The Home Depot, Inc. (HD) Earnings Call Transcript & Summary

All right. Good morning, everyone. I'm Matt McClintock, the retail hardlines and softlines analyst at Raymond James. And I'm very excited about introducing our next company. This is the session where you're going to learn How Doers Get More Done.

All right. Matt, I love that.

Of course, I'm talking about Home Depot, the world's largest home improvement retailer, have more than 2,200 stores. They do more than just retail products. They have a lot of services, installation, et cetera, MRO, et cetera. A lot of interesting things they're doing right now. We'll get into that when we do this fireside chat. But I'm very pleased to present Ted Decker, the Executive Vice President of Merchandising. With Ted, next to Ted, is Isabel Janci. She is the Vice President of Investor Relations and she's also the Treasurer. And also from The Home Depot team, we've got Tim Walsh over there, and we've got Charles Wilson right over there, too.

And so with that, I guess we'll just go right into open Q&A.

Matt, I love the intro. That's our new marketing campaign and tagline, How Doers Get More Done. So I'm glad it resonated. We're super excited about it and just excited to launch the next 40 years of Home Depot, the new tagline.

Well, it feels like before it was, "Let's get this done," and you got it done. So now you need to do more. So it works really well for me.

Exactly.

Well, so maybe we can just start the chat off with -- you recently reported your fourth quarter results. And you mentioned that you were ahead of expectations. What drove those results? And how are you feeling as we enter 2020?

Right. So we were very pleased with the fourth quarter of 2019. The business really performed across geographies. It performed across our merchandising categories. So we had positive comps in all 19 of our geographies throughout the United States. We had positive comps in Canada and Mexico. We had positive comps in each of our 14 product categories. We had strength with our Pro customer. We had strength with our consumer customer. Where we had, had a lot of headwind throughout the year in commodity deflation that abated in Q4. So we were more neutral in both weather and commodity in Q4. And it was really a demand-driven strength in our business and just really good execution from our field store team and our merchant team. Q4, for us, is driven by a lot of events. So as we go into decorative holiday, in our gift center, in our Black Friday events, there's a tremendous execution throughout the business, both in-store and our online properties. Since we build out this interconnected experience, it is resonating. Just great products, gift centers is a lot of tools, power tools, hand tools and power tool accessories and storage. Just taking a lot of share in those categories. Again, just great displays in sets and execution by the field and great offers by our merchandising teams. So just a very broad, robust Q4. And as we enter this year, we had our analyst presentation in mid-December and updated and gave our formal guidance, 3.5% to 4% comp for 2020. And yes, feeling good, so excited about 2020.

So you talked about a lot there. And there's always a lot going on at Home Depot. But it feels like this year, there might be more than normal going on at Home Depot. So you have a lot of initiatives underway in 2020. How are you tracking those initiatives? How are you staying on top of that? And then can you just talk about improvements to the overall customer experience as you roll these initiatives out?

