The Home Depot, Inc. (NYSE:HD) Q4 2022 Earnings Call Transcript

The Home Depot, Inc. (NYSE:HD) Q4 2022 Earnings Call Transcript February 21, 2023

Operator: Greetings and welcome to The Home Depot Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. 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 Home Depot’s fourth quarter and fiscal year 2022 earnings call. Joining us on our call today are Ted Decker, Chair, President and CEO; Jeff Kinnaird, Executive Vice President of Merchandising; Ann-Marie Campbell, Executive Vice President of US Stores & International Operations; 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. And as a reminder, please limit yourself to one question with one follow-up. 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 presentations 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.

Ted Decker: Thanks, Isabel, and good morning, everyone. Fiscal 2022 was another record year for our business, as we achieved $157.4 billion in sales. We added over $6 billion in sales and increased diluted earnings per share 7.5% versus last year to $16.69. Over a three-year period, we have grown sales by over $47 billion and delivered diluted earnings per share growth of over 60%, while investing in the long-term health of our business. Throughout fiscal 2022, we continue to face reduced friction for our customers to improve the shopping experience. As Anne will discuss, we invested in an improved customer and associate experience in our stores by implementing a new store leadership structure. We also drove productivity within the four walls of our store through our Get Stores Right, or GSR space optimization initiative, and we’ve implemented new tools and technology in stores to reduce complexity for associates and improve customer service.

We’re also pleased with the traction we are seeing in our interconnected business. We’ve seen increased app engagement, downloads, conversion, as we’ve rolled out several enhancements, including an improved online experience for our Pro loyalty program, seamless connectivity for our military program and the launch of our new store mode feature, which makes store navigation and product interaction easier. We are very pleased with the continued progress on our supply chain build-out, as we reached an important milestone earlier this year. All our appliance delivery volume is now managed through our market delivery operations, significantly improving the customer experience. In the near term, we continue to navigate a unique environment. Throughout most of fiscal 2022, we observed a resilient customer, who is less price sensitive than we would have expected in the face of persistent inflation.

In the third quarter, we noted some deceleration in certain products and categories, which was more pronounced in the fourth quarter. This along with the negative impact from lumber deflation led to fourth quarter comps that were slightly softer than anticipated. We are closely monitoring our elasticities and trends across the business and believe we have the tools team and experience to manage in any environment. This team has been effectively navigating the unprecedented growth in the last three years and I have full confidence in their ability to execute as we go forward. The investments in our associates, stores, digital platforms, supply chain, technology and other strategic initiatives have strengthened our business and enabled us to grow share and deliver exceptional shareholder value over the long-term.

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. Today, our Board approved a 10% increase in our quarterly dividend to $2.09 per share which equates to an annual dividend of $8.36 per share. Turning to 2023. We are targeting approximately flat comp sales and a mid single-digit percent decline in diluted earnings per share compared to last year. Richard will take you through the details in a moment.

While we expect this to be a year of moderation in demand for home improvement, we believe that the long-term underpinnings of our market remains strong and we are well positioned to leverage our distinct competitive advantages to capitalize on compelling growth opportunities in our space. I could not be more pleased with the resilience and strength that our associates have continued to demonstrate and I want to thank them and our supplier partners for their hard work and dedication to serving our customers and communities. Now I’m going to turn it over to Ann-Marie Campbell, Executive Vice President of US Stores and International Operations to share a little more on how we are taking care of our associates and continuing to enhance the customer experience.

Ann-Marie Campbell : Thanks Ted, and good morning everyone. I’m very excited to have the opportunity to spend a few minutes talking about the best team in retail and the many ways we are investing in the associate experience at The Home Depot. 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 and enjoyable and rewarding experience.

As Ted mentioned, we are making a significant investment of approximately $1 billion in compensation for frontline hourly associates. This is a meaningful investment that we believe will position us favorably in the marketplace. But this is just one component of the associate investment story. We know that the key to an engaged and committed workforce is investing in the person, taking an interest in them and in their development. To that end, we began the year with a new store leadership structure, the first time we have changed the structure since our company was founded. The driving forces of these changes were customer service and associate development. We created new management positions focused entirely on the customer service experience, increasing the number of managers on the floor at any given time.

