Long term watchlist - Home Depot (NYSE: HD)
Long term watchlist
These businesses are worth between 25 and 30 times their free cash flow.
Everyone knows them, so I don’t expect to have any insight on something that will give me or my investors an advantage, so I don’t really think about investing in them. However, they become useful to know because once every decade, their industry may face problems, and the multiples go down; that is when they become interesting for us as long-term investors. Of course, we want to be ready in advance and keep an eye on them because, when problems arise, you already want to be familiar with the company.
Home Depot has recently announced its decision to lay off up to 19,000 employees, marking the worst layoffs the company has experienced in the past 20 years. This unfortunate outcome is primarily attributed to a significant decline in revenue and a weak outlook for the future. The company's revenue miss is even worse than the one observed during the 2008 financial crisis, and various factors have contributed to this decline, including colder weather, fallen lumber prices, and consumer delays in undertaking major projects. Home Depot anticipates that its sales and comparative sales will decline by an estimated range of 2% to 5% for the fiscal year, leading to a decrease in its operating margin rate. The CEO also noted that Americans had already made substantial investments in home improvement throughout 2020 and 2021, thanks to stimulus checks, resulting in a subsequent collapse in demand.
Home Depot (NYSE: HD)
Home Depot was founded in 1979 as a bigger and cheaper alternative to competitors.
Home Depot is the world's largest home improvement retailer, with over 2300 stores across North America and a wide range of products, providing customers with a one-stop shop for their home improvement needs.
Home Depot has a strong foothold in the professional customer space, attracting electricians, remodelers, plumbers, and other home professionals.
About 50% of Home Depot's sales in the 2021 fiscal year came from professional customers, even though they made up less than 10% of its customer base.
The company's distribution network works with its online strategy, providing pro customers with flexible options and boosting e-commerce sales.
Home Depot faces competition from other big chains and smaller mom-and-pop stores in the home improvement retail space.
The industry is sensitive to economic fluctuations, especially those tied to the housing market.
I believe that the “uncertainties” in the housing market affect the price in the short term, creating opportunities for the long-term investor. Just keep an eye on the three pillars of the strategy, especially in the “low-cost provider” competitive advantage. If they can defend that, I believe Home Depot will excel in decades to come.
By focusing on customer experience, being the low-cost provider, and being the most efficient capital investor in home improvement. The company believes these goals will help it grow faster than the market and deliver value to its shareholders. Today, it holds its position as the dominant force in the home-improvement industry. Home Depot consistently outperforms its competitors with its vast network of stores, strategic supply chain management, and commitment to customer satisfaction.
Despite the leveraged financial mix, the financial structure is stable due to value creation and a manageable Net debt/EBITDA ratio. Increasing debt levels contribute to increasing value for shareholders, making it a strategic competitive advantage for the company.
"Our Customers": Home Depot serves two primary customer groups - consumers (DIY and DIFM customers) and professional customers. DIY customers are homeowners who purchase products and complete their own projects and installations. Professional customers include professional renovators/remodelers, general contractors, maintenance professionals, handymen, property managers, building service contractors, and specialty tradespeople. Home Depot assists these customers in-store and through online resources and other media designed to provide product and project knowledge.
"Our Products and Services": Home Depot continuously assesses its merchandising departments and product lines for opportunities to expand the assortment of products offered within its portfolio of proprietary and exclusive brands. The company offers several services for its customers, including installation services for DIY and DIFM customers and tool and equipment rentals at locations across the U.S. and Canada. Home Depot maintains a global sourcing program to obtain high-quality and innovative products directly from manufacturers.
"Competition and Seasonality": Home Depot operates in a highly competitive, fragmented, and evolving industry. The company faces competition for customers for its products and services from a variety of retailers, suppliers, service providers, distributors, and manufacturers that sell products directly to their respective customer bases. These competitors range from traditional brick-and-mortar to multichannel to exclusively online. Home Depot's business is subject to seasonal influences, with the highest volume of sales occurring in the second fiscal quarter as the company moves into the spring season in the regions in which it operates.