Sure. So as you all know, at the end of 2017, which was our prior investor conference, Craig launched a big investment initiative for The Home Depot. We were tracking extremely well, taking share in virtually all categories, by all rights, sitting in a good market position. And Craig said, from this position of strength, we are going to double down, if you will, and take The Home Depot experience for our [indiscernible] customers to the next level. So we launched an $11 billion 3-year investment program. And one of the things we needed to do, as Craig says, we need to run the business and we need to change the business at the same time. And as you can imagine, a company as large as we are, when you're making that sort of incremental change and just the mind share of building and working on these initiatives that you might lose sight of the execution. And the teams have done a great job executing, witness 2019 and particularly Q4 of '19. But 2020 is our peak year. It's the third year of the investment cycle. We're very positive on what we're accomplishing. Again, everything is customer-backed and interconnected-focused. So the bulk of those investments, half of it is going back into our stores. So we're 40 years old now. And our store based on average, and average store age is over 20 years now. And while we're working warehouse, we want to be a clean, safe, friendly, light place. So about $5 billion is going back into the 2,400, 2,300-odd stores to improve the environment, so LED lighting, painting, buffing floors, new break rooms, new restrooms, new front-end checkouts, new sign packages, et cetera. We're bringing the brand standard. And it was a lot of fun launching our new ad campaign because we're ready to reintroduce customers to The Home Depot, if you will. It will be the first time probably since the first 2 stores opened that a Home Depot look and feel will be the same across the United States. So when we're done by the end of this year, we will have the same environmental sign package across the store and have updated all stores in the United States. Another big piece of transformation is in our IT platforms. We had a lot of legacy, a lot of homegrown legacy systems throughout the enterprise. And we're replatforming in process sort of finish or to finish virtually every IT system business. That's going well. I'm not sure this one is working. That's going well. That's all on track. That's going to carry out a bit past 2020. Okay. But that's all on track. We're making great progress replatforming all of our major systems. And then the last big piece is our supply chain. In the supply chain, the strategic intent there is when we're finished, we will be able to service 90% of the U.S. population with same- or next-day delivery for every single thing we sell. So the difference here of a normal delivery of parcel is we will -- we're talking about truckloads of concrete and lumber to a power tool. We will be able to deliver anything and everything The Home Depot sells, same or next day to 90% of the U.S. population. And we're going to do that by building out about 140 new facilities. Mark Holifield, our Head of Supply Chain, has outlined a number of different facilities from pick, pack and ship, parcel freight DCs to bulk DCs for building materials to flow DCs, to move things like appliances through as we take over more control of that end-to-end customer service selling cycle and installation cycle of appliances. So that's all on track. That's going to go into 2022. But with all the investments, this is the peak year. And we're again focused on running the business, hitting that guidance we outlined and continue to execute on this investment program. So again, feeling really good.

So if we could talk about that, again a lot of investments, a lot of initiatives, a lot of dollars being put to this. How do you measure the return on those investments? It seems like what you're building is something that's never been built before. And so it's -- there's a lot of uncertainty in terms of timing of payback, et cetera. But how internally are you thinking about the timing of that payback, the return on that? And how should we, as the investment community, start to think about this -- these initiatives driving top line, driving margin, driving future returns?

So everything we're doing is certainly to get incremental growth. And that largely translates to incremental share, particularly with our Pro customer. And everything we do at Home Depot, we've had a lot of discipline in the business in partnering with our finance teams to do -- we test and learn everything we do. Whether it's a merchandising reset, we'll start with -- and we're putting a lot of money, part of the store investment is accelerating merchandising resets. But everything we'll do -- we'll do 30 stores. We might do a proof-of-concept of 10 stores, iron out what the fixtures are going to look like in the actual installation in the store. Then we'll do 30-odd stores and do a test and learn, to see if we get the lift to get an ROI on the investment. And then we'll start rolling out in an orderly fashion. And literally, everything we do, we have robust models. Our ROIC is, what, Isabel? 45%-plus. So we want to keep that return on capital strong. And we do monitor literally everything we do. But I would say what fundamentally we're building here is an ecosystem. We're building an end-to-end customer-backed ecosystem that, I would say, is going to be extremely challenging to replicate. So if you think of Home Depot, we're blessed with an incredible brand, an incredible culture in set of values in the company that our founders established. We have, I would argue, a irreplaceable real estate portfolio and real estate advantage. And now what we're doing is we're putting together an end-to-end business model and set of capabilities, to your question, what's the $11 billion for. And it really is an ecosystem. So at the analyst conference, I mentioned our tool business that has been growing incredibly well. We've been taking share for years now. And while we measure incremental things we do with the tool business, when you put it all together, when you say what is the key to Home Depot growing like we're growing and taking the share we're taking in power tools. You'd have to start saying, "Well, is it the 400,000-odd associates who live the culture, who have terrific training, who have terrific leadership in the field, who provide excellent customer service?" Is it the set of brands we have that many are exclusive to The Home Depot? Is it the $100 million we put into our tool corrals, to reset the corrals by product branding? Because as the business has moved to cordless, people tend to get on a battery platform, and they are increasingly shopping by brand. So we've represented in our displays now the product by brand. Is it the interconnected experience that we have, just terrific website and mobile app? Is it the fact that we offer lockers, so you can buy online and pick up store and pick up in a locker? Is it because we have parcel shipment? And today, in parcel, 1- and 2-day parcel, we're certainly the vast majority, 70-plus percent of the United States, in 1- or 2-day parcel. Is it tremendous marketing and agile and digital marketing that we've built out in our capabilities in marketing and personalization? So the answer is, it's all of it. And including the terrific real estate positioning that we have. You put all that together and you get CAGRs of high single digit, low double digit in power tools for the last several years.

