

Edward Decker: Thanks for the question. I would say Pro and consumer, it had the narrowest performance gap in some time. So they both performed reasonably well. If you step back and look at the quarter, we feel really good about the third quarter and we narrowed our comp guidance for the year because of that. And in fact, if you look at the performance of the business overall this year, if you look at the seasonality of Q1 and Q2, we’re pretty smooth in that minus 3% comp through the first 3 quarters of this year, and that’s normalized for weather and storms and commodity price deflation. And then our regional businesses are also pretty consistent. We’ve seen the least variability in regions. And as I said, the narrowest gap between Pro and consumer.

We had really good seasonal sell-through. And as prices have settled with abating deflation, we feel pretty good about that. And our operations are increasingly getting back to normal. The supply chain is operating very well. Our inventory positions are better. Our in-stock rates are much better, as Ann took you through all the things we’re doing in the store to improve on-shelf availability. Our value propositions, as Billy mentioned, are in great shape and product innovation is better than it’s ever been. And the wage investments are paying off. Our attrition is way down. And with that attrition being down, our associates have had more time in the store, their ability to serve customers has improved. So all of that really is what delivered that consistent comp throughout the year.

But to answer your specific question, as we sit here feeling really good about the operations, the share shift of PCE from pre-COVID to today has not completely reverted and we’re still not exactly sure where that reverts to. The asset class for home improvement is worth $15-odd trillion more than it was pre-pandemic. And we know now that the Fed definitely has a higher-for-longer monetary posture and that’s going to continue to pressure durable goods, in financing or motivation for larger home improvement projects. So as we said, we see great engagement, engagement in seasonal goods, engagement with smaller projects. It’s the larger projects are a bit down at the moment. So that’s what we’re watching. I mean we’re not obviously talking about 2024 today, but lots of good news in the operations of the business.

Great news with still a very resilient customer. I mean we just came off of 4.9% GDP in Q3, driven by the consumer. But as you know, we’re looking at it this year, this period of moderation for home improvement spend. But I couldn’t feel better about the business and our operations overall.

Simeon Gutman: And then maybe the follow-up, you mentioned GDP. Given that home prices seem to be pretty sticky even with pretty weak turnover and may not get any better, how should we think about GDP — should we revert to GDP as maybe a better proxy for how the business could do?

Richard McPhail: Simeon, this is Richard. We have tried to take the most thoughtful approach possible in — over the last few years of what the drivers of the business are and those things that indicate to us how we have settled back out of the pandemic period, and that’s why we focused on share of PCE. Like Ted said, we’re not going to talk about 2024 today. There is an underlying kind of layer of economic activity that supports the business. But as Ted pointed out, number one, we still haven’t reverted all the way back to 2019 levels of PCE share. And the Fed stance of higher-for-longer has had and could have increasing pressure on the outlook for durables and housing-related spend. So like Ted said, that’s what we’re watching at the moment. And we will talk about 2024 when we get to our call next quarter.

Operator: Our next question comes from the line of Zach Fadem with Wells Fargo.

Zachary Fadem: Richard, considering all the ins and outs of your cost base this year with wage investments, you’ve got the legal settlement in Q1 plus the cost saves next year, is it fair for us to assume your operating margins can expand in 2024? Or is there a certain level of comp that you will need to see to hold this 14%-plus margin?

Richard McPhail: Thanks for that question. Margin expansion is largely a function of top line growth. There is a point there in the low positive comp digits where you see expense turn from deleverage to leverage. We’re not going to take on 2024 guidance today. What we have done is we have put in place measures, and in fact, now have essentially completed actions that will provide us with a $500 million cost buffer heading into 2024. And so regardless of the outlook, that provides some buffer in margin.