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Home Depot

(HD) - Get Home Depot, Inc. Report

capped a turnaround year with a strong fourth-quarter performance.

The home improvement retailer bested earnings expectations with a 40% jump in earnings per share on a 14% sales increase. And with the help of the holiday quarter, the company posted a 3.8% gain in same-store sales, its first year of positive growth since 2000, noted CFO Carol Tome on a conference call with investors and analysts.

Investors reacted positively to the company's report; Home Depot shares were recently up 61 cents, or 1.7%, to $35.99.

In the fourth quarter, Home Depot earned $951 million, or 42 cents a share, on $15.13 billion in sales. That was up from the year-ago period, when the company earned $686 million, or 30 cents a share, on sales of $13.21 billion.

Wall Street had projected that the company would earn 39 cents a share on $15.15 billion in sales, according to Thomson First Call. The company had previously forecast earnings would come in at about 37 cents to 39 cents a share for the quarter.

For 2004, Tome reiterated the company's guidance of earnings per share growth -- before an accounting change -- of 10% to 14% on a sales increase of 9% to 12%. Including the accounting change, Home Depot expects its earnings per share to grow 7% to 11%.

That guidance implies full year earnings of $2.01 to $2.09 a share, or $2.07 to $2.14 a share excluding the accounting change, on sales ranging from $70.65 billion to $72.59 billion.

Including the accounting change, analysts surveyed by Thomson First Call were projecting earnings of $2.06 a share on $72.02 billion in sales.

In the fourth quarter, Home Depot saw the benefit of strong sales at its older stores. The company's same-store sales -- which compare results at like outlets open more than one year -- grew 7.6% in the quarter. That growth topped the 7.3% same-store sales gain posted by rival


(LOW) - Get Lowe's Companies, Inc. Report

in its fourth quarter; however, Lowe's, unlike Home Depot, posted a positive same-store sales gain in the year-earlier period.

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"They had a good quarter. They finally caught up with Lowe's on

comparable-store sales," said a buy-side analyst who asked not to be named. But noting Home Depot's easy sales comparisons with last year, the analyst added, "If they couldn't

catch up now, they were not going to do it."

The analysts' firm, which manages more than $11 billion in assets, is long Lowe's, but holds no position in Home Depot.

Meanwhile, the retail chain held the line on costs. Its gross profit margin, for instance, expanded by 80 basis points as a portion of sales to 32.75%. Tome attributed the rise to a change in the mix of its products sold, cost savings from the company's new centralized distribution system and a decline in lost inventory or "shrink."

While Home Depot's gross margin rose, its operating costs declined in the quarter by 90 basis points as a portion of sales to 22.77%. The company achieved higher sales per labor hour during the quarter and put in place other expense controls, Tome said.

One lowlight of the company's report was a decline in inventory turns during the year to 5 times from 5.3 times the year before. A decline in inventory turns could imply that the company is having a more difficult time selling its products and therefore has older, out-of-date inventory on its shelves and in its warehouses. Also, the faster a company turns its inventory, the less it generally has to pay for holding on to it in financing or vendor costs.

But Tome said Home Depot wasn't too concerned about the decline.

"While we're disappointed, we're comfortable with the quality of our inventory," she said.

Another potential concern is the company's continuing store build-out. Home Depot opened some 175 new stores last year and plans to open another 175 stores this year, or more than 10% of its 1,707-store base.

Tome and other company officials argued that the company still has significant growth opportunities. Home Depot can add more stores in its existing markets as populations grow there, they said. Meanwhile, Home Depot has been trying to grow its sales by offering services such as carpet and window installation through its stores.

"We're not close to realizing our growth potential over the long term," company CEO Bob Nardelli said on the call.

But analysts have questioned in the past whether Home Depot has too many stores as it is, noting that each new store opening tends to steal significant sales from older stores. In fact, in the fourth quarter, the company's same-store sales would have been 2.3 percentage points higher if not for cannibalization of sales, said Tome.

Meanwhile, the services business carries significant risks. The company contracts out such services to local providers in each market, noted the buy-side analyst. Because Home Depot doesn't provide those services directly, it could have a difficult time enforcing national standards, the analyst said. The problem is that customers could well blame Home Depot for its contractors' mistakes.

"They are having problem growing," said the analyst. "The services business makes a lot of sense -- it doesn't require a lot of assets, you can get a lot of returns. But it's not a slam dunk."