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Home Depot's Woes Build

The housing slump continues to slam sales, and now the credit market may hurt its buyback.
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Before,

Home Depot

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was a casualty of the U.S. housing slump. Now it also may be a casualty of the U.S. credit crunch.

The 15% drop in second-quarter earnings reported by Home Depot on Tuesday may have beat expectations on Wall Street, but that wasn't enough to support its stock as shareholders faced the prospect that the long-awaited sale of its supply business could be in jeopardy.

Shares of Home Depot were recently down 97 cents, or 2.7%, to $34.27 after its chief financial officer, Carol Tome, told analysts on a conference call that if the sale of HD Supply fails, the company will be forced to reduce its $22.5 billion share repurchase plan.

"If we have no proceeds from HD Supply, and I'm not saying that's the case, but if that were to happen, our recap would be reduced to $12 billion," Tome said.

The Atlanta-based home-improvement chain said last week that it may have to accept less for HD Supply than the $10.3 billion price tag it had already agreed on with a group of private equity buyers that includes Bain Capital, Carlyle Group and Clayton Dubilier & Rice.

Home Depot said it's renegotiating the terms of the deal with the buyers in light of the recent turmoil in the credit markets, which has stalled the train of leveraged buyout deals that was driving stock valuations higher.

"The company will continue to assess financial market conditions and the impact of any restructured HD Supply transaction, or failure to complete that transaction, on its overall recapitalization plan and on the terms of the tender offer part of that plan," Home Depot said in its earnings release.

The company last week cut the price range at which it's willing to repurchase up to 250 million of its shares in a Dutch auction tender to between $37 and $42 a share. Previously, Home Depot was offering to buy back shares at $39 to $44 each.

Share buybacks have been a major engine for stock valuations at companies like Home Depot as cheap borrowing costs allowed them to take on more debt and repurchase shares to deliver value to shareholders. With borrowing costs on the rise, the wave of huge share buybacks being offered by Corporate America is being ratcheted down.

All this comes as bad news for shareholders amid a slowdown in the U.S. housing market that is crimping Home Depot's retail business even while it threatens to spark a broader slowdown in consumer spending. Those concerns gathered steam on Tuesday as

Wal-Mart

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, the world's largest retailer, cut its earnings forecast for the second half of 2007, citing bad economic conditions that are pressuring customers.

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For the second quarter, Home Depot posted net income of $1.59 billion, or 81 cents a share, down from $1.86 billion, or 90 cents, a year earlier. Excluding one-time items, the retailer's earnings per share slipped to 77 cents from 82 cents, even as buybacks brought its shares outstanding down 5% to 1.97 billion from 2.07 billion.

On that basis, analysts on Wall Street were expecting earnings of 72 cents a share, according to Thomson First Call.

On a conference call with analysts following the release, Home Depot CEO Frank Blake said the quarter was "more difficult than disappointing." While Home Depot reaffirmed its earnings guidance for the back half of the year, Blake said he expects difficulties to continue as the U.S. housing market continues to struggle.

The company expects earnings per share from continuing operations to decline by 12% to 15% for fiscal 2007. Consolidated earnings per share are expected to drop 15% to 18%.

On its top line, Home Depot's second-quarter sales fell 1.8% from a year ago to $22.18 billion. Sales at stores that were open for at least a year, also known as comps, were down 5.2%, reflecting not only a consumer slowdown but also a loss of market share to competitors such as

Lowe's

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.

Blake said the quarter's results showed some improvements in comps, but he still was not satisfied.

"We don't want to be losing less share," Blake said. "We want to be gaining share."

Blake took the reins at Home Depot after its former CEO, Bob Nardelli, was ousted amid a scandal over his excessive compensation package and his shabby treatment toward shareholders at the company's annual meeting in 2006.

Nardelli, a former

General Electric

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executive who was recently named CEO of Chrysler, was blamed for letting service in Home Depot's stores deteriorate in an effort to cut costs, which opened the door for Lowe's to steal business.

He is also criticized for expanding Home Depot's supply business while its core retail business lost its dominance.