Home Depot Q2 2024 Earnings Call Transcript

Well, I think it's just in broader projects, Scot. As we said in the prior couple of few quarters, the consumer remains engaged. Our consumer, in particular, remains quite healthy. Again, these are consumers who have seen their home values go up 50% in the last 4 years, their home equity has increased almost 70% since the -- right before the pandemic. So that translates to over $13 trillion. Equity values have been strong, jobs are strong, earnings are strong.

But we saw engagement the last several quarters in smaller projects. What we saw this most recent quarter is further pressure in larger projects. And we see that in building materials in lumber categories that are very specifically tied to construction in a larger project. And that was really the change that we saw as the quarter progressed.

Yes. And you said it. I mean the change that we believe happened over the course of the quarter. And so if you go back a bit to the environment that we've been working through this period of moderation, the first thing we saw was a shift in spending -- PCE spending from goods back into services. And we're effectively through that transition, the relative share spend is more or less equal to where it was before the pandemic.

And then we had, some certainly some pull forward in our segment. I'd say we're not completely through the pull forward, but largely. I mean we're now going on 4 years from the first spring of the pandemic when people were buying lots of grills and patio furniture et cetera. We're largely working our way through that.

And then the higher interest rate started to impact the housing market in housing turnover in particular, which is down some 40%. And I think last quarter, last month, we saw numbers that on an annualized basis, we're approaching 40-year lows. That's also impacting customers' interest in financing larger projects. Everyone's expecting rates are going to fall. So we're deferring those projects.

But again, what more recently has happened is a broader concern with the macroeconomy. There's just a lot of noise with political and geopolitical environment, unemployment ticked up, inflation keeps eating away at disposable income. And I think people just took a pause as we progress through the quarter or more of a pause because of these macro uncertainties.

Thank you.

Sure, Seth. Well, we're -- I'll tell you, we're very proud of all components of our business. We are executing at an exceptionally high level across the core and across the businesses that you call out. While we don't split out HD Supply is part of our core, we are proud to say that we have had -- and HD Supply has had an exceptional track record as of late even penetrating through to generate positive sales growth in the second quarter. And so that's a real bright spot for The Home Depot.

Now SRS, as we told you when we acquired SRS, this is a growth Company acquiring a growth Company. SRS has a track record of growing faster than their competition in all of their verticals and has done so for the last 15 years. If you look at what SRS accomplished in the first six months of the year, again, we only own them for six weeks, so we only book six weeks of results. But they grew in the high single-digit percentages in the first half. They had healthy growth in the second quarter and we expect them to, again, book single-digit growth in the entirety of the year 2024, even though we'll only own them for seven months.

So these two business models, HD Supply and SRS are great examples of market leaders who are accustomed to growing share and delivering the bottom line as well.

Yeah. And I'd add to that, Seth, we're not going to break out operating segments. But in HD Supplies' case, there's some appropriate comparatives in SRS, there's very much publicly traded comparatives. And we feel really good about the MRO business, the roofing, the pool, and the landscape business against those comparables.

Thanks, Seth. So it's Billy. Listen, as I did mention in our prepared remarks that we continue to talk about the finance projects, we continue to see ongoing pressure. I don't think that's new news. Having said that, we called out a number of businesses that you just mentioned it, Vinyl Plank, we saw great performance in both sales and unit comps. Water heaters, as I mentioned, certainly, paint. We're thrilled with the efforts we've had in paint with the Pro That Paints and our paint business in total. And again, power across our platforms as well.

So non-finance projects, while we did see some softness in some of the seasonal pieces that we alluded to in our prepared remarks, the continued ongoing pressure of just the uncertainty as it relates to interest rates, it's going to continue to put some pressure on those finance projects. But we're pleased with some of the other pieces I mentioned, larger ticket, one-time purchase categories like riders as an example, we continue to see good engagement in businesses like that as well.

Hey, Michael. Good morning. Full question there. Hard to pinpoint what that magical rate number is historically and then as you say, with some added pressure. All I can do is reference towards the end of last year when rates came off, the high is over 7% and moderated down, I think even hit below 6.5% there for a bit. You saw an immediate increase in housing activity, mortgage applications, mortgage refi applications. And then, unfortunately, the rates spike back up think almost to 7% again.

So we're trending down again. I think you're approaching 6.5% for qualified mortgage. And based on what we saw towards the end of last year, we would think you're approaching a level that people are going to engage. A caveat to that would be, again, this broader economic, geopolitical even concerns that people still might pause a little bit until some of this gets sorted out, which would be understandable, but as rates head down towards 6%, we would expect to see activity.

