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

Good afternoon. This is Kate McShane again from Goldman Sachs. We're very happy to be at the Keynote Lunch for today with The Home Depot management team. Today, we have with us Craig Menear, Chairman and Chief Executive Officer of Home Depot; and Ted Decker, President and Chief Operating Officer of Home Depot. We also have with us Isabel Janci, Vice President of Investor Relations and Treasurer. Thank you so much for joining us today.

Thanks for having us, Kate.

So if we could maybe just launch our questions with state of the macro environment, all the tenants of -- they are there, I think, for a very strong housing market. You still see home price appreciation, aging housing stock, low mortgage rates. But the amount of incremental dollars that you will likely generate in 2020 and 2021 equals the same dollar amount, I think, you've made over the last 6 years. So how do you plan for demand beyond what we just saw in the context of what still seems to be a robust environment but a lot of dollars already spent?

Now great question. You're right. We've -- and really, in the last 6 quarters, we've grown the business $34 billion. So obviously, the customer is engaged in our space with our industry. And we look at the backdrop. As you called out, Kate, there's a lot of positives when you look at the big picture as it relates to housing. We've had tremendous home value appreciation. Part of that is driven by the fact there's a lack of new housing availability in the market, and it's going to take quite some time for that shortfall to be solved. So we think home values will continue to appreciate, not at the levels that they have the last couple of years, but even with modest growth in home values, customers are willing to invest in their homes. When you look at the amount of time customers have spent around their homes over the last 18 months, they clearly tell us that they have a laundry list of projects that they want to continue to do. When you look at the remodeling index, it's at its peak levels from that perspective. And when we talk to our Pro customers, they tell us their backlogs are as big as ever. So it's hard to really think about short-term what all happens quarter-to-quarter in the demand cycle. But we think, over the near term, the demand cycle for home improvement is going to be a pretty good environment, we believe. And so we're positioning ourselves to be able to take care of that. And we're doing that through the investments that we've made in the business over the past several years and we've continued to make to support the customer and how they engage with us, and that's in an interconnected way. They're blending the digital and physical worlds together. So we're pretty -- we feel pretty good about the near- to longer-term outlook for home improvement and what opportunities that presents to The Home Depot.

That's great. And then if I could maybe ask, so you talked about the strength in the cyclical, and then just from a company execution standpoint, what about any kind of secular trends? One thing that we have observed is prior to the pandemic, there seemed to be some fits and starts with millennial homeownership. And now, it seems that the pandemic has been a bit of a catalyst and accelerated things for that particular customer. So how are you looking at that demographic change and how that plays into the longer-term sales trends at Home Depot?

Yes. You're right. The pandemic certainly accelerated engagement with the millennial generation and home improvement and quite frankly as well as homeownership. We've seen, over the past several years, the millennial generation step into homeownership, and that accelerated during the past 18 months. Ted, you've watched the millennials step into our business, and you see them gain confidence to take on more, right?

Yes. No, you said it, Craig. For the medium and longer term, we are thrilled that the millennial had shown engagement. There was a big question for the industry, frankly, with this next newest largest generation engaged in home improvement to the same extent, say, the baby boomers did, which the industry was really built on, on the baby boomers engaging. And instead, the baby boomers aged out and started to downsize. There is this whole notion of rental economy, and millennials weren't going to own. They certainly could own homes, and they weren't going to engage in DIY. We had done research that said that they were interested in and were going to, but there was a delay. This is a dynamic of the delay with the economic downturn back in '10 -- '08, '09, '10, et cetera. What the pandemic did was accelerate that. So where they were delayed, the pandemic accelerated that because people wanted to move out of urban settings, wanted a single-family house. Participation in homeownership increased dramatically in the household formation of millennials. But on top of that, and more important for us in particular, was the engagement in DIY projects. So paint was the category. It's often the very first category that a homeowner will engage in. It's that first project that you would start to get some confidence in your ability to engage in home improvement. Paint had grown 1%, 2%, 3% for years and years and years. We just had an explosion of people at home starting projects and painting. And we've seen that continue into bigger projects. Millennials are fully engaged digitally. They're engaged in businesses like HD Home, which is our digital core business. So we're just thrilled for the medium term that this next generation is indeed going to be as active in home improvement.

