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Home Depot to Renovate

Nat Worden

With weakness in the U.S. housing market continuing to plague its business, Home Depot (HD Quote) will seek to reverse course after ousting its CEO and posting a 39% decline in fourth-quarter profits.

On a conference call with analysts Tuesday after the earnings release, the home-improvement retail chain's new CEO, Frank Blake, elaborated on plans to explore strategic options for the company's supply business. His predecessor, Bob Nardelli, steered the company headlong into the supply business with 27 acquisitions over the past two years before he was ousted last month amid intense criticism of his compensation and corporate governance practices.

Blake was a member of the board of directors that approved Nardelli's compensation and failed to show up at last year's controversial shareholders' meeting. Now he faces the prospect of selling off the HD Supply business at a time when its growth has slowed dramatically and Home Depot's retail business is suffering same-store sales declines thanks to a collapsing housing market.

"If it turns out that the best path for creating shareholder value is to hold on to the business, that's what we'll do," Blake said on the conference call.

A New Direction

Home Depot said it hired Lehman Brothers to explore a sale of the division less than two weeks ago, marking a stunning reversal for a company that had previously viewed the supply market as a key expansion area as domestic growth for its retail business slowed.

The company's change of heart may have been inspired, at least in part, by Ralph Whitworth of Relational Investors, who was invited to join Home Depot's board of directors after threatening a proxy fight for a change of direction at the company.

Now, it's focused on investing in its retail business and growing that business in overseas markets. Those investments weighed on its fourth-quarter profits, which fell to $925 million, or 46 cents a share, for the quarter ended Jan. 28, down from the year-ago $1.29 billion, or 60 cents share. Excluding certain items, latest-quarter earnings were 50 cents a share, matching the Thomson Financial analyst consensus estimate.

The company's operating expenses grew faster than its sales as it spent money to improve the level of service in its stores and its product mix. It also took a charge related to Nardelli's $210 million severance package. But its sales also suffered from the effects of the slowdown in the U.S. housing market.

The company's overall sales rose just 4% from a year ago to $20.27 billion, falling far shy of the $20.8 billion analyst target. Retail segment sales dropped 2% from a year ago while sales of the HD Supply business rose 64% after a string of acquisitions.

Same-store sales at its retail business, a closely watched sales gauge measuring stores that were open for at least a year, were down 6.6% for the quarter. In January, its same-store sales were down 11%.

"Reflecting the challenging housing market, our 2006 retail results were disappointing," said Blake. "We may not be able to impact the housing market or general economic conditions, but we know that we can improve our performance relative to our overall market share. That will be a central point of emphasis for us in 2007 and beyond."

The company will present its 2007 outlook next week at its annual analyst conference.

On the conference call, Home Depot's chief financial officer, Carol Tome, said the retailer's efforts to sell consumer electronics items in the holiday season, such as flat-screen televisions, ended in failure.

"We didn't make any money on consumer electronics," said Tome. "In fact, we lost money on the sale."

The sales increase at the HD Supply business was muted by the fact that its profitability and organic growth rate plummeted in the fourth quarter as the residential home construction business slowed. That raised questions about whether Home Depot is about to sell its supply business at the bottom of the market after buying into it at the top.

Craig Johnson, president of Customer Growth Partners, says the supply business doesn't offer Home Depot the growth prospects that the retailer's overseas retail operations promise, and he said it's also a diversion for the company.

"They run into trouble when they get diverted from the core retail business," Johnson says.

Shares of Home Depot were recently down 38 cents, or 0.9%, to $41.06.