The other thought or piece of this whole puzzle is the amount of folks, as you know, who are in mortgages as low as 3%. And plenty of mortgages under 5%. There's definitely a little bit of a golden handcuff dynamic going on with those rates. But again, as time goes on, family dynamic changes. And for 1 or 2 years, you might stay in those golden handcuffs and enjoy the low rate, but family size increases, household formation, moves for employment, retirement, et cetera. So we would see a gradual unlocking of that even if that adds to a little bit of a delay response to housing for -- from a traditional rate cut environment.

Yeah, Michael, thanks. I'll take the first part of that, and then I'll hand it to Richard on a second piece of that question.

As it relates to just the promotional activity, I mean, listen, we're going to continue to drive innovation and create value for our consumers. We are in a very rational environment as it relates to the home improvement sector, while there's been some pressure in the category like appliances. We don't see the need nor are in the environment where we need to be more promotional. We're focused on driving innovation and value, creating opportunities for our customers to come into our stores every day. We don't want to be in the promotional business. We feel very good about our position and creating these opportunities and excitement in our stores around just those things.

And we've seen great adoption. We've been able to bring value into the marketplace. Areas like our proprietary brands continue to perform very well and we're very pleased with that and don't see a change in really the promotional cadence going forward.

Now I'll toss it to Richard for more on the gross margin piece.

Yeah. Great. So let me actually broaden the question because I think it's important to give the broader context, if you're asking about gross margin, let's just talk about SRS for a moment.

So in last June's Investor conference, we laid out a base case and we said that there could be contributors to that base case that would push us to grow sales and earnings faster than that base case, right? So base case was 3% to 4% top-line and high single-digit -- mid- to high single-digit EPS growth.

The acquisition of SRS is one of those accelerants that we pointed to in our investor conference, pushing us towards the accelerated case. The objective of SRS is to grow our share with the Pro, to accelerate sales growth, to accelerate operating profit growth, and to accelerate EPS growth.

So from a sales and operating profit perspective, as you can see, it's already contributing to our Company immediately. From an EPS perspective, the acquisition of SRS will be cash EPS accretive in the first 12 months of ownership as we said in March. It will be cash EPS accretive in the first 12 months of ownership adjusting for the associated noncash intangible amortization.

So let's talk about how SRS is reflected in our -- in our financials. Again, just as a reminder, we include six weeks of results in Q2 from SRS, and we will include about seven months of SRS in our full year. So just thinking about SRS, look, they have a different product mix than Home Depot, right? About 2/3 of their product is roofing and then the remaining 1/3 is in pool and landscape.

SRS carries similar margins on similar products as The Home Depot. Those products carry a lower gross margin rate than The Home Depots Company's average. But their margin simply reflects a different mix than The Home Depot. And so when we think about gross margin, SRS impacted the second quarter gross margin by about 35 basis points. And if you think about what that means for kind of an annualized figure, you're talking a kind of a reset of our margin profile of about 45 basis points in gross margin.

So again, that will be about 35 basis points for 2024. And then if you look at sort of an annualized figure, it's somewhere around 45 basis points. That's kind of a reset to reflect what is, in effect, a new mix of products at The Home Depot.

So now let's talk about operating margin and SRS' impact because it's important to look at gross margin in that context. So if you -- when you add SRS to our mix, it adjusts our base operating margin profile, lowering it by about 30 basis points in Q2 and it lowers our base operating margin profile by just about 40 basis points for the full year of 2024. So that's 40 for the full year of 2024. Again, if you annualize that number, then the adjustment to our base margin from SRS is about 60 basis points for an annual period. And those are GAAP numbers, and we can get into adjusted numbers, if you'd like.

When we think about gross margin again for the quarter, we want to point out several exceptional performances across our operators. First of all, significant transportation benefit brought to us by our supply chain partners and our merchant partners and significant benefit from a decrease in shrink year-over-year. We have now put several quarters of shrink benefit versus last year together in a row. And we can point directly at what drives that performance. It's a fantastic team that we continue to invest in. And the returns on those investments are exceptional.

That's a long way of saying, if you look at our gross margin performance year-over-year and you back out the SRS mix shift of 35 basis points, we were actually 75 basis points versus last year, an exceptional performance in gross margin across the Board by our entire team.

Thank you.