This frees up time for other store leaders to devote to associate training and development. The net result of all this is both an improved customer and associate experience, while also creating new career paths for our associates. Another important element of a best-in-class associate experience rests on simplification, how can we simplify processes and systems in our stores to enable associates to deliver a better customer experience and how can we simplify and streamline paths, so that an associate can spend more time serving our customers. One example we have talked about before is the work we’ve done to simplify order management in our stores with the order up initiative. Historically, our associates have to navigate dozens of systems but with order up, we have been able to streamline multiple systems into one that is simpler and more intuitive.

We took simplification even further this year with the introduction of the new HD phone and associated applications such as Sidekick. The rollout of our HD phone was a direct result of associate feedback on the limitations of our first-generation in all devices known as first phones. For the first time ever, every associate on the floor will have an HD phone in their hand with enhanced communication features, tools and training capabilities. This increased accessibility to real-time support is significant in helping our associates better serve our customers. In addition to enhancing the customer service experience, the home — the new HD phone provides real-time access to tools and applications such as Sidekick that helps associates prioritize the highest value tasks more effectively.

Powered by machine learning, Sidekick directs associates to key bays where on-shelf availability is low or out exist. The HD phone empowers our associates to provide a best-in-class customer experience, increase operational efficiency and generally makes an associate job much easier. These are just a few examples of the many ways we’re investing to enhance and improve the associate experience at The Home Depot. Our associates are trusted advisers for our customers and are the heartbeat of our company, and I want to thank them for all they do to take care of our customers. We will continue to invest in them with a focus on listening to their needs, maintaining competitive wages and benefits and continuing to enhance our tools, training and development opportunities.

With that, let me turn the call over to Jeff.

Jeff Kinnaird: 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. During the fourth quarter, our comp average ticket increased 5.8% and comp transactions decreased 6%. The growth in our comp average ticket was driven primarily by inflation across our product categories, as well as demand for new and innovative products. Inflation from core commodity categories positively impacted our average ticket growth, by approximately 15 basis points during the fourth quarter. On lumber specifically, during the fourth quarter, we saw a significant decline in lumber prices relative to a year ago. On average, lumber prices were down over 50% year-over-year.

Given this dynamic, comp sales were negatively impacted by approximately 70 basis points in the fourth quarter. Turning to our department comp performance for the fourth quarter, seven of our 14 merchandising departments posted positive comps. Building materials, plumbing, millwork, hardware, tools, outdoor garden and paint had comps above the company average. Big ticket comp transactions or those over $1,000, were up 3.8% compared to the fourth quarter of last year. While we saw big ticket strength across Pro-heavy categories like portable power, hype and fitting, and gypsum we did experience softness in other categories like laundry, soft flooring and roofing. During the fourth quarter, Pro sales growth outpaced DIY. Pro backlog still remain elevated compared to historical averages, and we saw positive comp performance in our build materials, plumbing and millwork departments as well as in certain bath-related categories.

Turning to total company online sales. We are very pleased, with the performance of our digital assets. Sales leveraging our digital platforms increased over 4%, compared to the fourth quarter of last year. This was driven by our continued investments, which are resonating with our customers. For those customers, that chose to transact with us online during the fourth quarter, approximately 45% of our online orders were fulfilled through our stores, a testament to the power of our interconnected retail strategy. During the fourth quarter, we held our Decorative Holiday, Gift Center and Black Friday events. 2022 was a record sales year for these events. We are the product authority in home improvement. And together with our supplier partners, we continue to offer the best product at the best value for our customers every day.

