Tuesday, August 14, 2007

Home Depot: Supply Sale and Buyback Soon Dead

Home Depot (HD) released earnings today and it was just ugly. It also will lead to the death of the Supply division and a drastic reduction of the massive buyback that was announced because without one, the other cannot happen. Even if I am wrong and they do manage to sell Supply, it will be for such a reduced price that the buyback will still be reduced even father than already announced.

First, earnings. 2007 Q2 consolidated net earnings of $1.6 billion, or $0.81 per share, compared with $1.9 billion, or $0.90 per share, last year. Earnings from continuing operations in Q2 were $1.5 billion, or $0.77 per share, compared to fiscal 2006 Q2 earnings from continuing operations of $1.7 billion, or $0.82 per share. The Company is now breaking out results of HD Supply as a discontinued operation.

Sales for the Q2 were $22.2 billion, a 1.8 percent decrease from Q2 2006, reflecting negative same store sales of 5.2%.

HD reiterated in its outlook that it expects its EPS from continuing operations to decline by 12-15% for 2007 and EPS is expected to decline by 15-18% for 2007.

Home Depot said that it will "continue to assess financial market conditions, and the impact of any restructured HD Supply transaction to sell its supply business, or failure to complete that transaction, on its overall recapitalization plan and on the terms of the tender offer part of that plan."

CFO Carol Tome said the company had previously sized its recapitalization plan based on $10.3 billion of anticipated proceeds from the sale of HD Supply and $12 billion of debt finance to be raised "as soon as practical". "If we have no proceeds from HD Supply -- and I'm not saying that's the case -- but if that were to happen our recap would be reduced to $12 billion," said Chief Financial Officer Carol Tome.

Well, I would count on the reduction. Let's look at it. Supply profits fell $22 million last quarter so the sale price reduction the PE guys will want will be substantial. Also, they can walk away for $300 million if Home Depot does not want to play nice so they are in a position to push for a substantial price drop. They have Home Depot by the nuts. Does anyone care to wager when "as soon as practicable" will be for the $12 billion of debt? With Home Depot's credit rating dropping fast and looking to go lower and with debt markets becoming tighter, that $12 billion may not be "practicable" for years.

All in all Home Depot is in a self imposed mess trying to placate irrational investors. I bet they now long for the days when Nardelli ran things. He may have been unlikable and arrogant, but he got results. He doubled sales and the number of store operations while expanding into Mexico and China. Under him HD delivered more than 20 percent EPS growth for four consecutive years and more than quintupled its dividend to 90 cents a share.

From early 2003 to early 2006, Nardelli took HD shares from $21 to $43. When the bottom began to fall out of housing, HD dropped to $33 August of last year. When he left at the beginning of 2007, the stock was back at $40. Shares today sit at $33.

Be careful what you wish for...


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