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No Surprises At Home Depot

Posted: Nov 19, 2009 11:37 AM by Sham Gad

Tickers in this Article: LOW, BRK.B, BRK.A, WMT, HD

Home improvement giant Home Depot (NYSE:HD) reported its third-quarter earnings this week with no surprises for me. Sales were down 8% and net income was down by about 9% from 45 cents per share to 41 cents a share. This news follows on the heels of rival Lowe's Companies Inc. (NYSE:LOW) third-quarter numbers which experienced a similar downward trend.

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Prudence Dictates Pessimism
Like Lowe's, management at Home Depot is quick to point out the existing pressure in the housing market while careful mentioning the stabilization that they are seeing. Like Lowe's, Home Depot also indicated that they gained market share in the quarter.

The silver lining of terrible economic conditions is the ability for the strongest to gain mightily at the expense of the weak. Since Lowe's and Home Depot virtually control the home improvement space, you can expect both of them to benefit from the demise of weaker players. (For more, see Competitive Advantage Counts.)

Despite signs of stabilization, Home Depot didn't change its yearly outlook which calls for a sales decline of 9% and EPS to be up 9.5% from fiscal 2008. Management continues to run the company prudently in this environment. Capital expenditure is down nearly 60% year to date which suggests that the market share Home Depot is picking up is not requiring any capital. (For related reading, check out Economic Moats: A Successful Company's Best Defense.)

The Benefit Of Quality
Overall, the numbers were quite respectable considering the state of the housing industry. So far this year customer transactions are down 0.3% while the average ticket price is off by 8%, which nearly equates to the sales decline. As the economy improves, HD's profits will improve and free cash flow will surge as a result of the declining capital expenditures.

In fact, investors would greatly benefit by looking at businesses that profit from periods of distress by picking up market share. None is more obvious than Wal-Mart (NYSE:WMT) which is probably taking a little from every corner of the retailing space. Interestingly, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) nearly doubled its holdings in Wal-Mart this past quarter.

Slow And Steady Wins The Race
The big quality names aren't going to make you rich next week or next year. But they won't destroy years of capital appreciation in six months either. Besides, the stock market truly works when you view it through a prism of many years.

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By Sham Gad

Sham Gad is the Managing Partner of Gad Partners Fund's, value inspired investment partnerships modeled after the Buffett Partnerships of the 1950's. Previously, Gad ran the Gad Investment Group and delivered annualized returns of 22% from 2002 to 2005. Gad is also the author of "The Business of Value Investing" which will be out in the fall of 2009. Gad earned his MBA at the University of Georgia in May of 2007. Gad runs a value investing blog. He can also be reached by visiting the Gad Partners Funds site. When not writing or analyzing businesses, Gad enjoys hanging out with his wife Maggie, reading, golf, and yoga

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