A great example of this, is our recent partnership with Ecolab, a global leader in water, hygiene and infection prevention solutions and services. The Ecolab scientific clean product line, offers the cleaning solutions for commercial, industrial and residential use that Ecolab is known for to both our Pro and DIY customers, giving them access to innovative cleaning technology and this partnership is exclusive to The Home Depot. It marks the first of its kind, in Ecolab’s 100-year history. We’re looking forward to the year ahead particularly, with the spring selling season, right around the corner. We have a great lineup of products from live goods to outdoor power equipment. We continue to see an industry-wide shift from gas-powered to battery-powered tools.

And as we’ve been discussing for some time, we have been leaning into this trend, offering a broad assortment of outdoor power equipment, with cordless technology. We have the brands that matter across tools and outdoor power including RYOBI, Milwaukee, DeWalt and Makita. In our spring gift center event, we are expanding our assortment to include, cordless innovation in mowers, trimmers, blowers and chainsaws. As an example, our Makita XGT platform will have over 125 professional-grade cordless tools. I’m particularly excited, about our new 40-volt XGT mower, that delivers gas-powered performance with high vacuum lift for premium cut quality. The XGT mower can cut over an acre in less than 60 minutes on two 40-volt XGT batteries. These Makita tools are exclusive to The Home Depot in the big-box retail channel.

One of our key focuses in the spring is to provide great value and innovation for our customers within our live goods offerings. We continually work to strengthen our relationship with key vendors throughout the industry providing the best value, innovation and guarded performance for our customers. We have expanded our offerings in national, regional and proprietary brands such as Vigoro, Rio, Southern Living and Knockout Rose just to name a few. Our teams continue to look for better garden performance varieties that provide solutions for our customers and we are excited about the upcoming spring season. With that, I’d like to turn the call over to Richard.

Richard McPhail: Thank you, Jeff, and good morning everyone. In the fourth quarter, total sales were $35.8 billion, an increase of approximately $100 million, or 0.3% from last year. During the fourth quarter, our total company comps were essentially flat at negative 0.3% for the quarter. As Jeff mentioned, lumber prices in the quarter negatively impacted comp sales by approximately 70 basis points. We had comps of negative 1.3% in November, positive 0.8% in December, and negative 0.1% in January. Comps in the US were negative 0.3% for the quarter, with negative comps of 0.4% and 1.4% in November, positive 0.7% in December, and negative 0.1% in January. For the year, our sales totaled a record $157.4 billion with sales growth of $6.2 billion, or 4.1% versus fiscal 2021.

For the year, total company comp sales increased 3.1% and US comp sales increased 2.9%. In the fourth quarter, our gross margin was approximately 33.3%, an increase of seven basis points from last year. For the year, our gross margin was approximately 33.5%, a decrease of 10 basis points from last year. Gross margin was in line with our expectations, reflecting planned investments in our supply chain capabilities. Throughout the year, we continued to successfully offset significant transportation and product cost pressures as well as increased pressure from shrink during the back half of the year and we did this while maintaining our position as the customer’s advocate for value. During the fourth quarter, operating expenses were approximately 20% of sales, representing an increase of 32 basis points from last year.

Our operating expense deleverage is driven largely by charges unique to the quarter related to litigation in California storm-related expenses and an unfortunate fire in one of our stores. For the year, operating expenses were approximately 18.3% of sales representing a decrease of 13 basis points from fiscal 2021. Our operating margin for the fourth quarter was approximately 13.3%, and for the year was approximately 15.3%. Interest and other expense for the fourth quarter increased by $85 million to $408 million due primarily to higher long-term debt levels than one year ago. In the fourth quarter, our effective tax rate was 22.6% and for fiscal 2022 was 23.9%. Our diluted earnings per share for the fourth quarter were $3.30, an increase of 2.8% compared to the fourth quarter of 2021.