That's great. If I can move on to market share, I know it could probably be fairly difficult to measure it in the context of what's happened over the last 18 months. But how are you thinking about Home Depot's ability to continue to take share after likely winning a good amount during the pandemic?

Yes, Kate, that's really the reason that '18 through '20, we made the accelerated investments in the business. We did that to position ourselves to be able to continue to grow share at an accelerated rate. If you look at that time frame, in that period, by triangulating multiple points of data, our best guess is, is that we gained about 275 basis points of share, which translates to about $10 billion of incremental volume per year. You throw out about $2.5 billion off on that, that's a heck of a return on the investment that we made. And so one of the things the pandemic taught us was that the areas that we were making those accelerated investments actually were critical to us being able to serve and grow the business the way we did over the last 18 months. And so as we look forward, we'll continue to invest at more of a steady rate, think 2%-ish of sales on a CapEx basis. And we'll do that in areas that the customer continues to take us as it relates to engagement in an interconnected way. We really believe that the customers are blending the physical and digital worlds to complete their projects, and we want to make that as seamless as possible. If you think about the second quarter, we ended the second quarter at $660 per square foot of sales. Part of the investments that we'll make going forward is to make sure that we're building out capabilities so that we never hit an operational cap on our ability to grow sales. And so you can expect for us to continue to invest, and that includes continue to invest in the supply chain, continue to invest in our digital capabilities, continue to invest in operational capabilities within the store to be able to handle those increased comp flows as we try to grow this business beyond where we are, the $200 billion in sales.

And I think that's a great point to make just in terms of how much you've been able to improve the productivity of the store because it's been quite some time since Home Depot has opened more units. So that seems to have been like the biggest driver of your comp for the last couple of years.

For sure. And we're not done there. We believe that we still have opportunity through both process improvement, technology, to continue to drive efficiency in how we operate our stores and how we do that for the customer when they choose to blend the physical and digital worlds together, Buy Online, Pick-Up In Store. We know there's opportunity there. I would say that with the supply chain that we're building out, and we're done with the supply chain and the goal is to be done at the end of '22. That will be, in many ways, the equivalent of adding almost 200 stores to our network, if you think about it from the capability standpoint of driving sales. It's just sales happening in a different way, being delivered to the customer, engaging in the capability for big and bulky with our Pro customers through flatbed delivery. So think of that investment as a, give or take, 200-store equivalent opening.

That's helpful. And I have quite a few supply chain questions next. So I just -- I wanted to sneak in just one question about the Pro since you've had so much success there in your business as well. In the past 2 quarters, you've seen the Pro outpace DIY. I think maybe you could explain it a little bit just with some pent-up demand for the Pro, but we wondered if there was anything else driving that Pro business.

Yes. No, it certainly is part of, if you will, catch-up over a 2-year period of time. When you look at comps with our Pro and our DIY customers over a 2-year period, the comps are actually pretty similar overall. We've stated all along that our objective is to grow both the Pro and the DIY customer over the long term, and that's really what we're focused on. When you look at the near-term outperformance of Pro in the past couple of quarters, part of that is the fact that we saw a recovery in our larger Pros that have a tendency to be more centered in urban environments, where, quite frankly, restrictions and customer sentiment about having people in their homes were a little bit more constrained as the pandemic took place. And then we've seen improvement over the last 4 quarters. Once customers got more comfortable, having work done in their homes, that Pro business began to come back. In the last 2 quarters, it overtook the DIY growth. But in general, we feel great about the total growth. And particularly, if you think about the growth we had last year, to then be able to put in the first half, roughly $12 billion on top of that, we're thrilled with that performance.

If I could maybe pivot to just staying focused kind of on the top line and what's driving your business, Ted, you've talked a lot about product innovation over the last couple of years, and it seems like we've seen a really good degree of innovation with cordless and battery-operated tools especially. I wondered if you could help us categorize the level of innovation currently, how important innovation is maybe to the business today or what you're facing next year versus how it's been in the past and just how does the innovation pipeline look.

