Tuesday, November 13, 2007

Home Depot: What Do They Cut, the Dividend, CapEx or Buybacks

Home Depot (HD) is just in a world of hurt. Shares are now down 30% this year and shareholders are looking at the 3rd consecutive year of losses.

Home Depot reported Q3 net income fell 27% and same store sales were down 6.2%. Net income was $1.09 billion or $0.60 a share, versus net income of $1.49 billion and EPS of $0.73 last year. Earnings from continuing operations came in at $0.59 less than expectations of $0.60 per share. Sales fell 3.5% to $18,96 billion, versus $19.65 billion last year again short of expectations of $19.43 billion.

The company now expects earnings from continuing operations to fall by as much as 11% in FY2007. To make matters worse HD continues to lose market share to arch rival Lowes (LOW).

Now, Home Depot shares currently trade at $28 and change, yields 3% and trades at 11 times earnings. Value? No, not really. Why?

Home Depot is deteriorating. Were it not losing market shares to Lowes, one could argue that "once housing turns around, HD will rally". Since they are, Lowes will reverse its current course far faster. One does have to wonder though hoe long HD can or will continue to pay a $440 million quarterly dividend. Consider that Capex runs them roughly $800 million to $1 billion a quarter, the interest on their now exploding debvt will run about $125 million a quarter and they only pulled in $1 billion last quarter and things do not look to be getting any better anytime soon.

How long can the negative math continue to not add up? Either they have to cut capex and risk falling further behind Lowes, cut the dividend or drastically reduce or just put the buyback plans on hold. Either one of the options will only hurt shareholders more...

What happened? Simple. Short term thinking and the sale of HD Supply. I first spoke out against it in June when it was announced. Three months later they finally managed to sell it at a reduced price, were forced to keep some of it and guarantee some of its debt. Shrewed.

Once Nardelli was ousted, incoming CEO Frank Blake sought to appease Relational Investors who lead the Nardelli lynching and caved to their demands. This included the Supply sale and HD taking on massive debt to repurchase shares. Now both those move are coming back to haunt Blake.

Supply, while not a fast grower contributed to HD's cash and profits substantially. What cash HD received from the sale was used to repurchase huge blocks of stock and then additional debt was added to buy more. While I am a fan of buybacks, they must be done intelligently. This one wasn't. With it's business environment deteriorating rapidly and its position in that business falling just as fast, loading up on debt and making promises you might be able to keep was less than wise.

One cannot even say with confidence that when housing turns around Home Depot will be a winner. If you are making a bet here, Lowes is the pick because they are at least managing their way through the housing downturn.

Miss Nardeli yet?

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