No, Simeon, thanks for the question. Your math is sort of spot on there. The good news is no. We're not seeing any broad step down in cost or retails. If you look at what we've laid out for AUR this year, we said that we'd have pressure of about 150 basis points of AUR in the first half, that would moderate to 50 basis points in the second half. That is all a function of lapping the cost and associated retail moves from last year. There really isn't a lot of net new activity on the cost or the retail front. In fact, sort of cost out and cost in activity. We have a very robust team that works with our merchants on this. It's all pretty neutral right now, we're not a ton of activity.

So as Billy said, we're not going to be promotional. We're an EDLP retailer that has to give value to our -- particularly our Pros every day. The cost environment is neutral. The price environment is neutral. We're not seeing a lot of trade down in particular. We're not seeing an increase in OPP penetration. Things are pretty neutral to several last periods of activity. And what we're seeing on the AUR is a matter of lapping.

So we're not seeing that, and we would expect the cost levels from where we are today to largely hold as well as the retail levels. Remember, there's -- in the cost levels from our supplier base, it's not just a matter of input costs in terms of materials, which you understand with our cost finance team, we have a very, very good view into that. But everyone over the last 4 years has seen significant increase in labor costs, and we're still working through transportation costs. So that 30, you can say, wow, that's highly inflationary, and that has to come back. Well, in fact, the cost structure, labor being a big component has increased similarly. And that's why we don't see the marketplace irrationally eroding those price levels.

So what I -- what I would do is -- let's -- why don't we talk about performance to date and how our guidance reflects the performance to date because we actually have, as I said, outperformed certain expectations in cost of goods sold. And the team has managed expenses in an exceptional manner. And so let me walk through what that means for the guide.

So you can recall, we began the year with a guide of a negative 1% comp with a 14.1% operating margin. In isolation, if we were to take -- well, as we take comp from a negative 1% to a negative 3%, that is, call it, 25 to 30 basis points of natural deleverage that we would see in that reduction in top line expectation.

However, we've had favorability year-to-date. We know where it comes from, and that favorability enhances our earnings. And so instead of taking our 14.1% operating margin, and by the way I'm excluding SRS in this discussion, so for simplification, if we were to set SRS to the side for a moment, naturally, our 14.1% operating margin would drop to something like a 13.9% to a 13.8% at a negative 3%. Instead, at a negative 3%, again, with SRS to the side, we are now guiding an operating margin of 14%. So we have held in essence, that core 14% operating margin at a negative 3% comp. That's because we are flowing through benefits that we have created through investments that we've made.

Now if we include SRS in this, obviously, as I said, there's about a 40 basis point mix shift in our operating margin base. So that 14% becomes the 13.6% that we've guided alongside the negative 3% top end of the range today.

And just to tie it all up together, that 13.6% corresponds with our adjusted operating margin of 13.9%. So for the year, when we eliminate noncash amortization expense on intangible assets, we expect to report operating margin of 13.9% on a comp of negative 3%.

Thank you.

Thanks, Chuck. Yes, they remain a robust share-taking grower, and that high single-digit is split between -- roughly equally split between organic growth and lapping of acquisitions.

Yeah. We wouldn't give any guidance in the '25. But remember, their mode of growth, which they have demonstrated this since inception in the mid-2000s, is there a balanced grower between comping their existing branches, their open base of branches, opening greenfield branches, and then some roll up M&A, geographical customer list add-on. So that's the profile that they've grown for years, and that is exactly the profile that we will support going forward.

And just for clarity's sake, SRS is not in our comp base. And so they are not reflected in our comp sales guidance. They will become comp once we've owned them for 12 months.

Well, intuitively, it's probably the converse of what we've seen. You think about the categories and Billy, please chime in, but those things that are components of the large project, kitchen, bath, flooring, lighting are all under pressure. And our customers tell us it's because that large project is being deferred. We're certainly not going to try to call timing.

But just to echo what Ted said, there is certainly a direct relationship between decreases in mortgage rates and the amount of activity that you at least see picking up in turnover. And so I think the important point here is, as we've said for years, the long-term fundamentals of home improvement demand are strong. We have continued to invest through this period of moderation. We -- 2024 marks the highest amount of capex that we've invested back in the business really in the last 15 years because we are bullish on the future. And timing is uncertain, but we're going to be ready for it.

Yeah, Brian, thanks for the question. And to reiterate in our comps, we were minus 3.7%, minus 0.9%, and then a minus 4.9%. While we did see some softness in July, as we alluded to in Ted's comments, there's no question that the extreme heat took some sales in weather-related categories, think ACs and fans, think air circulation, think watering, those typically come for us in the July time frame, and we saw, as I think everyone on the call is where we saw, a pull forward of that significantly back into June. So it was really just a shift as we saw some of those categories move into the back half of June, and I'll let Richard expand a little bit further.