Sure. It's incredibly important. It's a hallmark of Home Depot and our merchants. They are always looking for a great product, innovative product at a great value. And we do, we talk a lot about major technological advances in cordless technology. For several years now, the batteries and the motors and the electronics and these tools are really at the point that you can cut the cord in power tools, and many of our customers are. In the further development of these tools, through now not just replacing the cord, you're replacing, in many instances, a gas engine. So the same technology is going across to outdoor power equipment. So you're seeing lawnmowers. You're seeing riding lawnmowers, certainly string trimmers and blowers. So the cordless technology is certainly one of our larger innovation categories. But I love the fact we see it across the store. There's so many areas that we don't talk about. And we go bay through bay in the store, and there is exciting innovation throughout the store. Yes, there's cordless technology. The appliance industry, I mean, it's incredible technology that's going into appliances. We just launched a new paint with Behr, we believe, the best paint in the market, scuff-resistant, stain-resistant, one-coat coverage, et cetera. This is brand new. This was launched just weeks ago. But you go through areas like building materials, whether it's mold-resistant drywall; lighter drywall; insulation that is adding higher R Values at less cost; and noise reduction; faster-setting concrete at higher PSI levels; really across the store, LED lighting certainly, integrated LED lighting; the flooring category would -- you can get an incredible value, tile or wood-look flooring and now laminate flooring, that's easier, faster to install, all in lower cost of the project for either the DIY or the Pro customer. So innovation is incredibly important. Our merchants are working with our supplier partners, working with our customers; customer-backed innovation, deep integration in development with our key supplier partners. To the extent we're signing NDAs, we're going way up the funnel in terms of raw customer research and use case development of what kind of solutions we want to provide for the customers. So super important. We have all sorts of measurements, the famous 3M model, with percent of sales from new products, new products that we've introduced. And all are very, very robust and something we watch very carefully.

Is there any way to quantify how this product innovation has raised your average ticket over time?

Well, it has. I don't know if we'll give that result. But when you think of cordless power tools and outdoor power equipment, I mean, they're fantastic products, but a cordless mower is sort of a $399 to $699 price point. And that has clearly lifted, just in that one example, the price points of a DeWalt push mower.

Yes. And from a gas mower perspective, the comparable sweet spots would have been $199 to $299. So as the customers gravitate up, it clearly helps drive average ticket.

Great. If I could pivot to the supply chain now because I know there's a lot to discuss, both the near term and what you've been doing as a company over the last couple of years, but obviously, it's been a massive topic as of late, just given the port backups and the container shortages. And the list kind of goes on. So we just wondered, given all of the issues within the supply chain, where is the biggest bottleneck for Home Depot currently. And what are some of the levers that you're leaning into to alleviate some of this consternation in the distribution?

Maybe, Kate, if I take it at a 100,000-foot level, and then I'll ask Ted to share some of the details of how he sees this, because there's a lot in the supply chain, as you alluded to right now. But I would say, at the highest level, over the years, Home Depot has learned a ton from the work that we do on supporting communities in storm environments. Those are environments where you're in constrained availability compared to demand. You got to be able to be very creative about how you move goods and work with your suppliers and drive all the components of the supply chain to fulfill that demand. And I think we've learned a ton from that scenario over the years. And our teams are very creative in terms of doing whatever it takes to try to make sure we take care of the customer and serve the demand. We believe wholeheartedly that customer service starts with having the product available for sale. And so that is a key focus for all of us. But Ted, I know you have a very specific way you think about this challenge, so...