Diluted earnings per share for fiscal 2022 were $16.69, an increase of 7.5%, compared to fiscal 2021. During the year, we opened six new stores and lost a store in California due to a fire bringing our store count to 2,322 at the end of fiscal 2022. Retail selling square footage was approximately 241 million square feet at the end of fiscal 2022. Total sales per retail square foot were approximately $627 in fiscal 2022, the highest annual figure in our company’s history. At the end of the quarter, merchandise inventories were $24.9 billion, an increase of $2.8 billion versus last year and inventory turns were 4.2 times, down from 5.2 times from the same period last year. Moving to capital allocation. During the fourth quarter, we invested approximately $900 million back into our business in the form of capital expenditures.

This brings total capital expenditures for fiscal 2022 to $3.1 billion. During the year, we paid approximately $7.8 billion of dividends to our shareholders. We look to grow our dividend every year as we grow earnings. And as Ted mentioned today, we announced our Board of Directors increased our quarterly dividend by 10% to $2.09 per share, which equates to an annual dividend of $8.36 per share. And finally, during fiscal 2022, we returned approximately $6.5 billion to our shareholders in the form of share repurchases including $1.5 billion in the fourth quarter. Computed on the average of beginning and ending long-term debt and equity for the trailing 12 months, return on invested capital was 44.6% compared to 44.7% at the end of the fourth quarter of fiscal 2021.

Now, I’ll comment on our outlook for 2023. As we think about how 2023 might unfold, we think it’s helpful to look back on our performance since 2019. 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. The home improvement market also captured a greater share of the consumer’s wallet, as spending on goods outpaced spending on services during the period.

Beginning in the second quarter of 2021 and continuing through the fourth quarter of 2022, we reported strong sales and earnings growth driven by ticket while transactions steadily normalized back towards 2019 levels as the broader consumer economy shifted from goods and back into services. During this time, we continued to report positive sales growth in every quarter up to present. As we set targets for 2023, the context of the past three years led us to consider three factors that will likely influence our performance this year. First, the starting point for our target setting this year is our assumption regarding consumer spending. We’ve assumed like many economists that we will see flat real economic growth and consumer spending in 2023.

Second, over the last seven quarters, we have seen our transactions gradually normalize as consumer spending has shifted from goods to services. We believe that if this shift continues at its current pace, the home improvement market would be down low-single digits. And third, as an offset to this pressure, we plan to continue to capture market share. Our competitive advantages, the investments we have made over many years and the unique advantage that our orange-blooded associates give us over our competition position us to take share in any environment. Taking these factors into account, we are targeting approximately flat sales and comp sales growth for 2023. Further, our operating margin target of 14.5% reflects approximately 60 basis points of impact from the compensation investment we announced today.

Our effective tax rate is targeted at approximately 24.5%. Our diluted earnings per share, is targeted to decline by a mid-single-digit percentage. Outside of this target setting, if lumber prices remain at current levels for the remainder of our fiscal year that would equate to approximately 100 basis points of pressure to comp sales and an insignificant impact to earnings. At today’s current price, this would imply more pressure in the first half than in the rest of the year. We plan to continue investing in our business with CapEx of approximately 2% of sales on an annual basis. After investing in our business and paying our dividend, it’s our intent to return excess cash to shareholders in the form of share repurchases. We believe that we have positioned ourselves to meet the needs of our customers in any environment.

The investments we’ve made in our business have enabled agility in our operating model. As we look forward, we will continue to invest to strengthen our position with customers, leverage our scale and low-cost position to drive growth faster than the 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: Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question comes from the line of Michael Lasser with UBS. Please proceed with your question.

Michael Lasser: Good morning. Thanks a lot for taking my question. Ed, in this environment, we’re all just kind of guessing, but we assume that your guesses are a lot more educated than any of the rest of us. And in that case, what do you see as the downside risk for the home improvement market in turn, Home Depot this year, both in terms of the depth of a potential decline and the duration of a downturn. And in that case, how would Home Depot’s earnings look in that scenario?

