Is This the 1 Secret to Home Depot's Success?
With trailing-12-month revenue of $152 billion, Home Depot (NYSE: HD) is one of the largest retailers around. Expanding the store base has helped drive up sales over the years, leading to impressive shareholder gains for longtime investors. For example, had you bought the stock 20 years ago, you'd have generated a monster total return of 1,520%.
Home Depot clearly dominates the home improvement industry. But I believe there might be one key attribute to its long-term success. Here's what investors need to know.
Serving an important customer group
Through its network of 2,340 stores, Home Depot sells various tools, supplies, and appliances to DIY and professional customers. It's the latter group, which includes contractors, plumbers, and electricians, that deserves the attention here. These customers typically take on bigger and more complex renovation projects.
Home Depot rakes in about half of its revenue from this group, which is extremely valuable to the business. The market for professionals is more fragmented with better growth prospects, so it makes sense why the company acquired SRS Distribution to further tap the opportunity. Since these people only account for about 10% of Home Depot's customer base, they spend a lot more than the average DIY consumer does.
This is beneficial from a financial perspective. Smaller rival Lowe's only generates about 25% of its sales from pros. Consequently, Home Depot has averaged a much better operating margin and return on invested capital in the past five years.
I also suspect that pros have more loyalty than a DIY customer. With offerings like a rewards program, volume discounts, and dedicated customer service, Home Depot aims to be a mission-critical partner that helps these professionals handle all their projects efficiently. I'd bet that there are some switching costs involved.
"Pros outperformed the DIY customer, but both were negative for the quarter," Billy Bastek, EVP of Merchandising for Home Depot, said on the Q2 2024 earnings call.
Despite having a strong standing with professionals, Home Depot is finding out that even this customer group isn't immune from the current macro climate. The company reported a same-store sales dip of 3.3% in the latest fiscal quarter (Q2 2024, ended July 28). And executives expect a 3% to 4% decline for the full year.
After the company reported two fantastic years of growth in fiscal 2020 and fiscal 2021, things have cooled down dramatically. But the prospects of lower interest rates in the near future could spur demand from consumers to tackle home improvement projects. Maybe households will be more inclined to take out a loan to spruce up their homes, which could bode well for Home Depot.
Leading the industry
Some investors might hesitate to buy shares given that they trade at a price-to-earnings ratio of 25. That's a premium compared to its trailing-five-year average, which might not be compelling given the challenges the business is facing.
But even though sales are under pressure, the industry backdrop is favorable for long-term growth. In the U.S., the median home was 40 years old in 2022, up from 31 years old in 2005. And there is an estimated shortage of millions of homes in this country. Both of these trends favor durable demand from consumers to take on home improvement projects.
Other important factors, like Home Depot's brand recognition, large store base, developed supply chain, wide inventory assortment, and omnichannel capabilities, have and will continue to contribute to its success. This is true even though the near term might be full of uncertainty.
Home Depot's position with professional customers is something investors must understand if they're considering buying the stock.
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Home Depot. The Motley Fool recommends Lowe's Companies. The Motley Fool has a disclosure policy.