Yes. So as Craig said, we've made improvements. We've serviced $34 billion of growth in this pandemic over the last 6 quarters. While our in-stock levels are not where we would like them to be, they have improved and are improving again despite servicing that much sales growth. And if I can just -- I'll chunk up the way we look at the supply chain. You think about our distribution facilities, our suppliers' production capabilities and then transportation, ocean and domestic trans, starting with ours, most of our product flows through the -- our RDCs. And at the peak of the pandemic, we were having call-outs, and there's tremendous growth in cube. We were flowing product, but backlogs were growing. And these were flow facilities. The products were there for 2, 3 days in the normal course. We were up to 2 weeks in some of our facilities. We were having to rent off-site parking for trailers that were backing up. That has largely abated. So our facilities are down to low single digits. You might get a pickup here or there, but for the most part, our supply chain is flowing. On our suppliers, their ability to produce to this level of demand, we look at that, the key indicator is fill rate. And fill rate certainly fell way below where we would like it to be. But again, that has improved and it is improving just recently. There are still sectors where you think all things electrical and electric circuitry is particularly tough. It's one of the reasons we did our deal with ABB and Carlon to get the PVC boxes, exclusive to Home Depot and retail. The coatings industry, there's been a lot of news on coatings. I think we benefit there that we have multi-suppliers, Behr and PPG, 2 huge suppliers. Each suffered to keep up with demand. But we're at the point with Behr, the new DYNASTY paint, I just mentioned, we were going to release that in the spring. We didn't have the capacity, but we felt good enough that Behr had caught up and we launched that and it's in all stores for this past Labor Day. PPG is a great supplier and the RPM in spray paint, in our interior stain program. So that's been challenged, but our team of suppliers have done a particularly good job, and we think we're picking up share there. If you look at transportation, that's gotten a lot of the headlines lately. We all see the pictures, the ships outside L.A., Long Beach, 20, 30, 40 ships waiting to unload, the ocean rates, getting vessels, getting containers. Our team has been incredibly entrepreneurial. Much of our volume is under contract, purposely not all of our volume, and our teams have done some incredibly entrepreneurial things to get more freight. I would say, on both the domestic and the ocean transportation, we just recently wrapped up all negotiations for our capacity there. And in each case, we have secured higher capacity. So we did increase our percentage that will be under fixed rate. And having completed those negotiations, certainly, the rates are higher, but we've got more capacity. And following those negotiations, all of our tenders, so actually the flow of goods under those contract rates, are all increasing meaningfully. So we're getting more transportation. Our suppliers are increasing production. And as I said, our facilities are operating much smoother. I mean we're going to probably go well into 2022, if not through 2022, with lots of constraints and challenges in our industry, but couldn't be happier with the team's performance and our supplier partners.

Kate, I would tell you that our suppliers have worked really, really hard. When you think about -- nobody was planning for the kind of growth that we've seen here. And they got hit with all the challenges that we all got hit with during the pandemic, and they have worked really, really hard to help improve the situation and they were gaining ground every single day.

I would imagine too, just with some of the disruption, that this could be maybe a longer-term tailwind again on the market share side because I would imagine some smaller players might be having a harder time securing inventory and managing the costs as well as Home Depot.

I certainly think that's possible. Our focus is to grow share in any environment. It doesn't matter what it is. That's what we want to do. We've invested to grow at an accelerated rate. That's our focus. We know it all starts with continuing to grow market share.

And then if I could just wrap up the supply chain conversation with some longer-term questions. Craig, you mentioned, I think, the end of your multiyear investment in the supply chain ends 2022. So could you maybe just walk us through quickly what this supply chain investment will give you at the end of the day and how will it differentiate Home Depot?

Sure. So I would say a couple of things at the highest level. At the end of the day, when we have the supply chain buildout, we'll be in a position to be able to serve our customers with any type of product that we sell, whether that's big and bulky or parcel delivery, same-day, next-day capable for 90% of the U.S. population. So that's point one. Second point would be, we believe, at the end of the day, we will have the low-cost position in the supply chain for home improvement. And so that should give us a competitive advantage from a value standpoint that we can drive for our customers, which is part of how we continue to accelerate top line and grow share. The third thing I would say is as we focus on some of the opportunity areas that we have, Pro planned purchase being one of them, that's a different occasion than what we serve in-store for most of our Pro customers. What the capabilities that we're building out will allow us to do is expand depth of inventory carried as well as breadth of assortment that are key Pros', larger Pros' planned purchases, which are bigger, what they will need. And we'll be in a position to pull together kind of under one roof everything they need versus what they're doing today, which, in many cases, if you're a remodeler, you might get your lumber from us, you might get it from a lumber yard, you might have to go to a flooring store, you might have to go to a drywall house to do all these various stages. We can pull that all together for them under one stop, which is what the magic of Home Depot was for the DIY customer 42 years ago. And so we think that gives us a tremendous advantage and an efficiency that we provide to our customers and our Pros that will reduce the number of stops for them and drive a greater efficiency in their workflow process as well. So we're pretty excited about that opportunity.

