Home Depot Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 16, 2022

There are 14 speakers on the call.

Operator

Thank you, Christine, and good morning, everyone. Welcome to Home Depot's Q1 2022 earnings call. Joining us on our call today are Ted Decker, CEO and President Jeff Kinnaird, Executive Vice President of Merchandising and Richard McVale, Executive Vice President and Chief Financial Officer. Following our prepared remarks, the call will be open for questions. Questions will be limited to analysts and investors.

Operator

Deck. If we are unable to get to your question during the call, please call our Investor Relations department at 770-384-2387. Before I turn the call over to Ted, let me remind you that today's press release and the presentations made by our executives include forward looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the press release and in our filings with the Securities and Exchange Commission.

Operator

Today's presentations will also include certain non GAAP measures. Reconciliation of these measures is provided on our website. Now, let me turn the call over to Ted.

Speaker 1

Thank you, Isabel, and good morning, everyone. We appreciate you joining us on the call this morning. Fiscal 2022 is off to a strong start. Sales for the Q1 were $38,900,000,000 up 3.8% from the same period last year. Comp sales were up 2.2% from the same period last Dexter and our U.

Speaker 1

S. Stores had positive comps of 1.7%. Diluted earnings per share were $4.09 in the first quarter, up 6% from $3.86 in the Q1 last year. The strong performance in the quarter is Even more impressive given the robust performance we were comparing against last year. A year ago, we delivered the highest first quarter sales and company history as we benefited from outsized demand for home improvement goods, favorable weather and government stimulus.

Speaker 1

This year we achieved a new high watermark for 1st quarter sales as strong demand for home improvement goods continued despite a slower start to spring in many parts of the country. Delivering such strong results on top of last year's historical growth is a testament to our orange blooded associates. They are maintaining their relentless focus on our customers, while continuing to navigate the ongoing pandemic, global supply chain disruptions, inflation and a tight labor market. We are also thankful for the strength of our relationships with our supplier and transportation and Partners. Our respective teams are working tirelessly to flow product to stores and distribution centers as quickly and efficiently as possible.

Speaker 1

I would like to thank them for their ongoing support as we continue to navigate a challenging and dynamic environment. The demand seen in the Q1 exceeded our expectations. The home improvement consumer remains engaged. Customers continue to tell us that their homes have never been more important and project backlogs are very healthy. We believe that the medium to longer term underpinnings of demand for home improvement have never been stronger.

Speaker 1

We are thrilled with our Pro performance in the quarter, driven by underlying strength in project demand. We continue to invest in an ecosystem of capabilities, including enhanced fulfillment options, a more personalized online experience as well as other business management tools to drive deeper engagement with our Deck customers and we believe our efforts are resonating. We are navigating a unique environment, but we believe we have the tools, and the team and the experience to effectively manage through. While we don't know how inflation might impact consumer behavior going forward, We are closely monitoring elasticities and customer trends across our respective categories and geographies and remain encouraged by the underlying strength we see in the business. Jeff will provide a bit more color about what we've observed from a category and big ticket stand Point in a moment.

Speaker 1

And while inflation impacted our average ticket increase this quarter, it wasn't the only impact. As we've seen over the past several years, our customers continue to trade up for premium innovative products. In March, we held an in person store manager meeting for the first time in 3 years. One of the many highlights of that week is our product walk, where vendors showcase the latest in product innovation. And what I can share with you is that the level of innovation across the business is robust.

Speaker 1

In fact, almost 90% of the products on display this year are entirely new SKUs to the Home Depot. So the pipeline for innovative products remains very strong. Beyond product and innovation, my biggest takeaway from the store managers meeting is how energized the team is. The exceptional execution our associates delivered over the last few years hasn't been easy, but our teams have consistently risen to the challenge. We frequently survey our associate base and are pleased that engagement and morale remain high.