And just to add on to what Ted is saying, I think what we're ultimately trying to do is reduce friction from that shopping experience to create a unique experience and value proposition for the customer. And ultimately, we're looking to gain market share in any economic environment. That's really the end goal of all of these investments. And that's what they're really geared at.

Okay. And then since you talked about tools, I thought it'd be useful to talk a little bit more about broader merchandising at Home Depot. What type of innovation are you seeing in 2020, 2021? We've had a lot of innovation in a lot of categories in home improvement for the last several years. Flooring is a great example, right? How should we think about that over the next couple of years? And then could you maybe talk about your relationship with your vendors, how you partner close with them and how that might be a little different than how other retailers approach this industry?

Sure. So the innovation, we always say product is king. People don't come in to The Home Depot generally for the heck of it, right? They're fixing something, repairing something, building something, improving something. So they're fundamentally there to solve problems, interact with our associates and get products. So in our mind, product is king. And the innovation across the industry and across the store, there's no one thing. I mean it is super exciting, from fast-set concrete, where you're getting psi strength at faster and faster set rates. It's fireproof insulation. The tools we talked about going to cordless technology, power tools were always corded. You truly now get with the electronics and the battery or in the tool, the amp hours and the run time of the batteries, you can cut the cord. You're getting -- a Pro can go to a job site and get their job done with a cordless power tool. That is now transferring. Super excited about outdoor our power equipment. Our suppliers in tools, many of them exclusive, have terrific outdoor power equipment programs. These have traditionally been gas, increasing to cordless at a rapid rate. We are now doing the same thing to our outdoor power equipment. We're spending the capital to reset that business by battery platform. And the batteries are interchangeable between the power tools, drills, et cetera, with even lawnmowers. I mean you're seeing, again, power and run time to get a job done, including cut your grass, with a cordless lawnmower. Appliance innovation continues at a rapid rate. You mentioned flooring. The big winner lately in vinyl plank is our LifeProof program, where we have a solid core waterproof flooring product that's very forgiving on installation and fast and great value. The program has been growing markedly. Carpeting, our carpet business had a great quarter and is growing very nicely. And we have now lifetime guarantees on stain because what our supplier mills have been able to do with the fibers, to think of, we always talk about a radish versus a carrot. And the way they're extruding the polyesters and the nylons, you can provide a lifetime guarantee of staying on carpet. So literally, across the store, I can go on and on. But what we'd like to do with our supplier partners is we're very collaborative. And we talk to our supplier partners about momentum in the business and we talk about driving units. I mean at the end of the day, we're a working warehouse. We're a big box retailer. And our business model is built on unit volume. We love ticket. We love innovation and trade up and getting average unit retails higher and higher. But at the end of the day, we want to drive volume. And we understand with our supplier partners, their marginal profitability increases with every extra unit that they produce. So we're very much a symbiotic relationship that we are going to provide the volume. Our DNA is to deliver volume. They know they can get the volume with The Home Depot as long as we're collaborative, which I believe we are, and we approach it with a win-win attitude. On the margin, they should want to work with Home Depot. And on the margin, we're going to drive more units for their business.

And then since you used the word ticket, I was wondering if you could maybe talk about trends in big ticket, what you've been seeing there, how you think about that as a reference to the health of the consumer in general. And then maybe we could take that a little bit further and just talk about the health of the housing market. How Home Depot is thinking about housing in 2020? And how to think about potential upside or downside relative to where we are today?

So I'll do ticket and then Isabel can do housing. Really strong, big ticket in Q4. Our ticket is strong. And it's driven by a couple of things. People continue to trade up. So all the innovation I spoke about tends to be higher price points and people are trading up to innovation in buying more expensive products. So our comps and our line structure from OPP, good, better, best and premium and even super premium product that the comp accelerates across the line structure. Our Pro business is ticket-driven. So Pros come in, they're doing jobs and they're buying much more in a basket from a Pro ticket. That business is strong. Our services business, our installation business, including carpeting, had a really strong Q4. And we had comps above the company average in our service business. So that was north of 5.2%. And those tend to be projects and installations in bigger ticket. So we're very happy with the progress we've made with those businesses in delivering ticket.