Yes, Craig, if I can add a couple of near-term examples. So we have a few markets now where we build out all the different assets that we'll be deploying, and Dallas is the most mature of those, although they're all very, very early stages. But what we're seeing in Dallas is when you put together the complete offering of the supply chain, some enhanced sales force, we have a digital B2B website, we are seeing higher tickets, greater share of spend, engagement with our Pros. And the type of product, Craig mentioned the breadth and depth, things that we're not going to carry in the store, like maybe not a different product, but a 20-foot piece of lumber, for example, we're not going to carry that in a store. And the appreciation of depth of product for the Pro planned purchase, we have always supported the Pros. We've talked about job lot quantities in the store, so that a Pro can come in and get the full quantity in cash and carry it and take it with them. What we're -- we're really redefining what job lot quantity means for a Pro planned purchase. We just had a flooring sale, for example, in Dallas. A Pro customer was remodeling a multifamily unit, was getting a luxury vinyl tile. It was the exact same SKU. It's the #1 SKU we sell in-store. The volume that was purchased on one delivery was like 7x what we would have defined as a job lot quantity in a store. So this isn't 1 or 2 extra units. This is meaningfully different depth to satisfy the Pro planned purchase. And we're just thrilled with what we're seeing and what the capabilities are driving in Dallas.

And I think the last question I'll ask before we go into the 4 questions we're asking each company is just around -- just inflation, the inflation that you're seeing on the cost -- on the product cost side, on the supply chain transportation side, maybe even on wages. Can you talk a little bit about the level of inflation that you're seeing in aggregate and how much you're being able to offset with higher prices?

Yes. Kate, there's no question that we're living in a different inflationary environment than what we've experienced for many, many years now. And it is -- it's cost-led inflation and all the elements that you just described. We've always had fluctuations, and we deal with that. But this is a little different environment. So first thing would be, from our approach standpoint, we'll, number one, try to figure out how we can mitigate as much of this as possible. We always do that. That's part of our job as the customers advocate for value. And then from there, our job is to figure out how do we use our portfolio approach to make sure that we drive the greatest value for the project for the customer. And so we don't necessarily translate cost [ in product day ] to retail [ in product day ]. We look at how is the best way to apply what we need to apply in retail to keep the best value proposition for our projects for our customers. And we have a lot of tools that we've built over the years to help our merchants understand what's going on in the marketplace so that they can work to figure out how to drive that best value. We have the capability of looking at how we're positioned against the market. We do that on a weekly basis. So we evaluate that against multiple competitors and where we sit. So this is really something that we work on every single day every week to truly be the customer's advocate for value. We've got to do this better than anybody else in the market. And that's -- we'll use everything in our power, our scale, our relationships, our creativity and our technology to be able to do that.

Okay. I just want to say to the audience, if you would like to ask a question, please type it in. It will come to my e-mail. There's a little bit of a delay. So if you would like to get a question in, please send it now. I'm just going to ask the common questions we've been asking all of our company participants at this conference. First, and we've touched a lot on all of this, but how do you think about consumer demand in the second half of the year relative to the first half? Will it accelerate, decelerate or stay the same?

Great question. I wish I knew the answer to that. We didn't provide guidance for '21 because there's just so much uncertainty. Our job, candidly, through '21 is to be agile and flexible and deal with whatever gets thrown our way and try to take advantage of the capabilities we've built to accelerate our market share gains. If you step back into the latter part of 2020, most of the economists were projecting that consumers, as the economy opened up, would shift totally away from goods and move back to services. They had spent all their money in restaurants, travel, all of that, right? And we didn't know how that was going to play out because, certainly, our industry had a disproportionate amount of spend compared to historical norms through the pandemic. What is really exciting for us to see is that in the first half of 2021, even with that beginning to happen, customers going back to restaurants, personal travel coming back, we were able to grow $12 billion in the first half of the year. So we're bullish around the medium- to longer-term environment for home improvement. As I said earlier, how that plays quarter-to-quarter is still an unknown. How this Delta variant plays out is an unknown. I think if you look at patterns around the world, if this -- if it plays out the way it has in other places around the world, we might be on the backside of this thing over the next few weeks, and that would be terrific for the country. But we'll just have to wait and see how it plays out. What I can tell you is we're being incredibly flexible and agile and do what we need to do to try to drive the business and take advantage of the opportunity that's in front of us.

The second question we're asking, and we didn't talk much about digital today, but how do you think about your digital penetration in 2022 versus what we're seeing in 2021?

