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Home Depot Explains Its Reduced Expectations

Home Depot (NYSE: HD) recently announced a rare downgrade to its annual growth forecast as part of its second-quarter earnings report. The home-improvement giant now sees sales rising by about 4% rather than the 5% it had predicted as recently as late May.

However, while the lower outlook followed two consecutive quarters of surprisingly slow growth, it didn't represent a significant shift in management's short-term outlook.

In a conference call with investors, CEO Craig Menear and his team explained why they're still bullish on the industry and on Home Depot's competitive position. Below, we'll look at a few highlights from that presentation.

A couple shops for a vanity.
A couple shops for a vanity.

Image source: Getty Images.

Better than it looks

While we had a slow start to the second quarter, we were pleased to see demand accelerate throughout the quarter, as we help our customers tackle a variety of interior and exterior projects.
-- Executive VP Ted Decker

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The 3% comparable-store sales gain that the company reported for the full quarter doesn't fully capture the retailer's growth rate because the month of May was affected by the same wet weather patterns that hurt results in the previous quarter. Comps were flat that month, executives explained, but rose by 4.1% in June and by 4.6% in July.

Those last two figures help explain why management remains so bullish about their outlook. All product categories, except for lumber, grew during the second quarter, and each of Home Depot's geographic markets saw rising sales. Lumber price deflation shed about $340 million from sales, CFO Carole Tome said, or roughly a full percentage point from the comps figure. In other words, demand is strong, and accelerating, despite that lumber price headwind.

More capital efficiency

We plan to repurchase approximately $2.5 billion of outstanding shares in the second half of the year, bringing fiscal 2019 share repurchases to $5 billion in line with our guidance. Further during the quarter, we took advantage of an attractive interest rate environment and raised $1.4 billion of long-term debt, of which $1 billion was used to repay senior notes that came due in June.
-- Tome

Home Depot is one of the most efficient businesses in the market in part because management keeps finding attractive avenues for raising and spending cash. The company was busy on that score this past quarter, spending $1.25 billion repurchasing shares. It also took advantage of falling interest rates to lower average debt expenses. Overall, return on invested capital landed at 43.7% of sales, or nearly six full percentage points higher than this time last year, executives said.

Out of an abundance of caution

While global economic pessimism has increased due to geopolitics, currently the U.S. consumer remains healthy. Consumer confidence is near record high level and wages are up over 3% from last year. Housing metrics are in line with the assumptions we used to build our 2019 financial plan.
-- Tome

All of the positive economic and market factors Home Depot relied on when making its initial 2019 forecast are still in place, with the housing market benefiting from rising consumer spending and an aging stock of homes lifting home improvement demand. What the company didn't predict was a near 50% plunge in the price of lumber, and with prices edging lower in recent weeks, the prudent choice was to predict no rebound in that niche. At the same time, executives saw another reason to be cautious about the next few months as tariff rates have the potential to slow consumer spending.

These explanations add weight to the idea that Home Depot's growth downgrade is mainly a precaution and not a reflection of any weakening in the industry. Instead, the 1 percentage-point headwind that lumber prices caused this quarter might persist over the next few months, so executives thought it was sensible to reduce their outlook by the same amount. They made sure to express confidence in their wide growth plan, though. "The building blocks of our financial model remain in place," Menear explained.

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Demitrios Kalogeropoulos owns shares of Home Depot. The Motley Fool has the following options: long January 2021 $120 calls on Home Depot. The Motley Fool recommends Home Depot. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com