Much like we said at the December conference, we see the housing metrics that we track more closely as stable and supportive of the business. And those would be turnover, household formation, the age of the home and home prices. And the difference in the view of housing than maybe we had last year is when we think about our guidance and how we build our guidance, we, first and foremost, start with GDP. We build on demand for home improvement driven by these housing metrics and then we add market share gains. And so for the housing component, I would say that this year, the way we're thinking about housing is, while stable and supportive of the business, much like last year. We're just not going to count on more of a contribution from housing. And that's essentially how we think about it.

Okay. And then just circling back on your relationships with your suppliers and your vendors, clearly the topic of the conference has been coronavirus. Can you maybe talk about the risks that you face with this? How you can -- what your flexibility is to adjust your supply chain to solve for getting deliveries on time, everything like that? And how you just think about the risk there overall for this year?

So on our global supply chain, I would say, for Q1, we're in pretty good shape. So product for Q1 is largely in our stores. So Q1 and 2, for us, is a big strength. Spring and outdoor project business, we're largely set. So all our merchandising space has largely transitioned to spring product. We'll be finished with that in our northernmost markets in the next week or 2. But -- so all that product that comes in, gas grills and patio sets and the outdoor power equipment, I was talking about previously, for Q1, that product is largely in-store, in our supply chains or on the water. Q2, I would say, it's a very fluid situation. So as you say, we have very strong relationships with our supplier partners. For our direct imports, where we're working directly with factories in Asia, we are in constant contact with them and monitoring their capacity and how they're getting back up to speed and what their shipping horizons, timing is going into Q2. It's fluid. We're literally looking at this PO to PO. The good news is the ports are open and functioning. We haven't had delays in ports. It's really a matter of workers getting back to factories from the Chinese New Year. Most of those workers or many of those workers are in residence at the factories. And for those 2 weeks of Chinese New Year's, they travel home to wherever their provinces may be out of the major cities. So it's been a transportation issue in restrictions of travel intra-country to get those workers back to the factories. So again, we're in contact, varying degrees, as you can imagine, of building back to capacity. The next set of suppliers are suppliers that, while we don't procure directly from China, we know the country of origin is China and Asia. And we're in constant contact with them, starting to build orders into Q2. Again, it's PO to PO. You're obviously not going to order too deep into Q2. You just -- the supply chain won't handle that sort of cube. So we just have to keep working it. Nothing alarming at this point. We said there was nothing in our guidance for 2020 that included coronavirus. We were 3.5% to 4% at our analyst meeting in December and after our first quarter -- after our Q4 earnings call. And there's no change to that at this point. But certainly, it's a fluid situation.

And I think we're running out of time, but one more question. The last question would be just on shrink. That's been a little bit more heightened than in prior years. Can you talk about where the challenges have been with shrink for the last year or 2? It sounds like you've already made some progress on this issue. What progress have you made? And how to think about shrink as we get into 2021 and cycle into later years?

Yes. So shrink has definitely been a pressure on our gross margin in 2019. We expect that to continue into 2020. We're making progress. There's really a short-term and a longer-term path for us. The shorter term is something really as basic as locking up some of these higher-value items, the tools that I mentioned, great product, incredibly innovative, higher value. And that's something that's in demand for theft. And so we have a shorter-term program in our higher shrink stores of actually locking up those tools and working with our store partners on much more customer engagement to assist that customer. That's going well, earlier days that we're rolling out those lockups. The longer term is probably a technology solution that we're working with our supplier partners. So think of your phone, where you can disable a phone or activate a phone. So we're thinking the same thing with things like tools, where you'll activate at POS or go online and register a serial number to activate. That's going to be a longer-term fix. So we'll have pressure into 2020. The other thing to think about, we inventory stores once a year. So it's a rolling inventory process. So there's a lag in getting inventories. And then just the accounting of our shrink, we account for shrink on a rolling 2-year average. So shrink, as we've said, in 2020, it's certainly with us. And just from our financials, that rolling average, it's the pressure -- it's manageable. We understand what it is, but it certainly isn't going to go away, unfortunately, overnight.

With that, I think we ran out of time. But I want to give a big round of applause for The Home Depot team, Ted, Isabel, the rest of the team. Thank you very much for coming. And have a good day, everyone.