Ted Decker: Well, good morning, Michael. Thanks for the question. We’ll certainly address that. But before we go into downside, I’d like to set the tone on what we see that’s favorable in the business trends. And we feel very good about our business. As we’ve just referenced, we’ve grown the business $47 billion over the last three years and grown earnings 60% during that time. Our associates did an amazing job, focusing on the customer in this challenging environment. And there’s really no way we would have captured that much share, had we not been making the investments over the past few years. We also still see a healthy customer. I mean, we have good jobs, job growth, growing wages, still strong balance sheets. And most of our customers tend to own their home which has seen a significant increase in value.

But as we’ve said, we do see a unique environment with many cross currents right now. Obviously, there’s heightened inflation and rising interest rates, a tight labor market and moderating equity and housing markets. So, given all that, we do expect moderation in home improvement demand. Pro backlogs are still healthy, Michael, although they are off their peak from last year. And customers are still spending time at home. Homes are aging and worth about 40% more than they were before the start of the pandemic. But people are also starting to shift spend more towards services. And as we’ve said, we see some more price sensitivity. So, given all that, we’ve set the stage for a moderating year in 2023 and Richard will take you through some of the downside cases that you alluded to.

Richard McPhail: So — yes. So Michael, just to recap quickly, the way that we set our target and our guidance for the year was to first start with the assumption of flat consumer spending. And then with respect to the goods sector of the economy, as I said over the last seven quarters, we’ve seen that shift across the consumer economy from goods to services. So, we would anticipate this would put slight pressure on our market. And then, we look to overcome that by taking share in the manner that we’ve done consistently over the past several years. So we’re targeting flat. If you — there are so many factors that influence our market right now, as Ted alluded to. But if you were to take a hypothetical situation, let’s just think about that share shift that we call out.

So we look at the share that we currently capture as a share of consumption PCE. And we’ve tracked that through the COVID period and over the last few years. As we said in our guidance, that share shift continued at the rates at which we have seen theism behave. Currently, we would expect the market to face low single-digit negative pressure. But if you were to take perhaps a more extreme case and say, if that share of PCE that our market holds were to shift all the way back to 2019 levels by the end of the year that would imply pressure of call it mid-single-digit percentages. And so that would sort of be one way to get your mind around a hypothetical case, where share shift happens more rapidly than it has been.

Michael Lasser: So in an environment, where the market down mid-single digits presumably Home Depot is going to do better than that. It will take some market share. So, can you frame out what you think the decremental margins would be in a down three or four type scenario? And as part of that, where do you think you would see this first? You’re already starting to experience some challenges in areas like soft flooring and others that you outlined. Is that a precursor to weakness that you might experience in other categories? Thank you.

Richard McPhail: So, just to keep it simple, because share shift is not a perfect science. In a hypothetical case, and again, we’re not guiding this way, this is not a downside case, but in a hypothetical situation that share shift. If our comps were to be mid-single-digit negative, we would see operating margin around 14%, as kind of a corollary to that hypothetical situation.

Ted Decker: And Michael, Jeff can give some further detail. But the price sensitivity is €“ while it’s a bit broader in Q4 than we saw in Q3, it’s still primarily those larger single ticket more discretionary items that we’ve referenced before appliances grills patio, but still being a project-oriented business and with the Pro backlog, again, albeit down still strong. We’re still seeing strong project business, but there is a bit more overall sensitivity as we saw more one-for-one offset with ticket and transaction in Q4.

Jeff Kinnaird: Yeah. Thank you, Ted. So yeah, in general to your comments more broad than what we saw in the third quarter, but still very good project demand. If you look at the seven departments that outperformed the plumbing business building materials millwork hardware tools, and paint above our company average and just reflected the strength of the project business. To your point, Michael, we’re watching categories like flooring very closely. We’re working assortments. We’re working different opportunities in the market to look at what’s happening in categories like flooring, but some broader-based sensitivity, but still good strength in the overall business.

Michael Lasser: Thank you very much, and good luck.

Operator: Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question.

Scot Ciccarelli: Good morning, guys. So, can you please clarify your expectations for unit elasticity, if we were to start to see same €“ see inflation pressures ease? And then secondly, any common denominators in categories or geographies, where you’re starting to see some of the incremental softness? Thanks.