Home Depot Seeks Repair

The weak housing market continues to hit profits.
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With the housing market collapsing,

Home Depot

(HD) - Get Report

will be pushing flat-screen TVs and other consumer electronics items this holiday season in a bid to juice its declining sales.

"We view this as really just an in-and-out move for us," said Home Depot's CEO, Bob Nardelli, on a conference call with analysts on Tuesday.

The move comes as demand for electronics, and

digital televisions in particular, has proven to be a sweet spot for a retail industry that is otherwise grappling with a sharper-than-expected downturn in the once red-hot U.S. housing market. Nowhere in retailing are the economic headwinds resulting from that downturn blowing stronger than in the home improvement business.

Home Depot, the largest home improvement chain, reported a 3% drop in third-quarter profits on Tuesday, missing Wall Street estimates. The company also lowered its forecast for the all-important fourth quarter, citing continued weakness due to a housing slowdown that Nardelli said "came faster and deeper" than he had expected.

"

The housing slump will continue throughout 2007," said Nardelli. "I think we have deeper to go than we've seen. The loss of jobs in homebuilding-related businesses is unlike anything I've ever seen."

Extraordinary gains in the residential real estate market in the early part of this decade were a major engine of growth for the economy. Now that the engine is sputtering, economists are struggling to gauge what the effects will be on the job market and consumer spending.

While the economy has shown signs of slowing, it has largely weathered the storm so far, but Home Depot's third-quarter results and its outlook suggest that the worst is yet to come.

The company said it earned $1.49 billion, or 73 cents a share, in the third quarter, down from $11.54 billion, or 72 cents a share, a year earlier. That performance marks Home Depot's first decline in quarterly profit since 2002.

Analysts had expected earnings of 75 cents a share, based on an average estimate compiled Thomson First Call. Shares of Home Depot recently were trading down 25 cents, or 0.7%, to $36.15.

On the top line, Home Depot's revenue rose 11.3% to $23.09 billion, falling short of consensus estimates calling for $23.4 billion. Its comps, or sales at stores open at least a year, fell 5.1%.

Home Depot did manage gains in its supply business, largely because of the March acquisition of Hughes Supply. Sales in Home Depot Supply increased 159% to $3.5 billion.

But overall, the company's expenses grew faster than sales, weighing down profit margins as it reinvests in its stores in order to attract customers and provide better service.

"Home Depot is in a very challenging position," said Credit Suisse First Boston analyst Gary Balter in a research note. "They appear to have underinvested in service and infrastructure through the better times," and now they've being forced to put cash back in their business at a time when the economy is working against them, and customers are dissatisfied with the level of service in the stores."

Meanwhile, the No. 2 U.S. home improvement chain,

Lowe's

(LOW) - Get Report

, is ratcheting up competitive pressure, though it too has been hit by the housing slowdown.

Lowe's is expected to report its third-quarter results Monday. Analysts are expecting earnings of 44 cents a share, up from the 41 cents a share Lowe's recorded for the same quarter last year.

For the year, Home Depot said it expects its earnings be up 4% to 5% from last year and sales to show an increase of about 12%. Previously, it projected 2006 earnings would come in at the low end of a range of 10% to 14% growth, with sales up 14% to 17%.

On Home Depot's conference call, Chief Financial Officer Carol Tome said the retailer's comps got progressively worse throughout the third quarter. In October, the company recorded an 8.7% drop in comps. Despite the negative trend, she said the company expects to post a negative comp in the mid-single digits in its fourth quarter, marking a slight improvement from October.

"We are seeing improvement from where we exited the third quarter," said Tome, citing current sales trends and new merchandise initiatives like Home Depot's foray into the consumer electronics business, where competitors such as

Best Buy

(BBY) - Get Report

and

Wal-Mart

(WMT) - Get Report

lie in wait.