Housing and Home Depot: Unhappy Together

The sector's hard times have filtered through to the large-scale retailers who supply the basic building ingredients

by Sonja Ryst

The housing downturn is now firmly established in retailing, too. Retailer Home Depot (HD) and homebuilder D.R. Horton (DHI) reported weak results for the third quarter on Nov.14, as the fortunes of the latter company sank on cooler activity in the sector, leading to lower income for the retail giant.

Home Depot is also predicting a chilly fourth quarter, with per-share profits falling 12% to 16% from a year ago. "I know there are a lot of points of view out there, but I still think we have deeper to go than we have seen," Chief Executive Bob Nardelli said on a conference call with analysts. "I do not think we have seen bottom yet. I do not see anything that says it's going to get significantly better in '07," he added.

For the three months ended Oct. 29, Home Depot's net earnings sank 3.1% compared to the same quarter of 2005. The company's sales in stores open more than a year dropped 5.1% during the quarter, as the housing market slowed and fewer customers looked for ways to upgrade or settle into new homes. Net income fell to $1.49 billion, or 73 cents per diluted share, from $1.54 billion, or 72 cents a share, in the same period last year. The mean analyst estimate had been for 75 cents per share, according to the San Francisco research firm StarMine. Home Depot's total sales grew 11.3% year over year, to $23.1 billion during the third quarter of 2006.

Could Be Worse

Beyond the moribund market for home construction, Home Depot was crimped by a tough comparison to 2005, when the Atlanta home-improvement retailer was flush with proceeds from the massive rebuilding that followed Hurricane Katrina. "While part of our sales performance is due to the fact that we were lapping really two years of active hurricane seasons, we [had] some tough comparisons. We believe that the slowing housing market was really the biggest contributor," Nardelli said.

Craig Menear, Home Depot's senior vice-president of merchandising, also blamed the results on lumber prices, which have fallen, and softness in discretionary projects among big ticket items such as kitchen upgrade materials, wood flooring, and windows.

In a similar vein, homebuilder D.R. Horton heartened investors with a report that, while anemic in terms of performance, could have been far worse. The Fort Worth homebuilder announced a 50.7% drop in profit, to $277.7 million during the fourth quarter, ended Sept. 30, compared with the year-ago period. But that amounts to 88 cents in earnings per diluted share. The mean analyst estimate for the recent quarter had been for 69 cents in earnings per share, according to StarMine.

Year of Transition

Investors had been worried about the company's heavy exposure to properties in areas such as Florida and California, as the housing market cools this year in formerly red hot areas. Company founder Donald Horton had already warned them to brace themselves on Oct. 10, when he said his company's net sales orders for the Sept. 30 quarter fell 34.2%, to $2.5 billion, compared with the same period of 2005. And D.R. Horton's cancellation rate—the number of home orders canceled divided by the gross number sold—for the fourth quarter was 40%, compared with 29% in the third quarter of 2006.

D.R. Horton slashed its total homebuilding inventory by $662 million and the number of homes under construction by about 27%, to 11,000 homes. The move helped the company's cash flows stay in the green. Homes closed dropped by 7.3%, to 17,261 homes, compared to the year-ago quarter. The sales order backlog of homes under contract—i.e., the number of unfulfilled orders—fell 5.8%, to 18,125 homes, year over year.