HD's Valuation Is Tempting

For Gilmartin's preview heading into the Home Depot conference call, please click here.

Home Depot (HD - commentary - Cramer's Take) reported a strong third-quarter upside earnings surprise this morning, printing 45 cents in EPS vs. the 38-cent consensus, for a year-over-year decline of 24%, and revenue of $17.78 billion vs. the consensus estimate of $17.78 billion, for a year-over-year decline of 6%. Home Depot has now reported upside earnings surprises of 11%, 16% and 18% over the last three quarters.

The gross margin was the pleasant surprise in the quarter, improving 27 basis points year over year in third quarter 2008, to 33.7%, despite a steadily weaker comp for August, September and October. According to management, the progression of comps during the quarter for Home Depot was from down 6% in August to down 7.5% in September to down 10.5% in October. Comps in the quarter fell 8.3% (or down 7.1%, after adjusting for the added sales from a calendar shift).

Ten percent of Home Depot's sales are now non-U.S., of which the stronger dollar is expected to have an impact in the fourth quarter. Guidance for the fourth quarter actually was close to what was called for coming out of the second quarter, but the stronger dollar had a negative impact at the margin.

The average ticket, particularly for big-ticket items (greater than $500) was off double digits in October vs. the 4.5% decline in average ticket. Inventories fell 6% year over year vs. the 6% year-over-year decline in revenue.

To conclude, the upside earnings surprises that Home Depot has put up over the last three quarters despite the macro environment and the opening of rapid distribution centers has improved store productivity, inventory management and lowered cost of goods sold. Home Depot's return on invested capital has risen three of the last four quarters, from bottoming at 4% in October 2007 to the current 11% to 12%.

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At the time of publication, Gilmartin had no positions in the stocks mentioned, although positions may change at any time.

Brian Gilmartin, CFA, founded Trinity Asset Management (TAM) in 1995, where he is currently a portfolio manager. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gilmartin appreciates your feedback; click here to send him an email.