The Supply Chain Advantage
The company's supply chain includes multiple distribution center platforms in the U.S., Canada, and Mexico tailored to meet the needs of its stores and customers based on types of products, location, transportation, and delivery requirements.
Home Depot's key competitive advantage remains its efficient supply chain management. The company revolutionized its distribution process by establishing its own distribution centers (Rapid Deployment Centers) to streamline the flow of goods from suppliers to stores. This approach allowed Home Depot to gain greater control over inventory, reduce costs, and improve forecasting accuracy.
The success of Home Depot's supply chain transformation is evident in the graph showcasing Days of Inventory Outstanding (DIO) since 2008. While Home Depot's DIO decreased significantly, its largest competitor, Lowe's, experienced an increase, highlighting the effectiveness of Home Depot's supply chain strategy.
Currently, days of inventory are at their worst in the last decade. However, it is obvious to me that this is something management knows and will rectify in the future.
For comparison, let’s use its direct competitor, $LOW:
Home Depot and Lowe's have different store appearances and cater to different customer categories. Home Depot stores have an industrial look and target professionals, while Lowe's stores have a different color scheme and often highlight special products. Both companies cater to retail customers who prefer DIY projects and professional customers who require advanced services. While both companies target the same market, their branding and supply chain strategies differ. Home Depot has been modernizing its supply chain to improve efficiency, moving towards a centralized distribution network.
Adaptability and Innovation
Home Depot's ability to adapt quickly to market realities has been crucial to its success. During the 2008 financial crisis, the company shifted its focus from expansion to execution and cost-cutting. This prompted Home Depot to make significant improvements in its supply chain to enhance efficiency and reduce costs.
Furthermore, Home Depot has consistently invested in upgrading its logistics capabilities to cater to changing customer demands. It added Direct Fulfillment Centers (DFCs) in 2014, allowing it to serve online customers more effectively. In 2017, the company announced a $1.2 billion plan to offer same-day and next-day delivery options to 90% of the U.S. population. Currently is enhancing its capabilities to provide a frictionless, interconnected shopping experience across its stores, online, on job sites, and in homes. The company focuses on continued investments in its website and mobile apps to enhance the digital customer experience.
These strategic initiatives demonstrate Home Depot's commitment to staying ahead of the competition and meeting customer expectations in the rapidly evolving retail landscape.
Financial Strength and Performance
Home Depot exhibits remarkable financial strength, with several key financial markers highlighting its excellence as a business. cash, further reinforcing Home Depot's financial stability.
Home Depot has also been a reliable dividend payer. Share repurchases have been another significant way the company returns value to shareholders, with the share count decreasing by 1/3 since 2012 and much more before that.
Risks
The Home Depot's 2022 Annual Report identifies several risk factors, such as the need to attract, develop, and retain highly qualified associates and manage third-party installers effectively; external risks like uncertainties in the housing market, economic conditions, political and social climate, and public health issues, as well as the impact of seasonal influences, extreme weather conditions, climate change, and natural disasters; supply chain risks related to identifying and developing relationships with qualified suppliers and potential disruptions due to factors like economic or political instability, public health issues, and trade restrictions; cybersecurity and IT risks associated with potential failures of internal or external IT infrastructure and increased cybersecurity threats; and risks related to the COVID-19 pandemic, including associate and customer safety-related risks.
Future Outlook
Looking ahead, Home Depot is well-positioned for continued growth and success. The company's strategic investments in expanding its product offerings, improving the shopping experience, and reducing delivery time are expected to drive revenue growth. The increasing demand for home repairs and upgrades and Home Depot's initiatives to cater to professional customers and enhance its digital presence will contribute to sustained revenue growth.
Conclusion
Home Depot is the king of the home-improvement industry. Its supply chain expertise, adaptability, and robust financial performance make it a leader in the market. With a solid foundation and strategic investments, Home Depot is well-equipped to capitalize on future opportunities and remain the go-to destination for home improvement needs.
I believe that the “uncertainties” in the housing market affect the price in the short term, creating opportunities for the long-term investor. Just keep an eye on the three pillars of the strategy, especially in the “low-cost provider” competitive advantage. If they can defend that, I believe Home Depot will excel in decades to come.