8/17/2010
By Brian Sozzi, Research Analyst

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After the $0.01 earnings miss for 2Q10 and tepid FY guidance/commentary by Lowe's (LOW) yesterday, it's safe to say the market was waiting on pins and needles into the report from Home Depot (HD) this morning.  Post our meeting with management last month, we left under the impressions 2Q10 would be solid overall, but not as robust on the bottom line as in previous periods.  Home Depot continues to invest in technology and in store initiatives to better utilize its asset base and with margin comparisons becoming tougher, and housing related data softening, it was apparent that Home Depot's wow factor as it pertains to earnings was moderating. 

As it turns out, this reasoning came to fruition in 2Q10.  Home Depot reported sales approximately $200 million shy of consensus forecasts ($400 million below our modeling) at $19.4 billion.  Diluted EPS was $0.72, $0.01 above forecasts ($0.01 below our modeling), which was the opposite the outcome at Lowe's.  The revenue miss, in our view, stems from the comp reading of +1.7% (consensus: +2.8%); Lowe's missed as well with its +1.7% comp.  Similar to Lowe's, Home Depot was likely negatively impacted by the heat (hurt nursery sales) and generally mixed weekly sales trends as consumer confidence eroded.  Encouragingly, Home Depot returned to growth in average ticket, though it was a modest 0.1%, and drove 40 bps of y/y gross margin expansion in spite of increased appliance sales (replacement plus stimulus fueled).  The EPS beat was the lowest in at least eight quarters.  Management revised slightly its FY10 EPS guidance to $1.90 from $1.88 (consensus: $1.90), underscoring a cautious second half outlook for same-store sales and increasingly difficult margin compares, in our opinion.

That said, we continue to be positive on Home Depot shares.  The stock is trading at an attractive P/E multiple of 11.5x consensus 2011 EPS estimates, roughly on par with slower growth story Lowe's and below the long-term average multiple.  Moreover, with the stock losing 27% of its value since a 52-week high on April 20, the dividend yield is an inviting 3.4%.  The company has a high probability, given a strong FCF outlook, of continuing to raise its dividend going forward.

Side by Side Comparisons

* Home Depot 40 bps of gross margin expansion; Lowe's 2 bps of gross margin expansion
* Home Depot a 1.9% increase in transactions; Lowe's a 1.4% increase in transactions
* Home Depot 0.1% increase in average ticket; Lowe's a 2.3% increase in average ticket
* Home Depot modest guidance raise; Lowe's modest guidance narrowing for full year

Brian Sozzi
Wall Street Strategies