Home Depot, Target in the Spotlight

Investors will be looking to the retailers' outlooks as signs of consumer pain mount.
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Updated from 6:59 a.m. EDT

Investors will be digesting outlooks from

Home Depot

(HD) - Get Report

and

Target

(TGT) - Get Report

Tuesday morning, as they comb for signs of weakness as a result of slowing consumer spending.

Both companies, which report financial results Tuesday, are already considered good barometers to measure how U.S. consumers are handling the economic downturn. If lower-than-expected guidance from

Lowe's

(LOW) - Get Report

on Monday and

Wal-Mart

(WMT) - Get Report

last week are any indication, there is some cause for concern.

On Tuesday, Target

posted drops in comparable store sales and profit

in the first quarter, but did not offer guidance in its intial press release. A conference call is slated for later in the morning. On average, analysts expect Target to notch a first-quarter profit of 71 cents a share on revenue of $14.9 billion, according to a poll by Thomson Reuters. For the year, Target is expected to say it expects earnings around $3.48 a share, although that number has dropped 1% over the last month as analysts have ratcheted back expectations.

The story is much the same at Home Depot. Analysts expected the home improvement retailer to report a quarterly profit of 37 cents a share on sales of $17.6 billion, according to Thomson Reuters. Again, analysts have been scaling back their full-year forecasts, with the average estimate coming down nearly 1% in the last month to $1.76 a share. Early Tuesday,

the company reported

net earnings that were 66% off the year-ago numbers and said it expected profits at the low end of its prior forecast.

Excluding a charge related to the closing of some 15 stores and 50 stores from the "pipeline," Home Depot reported consolidated net earnings of $697 million, or 41 cents per diluted share. Including the charge, the company's net earnings were $356 million, or 21 cents per diluted share. In the same period a year ago, the company's net was $1.0 billion, or 53 cents per diluted share.

Target

For Target, the best comparison comes in the form of the world's largest retailer, Wal-Mart. Last week, Wal-Mart put the blame for its dim second-quarter forecast on higher transportation and utility costs, as well as the usual culprit of uncertain economic conditions. This came even as Wal-Mart reported a first-quarter profit of 76 cents, which was a penny better than expectations.

If the signs of weakness out of Wal-Mart weren't enough to sink optimism, in the last few days retailers

Kohl's

(KSS) - Get Report

,

J.C. Penney

(JCP) - Get Report

and

Liz Claiborne

(LIZ)

have also had a part in disappointing Wall Street with grim forecasts for the coming quarters.

"Target has probably lost ground to Wal-Mart, which is why the latter has done so well," says Robert Pavlik, chief investment officer with Oaktree Asset Management. "In an economic slowdown, people are scaling down their retail shopping choices. The folks that were shopping at Kohl's and Target now are shopping at Wal-Mart."

And despite the introduction of a discount plan that Wal-Mart hopes will lure recipients of U.S. economic stimulus package tax rebates to their stores, the retailer's stock is down more than 1% since it reported first-quarter results. If Target offers no mention of a competing plan, Pavlik says that will also weigh on its stock.

Wachovia senior analyst Peter Benedict expects a tempered 2008 guidance update from Target. "Beyond updated full-year 2008 outlook, items of focus likely will include margin trends given weakness in discretionary parts of the store, food inflation pass through, efforts to manage expenses, and any update to buyback plans given what could be a more cautious view on the retail environment," he said in a note.

Home Depot

Home Depot is in a slightly different position. While Target lags behind Wal-Mart, Home Depot is the largest home improvement retailer. Still, the company's business should show signs of weakness due to the ongoing U.S. housing slump, much like its rival Lowe's has.

Lowe's cut its guidance for the year on Monday,

blaming a slide in sales

on the slumping U.S. housing market and weaker economic conditions. While the home improvement retailer topped the Thomson Reuters average EPS estimate for the first quarter by a penny, revenue came in lighter than analysts expected, which Chairman and CEO Robert Niblock blamed on a "challenging sales environment."

"The guidance from Lowe's was really below what the Street was expecting, even though they beat on the earnings estimate," says Pavlik. "People can't refinance to make major renovations to their homes, which is where Home Depot's bread and butter lie."

Bear Stearns analyst Christopher Horvers said that because of the two-quarter lag, the home improvement industry is still feeling the effects of the significant drop in existing home sales that occurred in the second half of 2007 after the credit markets seized in August.

"This is expected to be partly offset by more favorable spring weather this year and easing comparisons," Horvers wrote in a research note. "The stock focus, however, is likely to remain on the company's outlook and sequential trends in the business."

Analysts will also watch to see if Home Depot makes any more announcements over real estate. Recently, the company announced plans to close 15 underperforming stores in 2008 and will no longer open 50 new U.S. stores it had in its pipeline. Wall Street reacted favorably.

"There's no question to us that this is the right thing to do, but it also is not a surprising move," said BMO Capital Markets analyst Wayne Hood in a note. "Several retailers have come out and revised growth plans in light of the current economic environment and lack of visibility. In this case, the company's revised plan will improve return on invested capital and cash flow over the next five years."

Pavlik adds that if Home Depot can find a way to capture some of those U.S. economic stimulus checks being mailed out, it will undoubtedly see improved results in the following quarter.

"If they can outline the steps they are taking against a slowdown and make some mention of the economic stimulus checks that are going out, Wall Street will definitely look favorably on that," he says.