Stimulus Checks Lessen Home Depot Pain

The home-improvement giant's sales and earnings drop but not as much as expected.
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Updated from 9:42 a.m.

Home Depot

(HD) - Get Report

on Tuesday reported a sharp drop in its quarterly profit, but the results beat estimates as the company benefited from consumers spending their government stimulus checks.

Home Depot, the country's largest home-improvement retailer, which I have in the Bricks and Mortar mock portfolio, remains a 2009 turnaround story. The company's retail sales have historically correlated with housing sales, which remain weak today.

The company's sales fell 5.4% from a year ago to $21 billion in the second quarter. Sales at stores open at least a year fell 7.9%, or 7.2%, excluding the effect of 2007 having 53 fiscal weeks.

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These same-store numbers were worse than the 5.3% same-store sales decline that competitor

Lowe's

(LOW) - Get Report

reported Monday. The results show Home Depot may be losing customers to Lowe's in certain markets.

Home Depot's sales were helped by consumers spending their government stimulus checks. This effect should wane in the second half of the year.

Home Depot's earnings fell 25% from a year ago to $1.2 billion, or 71 cents per share. The results beat Wall Street estimates for EPS of 61 cents, according to Thomson Reuters.

Gross margin held steady at 33% in the quarter, while the operating income margin fell to 9.7%, compared with 11.5% a year earlier, as selling expenses remained high.

"We continue to see pressure on our market and the consumer, generally," CEO Frank Blake said in a statement. "Despite the macroeconomic conditions, we saw improved execution in our merchandising and operations initiatives during the past quarter."

Home Depot maintained its guidance for 2008, saying it expects sales to decline 5% and EPS from continuing operations to drop 24%. The guidance does not include store closure costs.

My bullish thesis on Home Depot is that sales and profit growth will return in 2009, once existing and new-home sales improve.

As well, Home Depot's substantial amount of free cash flow will allow it to buy back a large amount of stock in 2009, once the capital markets improve, which will boost earnings per share. Home Depot remains underleveraged today.

On its conference call, Home Depot pointed to several signs that current fundamentals may be nearing a bottom.

Housing expenditures in the U.S. are now at 3.5% of GDP, below the 60-year historical average of 4.75%, management said. This could be a sign that housing is bottoming, but Home Depot continues to remain cautious for the rest of this year.

Meanwhile, customers continue to spend to maintain their homes, particularly in plumbing and energy-efficient products, Home Depot said.

Two-thirds of the company's markets had better same-store sales performance in the second quarter than the first quarter, obviously helped by the government stimulus checks. (Nonetheless, this shows sequential improvement).

In morning trading, Home Depot shares remained roughly unchanged at $26.87.

This price equates to a forward P/E ratio of 15. Investors looking for the eventual turnaround in Home Depot are getting paid to wait with a 3.3% dividend yield.

Home Depot remains an attractive long-term growth story, and the company (along with Lowe's) will grab market share from smaller mom-and-pop hardware stores that are being ravaged by the credit crunch and weak economy.