Yeah. And Brian, Billy's comments were spot on. There were signs of maybe a little more general weakness. The major driver were those heat-related categories. There were some signs of more general weakness. That had an influence on our guidance range. But let's just -- let's talk about that range and kind of how we've started off the quarter.

August has started off at a level consistent with what we would expect in a negative 3% comp result for the year. And August comps are better than July, right? And so we -- there are a lot of factors that went into our guidance. But again, August has started off at a level consistent with what we'd expect in the negative 3% comp case.

Well, Brian, as I said, SRS will continue their activity to fill in geographies and segments, et cetera. Look, we just made a very large acquisition that we feel great about in early, early days of joint business planning and value creation, we've always talked about utilizing M&A for growth opportunities, whether it's segments or geographies, or customer bases. And expect us to continue to do that, but do not expect us to do anything large having just done this very significant transaction with SRS.

Thank you.

Yeah. Hi, Zach it's Ann-Marie. Pro certainly outperformed due to your selfers in the quarter. And as we have mentioned, we continue to invest in the Pro ecosystem to accelerate growth and really drive and grow the share of wallet. I'll go it over to Chip and just speak a little bit about the investments and what we're seeing there.

Yeah. Thanks, Zach. As we've mentioned in the past, we're investing in markets. In last year, we had 14 markets we invested in. We'll be fully invested in 17 markets this year. And when we talk about investing in markets, it's a distribution supply chain capability play, foundational capabilities that help us better serve the Pro, and then most importantly, our expansion of our outside sales team.

We've seen positive growth in all of those markets since we've been investing. And we see that quarter after quarter. So we're very, very pleased with our progress over the last 1.5 years as we've marched and we continue to march in '25 with the same progress and expectation of expansion.

Well, let's talk about share repurchases. So as we announced, as part of the SRS acquisition, we financed the acquisition with $10 billion in bond issuances and then some short-term commercial paper raising.

We are currently at a 2.6 times debt-to-EBITDA ratio. We like to see that ratio around 2.0 times. It's our intent to delever over time before we restart repurchases. That's going to take us likely into the year 2026, and we will obviously update our investors on how that looks over time. But that would be the kind of the current calculation, sometime in 2026, we have returned.

And then from a long-term structural perspective, when we laid out our basin in an accelerated case, we said to the base case. Look, we anticipate, in the base case, that we will always generate some degree of operating leverage. And that will always remain true. We're not going to talk about a high watermark. And we will continue to update you on our views.

But for now, we're executing with exceptional expense management, exceptional measurement, and cost of goods sold. And we are delivering -- over-delivering really on the profitability we would have expected at this top-line rate. So we are happy that we're running the business as it should be run. And we believe that in those base case and accelerated cases that we laid out in June.

Christine, we have time for one more question.

Sure. The good news is on their greenfield operations, it's reasonably capital light, at least a more modest-sized facility than a Home Depot DC would be, think of this as a branch operation. And high turning inventory and variable pay for the sales force. So they tend to be breakeven in year one of operation.

Similarly, when they make infill acquisitions, they have a great process to get that acquisition up on their ERP system. They literally do it over the weekend. They acquire a company on a Friday, and when that company opens up on a Monday, they are on the core ERP system of SRS. And that lets them get the operating process and technology synergies very quickly. And they have a track record of doubling EBITDA of acquired companies in the first three years of ownership.

So it's reasonably asset-light. It's quickly profitable on a greenfield basis, and it's multiples of earnings expansion on an acquired company. Since we've owned them. They've made -- in fact, I think last Friday, they closed on a small pool deal. They have a couple more under LOIs. So these are modest infill acquisitions that they do in the normal course of business. So we're really excited to watch them grow. And again, it's reasonably asset-light on greenfield in the multiples, they're paying, as you can imagine, on smaller regional companies that are generally in single-digit EBITDA multiple. So nice earnings profile on their acquisition case.

Yeah. The total amortization expense last year was $186 million for Home Depot for the full year of 2023.

And Steve, on branches, they're about 775. So when we announced in March, it was 760, you can see their growth profile. They've opened 20-plus branches just in the last few months. So these folks are super growth-oriented.

Thank you.

Thank you, Christine, and thank you, everybody, for joining us today. We look forward to speaking with you on our third-quarter earnings call in November.