Yes. We never actually talk about digital penetration from a planning standpoint whatsoever. Our belief is always that the customer will ultimately determine what that is based on how they choose to engage with The Home Depot. And it's interesting. Obviously, when the pandemic was really hitting hard, and we needed -- we constrained customers in-store. We kind of forced the customer to go to the digital world so that we could serve more customers, if you will. We saw our penetrations last year peak in the 20-ish range. By the end of the year, that was back down to about 14.5%. And we've hovered in that 14.3%, 14.4% range for the first half of '21. We really look at it as a capability and a way for a customer to engage with The Home Depot more so than it's a separate business model, if you will. And we really believe the customer will choose how they want to engage with us. And so we don't plan a penetration at all. We're building out capabilities to enhance the digital experience. As Ted mentioned, we've got opportunity with the core side of the business as we build out HD Home and products that finish rooms. We know that the customer engages the store in about 55% of the orders to be able to pick up product. And many times, that's because they're -- they bought something online for their project, but then they go into the store and buy more product to complete that project as well. So that's really how we approach it, Kate, is to let the customer determine where that ultimate water line flows.

And I think, Craig, when the dust settles -- certainly, we accelerated, call it, a year or 2 of -- with that digital engagement. As Craig said, it peaked at 20-ish. It's come back down in the mid-teens. When it's all said and done, we might have advanced a year or 2. What we like about it though is getting that digital engagement to our app, in particular. And through even first half of this year, traffic to the Home Depot app, which we've continued to upgrade and build out capabilities, certainly for our Pro and our Pro loyalty customer, in particular, that engagement with our app in terms of downloads, in terms of traffic growth, in terms of engagement and purchasing on the app itself, that has all continued to expand through 2022. So we love the engagement with our app, particularly with our Pro customer.

The third question we are asking, and this isn't really specific to Home Depot necessarily, but just the environment, is how we should think about promotions in 2022 and if it will be higher, lower, the same versus what we're seeing this year.

Yes. I think, for Home Depot, we have been really focused on how do we -- be a great every day low-price value retailer for the customer. That is our #1 focus. We're not 100% pure there. We haven't been able to break categories, like appliances, that have been incredibly high-low promotional for 100 years. But we know, at the end of the day, that we need to be an every day low-price value retailer. And for 42 years, we've had events in our business to drive urgency, special buys, unique items that we bring in to drive urgency with the customer. And Ted and the team, actually pre-pandemic, had been working to pull back on the number of events and reduce the breadth of events as we really focus on that every day retail. And that's a continued focus.

Yes. Right. And it's an opportunity to back off a little more. So as Craig says, we're going for EDLP every day and trying to get out of the percent-offs as much as possible. And we've knocked off a number of categories. I don't think we've had a percent-off ceiling fan event, and I can't tell you how long, some, like appliances or categories that are a little tougher. But we clearly backed off in 2020 with the pandemic. We had some more activity this spring and that sense of urgency, the spring customer, but we have no intention of increasing our promotional cadence. And when we do have promotions, it is a narrower focus, a little deeper value, fewer SKUs, shorter time span. The aim is to be every day value for the customer. And again, particularly for the Pro customer, Pros have to quote and bid jobs. And they do not want to see a high-level environment in any category. So we're trying as best as we can to make that the case.

Okay. Great. And I'm going to sneak in our last common question, which is do you expect your inventories to grow faster or slower than sales in the second half?

Well, we always expect -- in a normal environment, we would always expect inventory to grow slower than sales. And Ted and I would say that's true as we think about going forward.

Yes.

We've grown our inventory about $4 billion from the lows of last year. As Ted mentioned earlier, we're seeing our overall fill rate performance improve. We're seeing our in-stocks improve. I can't imagine a scenario where we grow, I don't think, sale -- or inventory faster than sales as we normalize here. We're getting back to closer to normal. And so that -- our focus would always be to grow sales faster than inventory. We just had a -- you think about last year at 6-plus turns, that's crazy for historical norms. And so we've got tremendous productivity in our inventory even this year at 5-plus turns. But I think we're headed back towards a more normal environment.

Well, this has been extremely helpful. Thank you so much for joining us today. And thank you to the audience for dialing in. Thanks, Craig. Thanks, Ted.

You bet you. Thank you.

Thank you.