Speaker 1

Last quarter, we talked about our customer backed approach to remove friction at every touch point of the shopping experience. To that end, we recently announced that Matt Kary has been named Executive Vice President of Customer Experience. In this newly formed role, Matt will partner across the business to help design and develop new and innovative solutions to drive a seamless experience for our customers. As Matt transitions to this new role, we also announced that Fahim Siddiqui has been promoted to Executive Vice President and Chief Information Officer, where he is responsible for all aspects of our technology development and strategy. These moves will help drive further alignment around our interconnected retail strategy, which will allow us to enhance what we believe is the best experience in home improvement.

Speaker 1

Richard will talk to you in a few minutes about our guidance for the remainder of the year, but the Q1 We're also encouraged by the continued strength we see in the business through the 1st 2 weeks of the second quarter As spring is breaking more broadly across the U. S, our team continues to focus on what is most important, our associates and customers. Our merchants, store and met teams, supplier partners and supply chain teams did an outstanding job delivering value and service to our customers throughout the quarter. I'd like to close by thanking them for their dedication and Hard work. With that, let me turn the call over to Jeff.

Speaker 2

Thank you, Ted, and good morning, everyone. I want to start by also thanking all of our associates and supplier partners for their ongoing commitment to serving our customers and communities. As you heard from Ted, during the Q1, we continue to Deck. Outsized demand for home improvement projects and strong execution from our teams and supplier partners. Turning to our comp performance during the Q1, 11 of our 14 merchandising apartments posted positive comps led by plumbing, building materials, millwork and paint.

Speaker 2

During the Q1 of this year, we saw double digit negative comps in our seasonal departments due to the late arrival of spring. Appliances posted slightly negative comps. Adjusting for a shift in event timing, appliance comps would have been positive for the quarter. Excluding seasonal categories, we are thrilled with the broad based strength across the business and healthy project demand. During the Q1, our comp average ticket increased 11.2% deck.

Speaker 2

The growth in our comp average ticket was driven primarily by inflation across several product categories, as well as demand for new and innovative products. Comp transactions reflect the late start to spring and the anniversarying of stimulus. And on a 2 3 year basis, both comp average ticket and comp transactions were healthy and positive. Inflation from core commodity categories positively impacts our average ticket growth by approximately 2 40 basis points during the Q1, driven by inflation in lumber, copper and building materials. Lumber prices remain volatile during the quarter.

Speaker 2

As an example, framing lumber peaked at approximately $1300 per 1,000 board feet during the Q1 before falling over $400 to approximately $900 Big ticket comp transactions for those over $1,000 were up 12.4% compared to the Q1 of last year. We saw big ticket strength across many pro heavy categories like pipe and fittings, gypsum and fasteners. During the Q1, pro sales growth outpaced DIY. On a 3 year comp basis, Deck. Growth with both our Pro and DIY customers was consistent and strong.

Speaker 2

We're encouraged by the momentum we are seeing with our Pros and they tell us that their backlogs are strong. And during the quarter, we saw many of our customers turn to pros to help them with larger renovation projects. This can be seen in the double digit comp performance of our building materials and plumbing departments as well as in certain kitchen and bath categories products like in stock kitchens, tubs and showers and countertops. We also saw double digit growth in our kitchen and bath installation business. This underscores the strength of project demand we are seeing across the business.

Speaker 2

Sales leveraging our digital platforms increased 3.7% during the first We are very pleased with the performance of our digital assets as we delivered the highest sales dollar volume in our company history. For those customers that chose to transact with us online during the Q1, more than 50% of our online orders were fulfilled through our stores, a testament to the power of our interconnected retail strategy. As you heard from Ted, we are very excited about the innovation we are introducing across the business. We continue to lean into products that simplify the project, saving our customers' time and helping them take on more jobs. One example is our Viega ProPress line of plumbing.

Speaker 2

Your plumbers can create a watertight copper connection in 60% less time than a traditional copper solder job. The AGA ProPress fittings require no flame and work in wet applications. ZIG is the market leader in the space and is exclusive to The Home Depot in the big box channel. In paint, working with Masco and PPG, We have put together a formidable propane lineup that is resonating with our propaneters. Masco's Bayer formulated pro specific offering continues to perform well in our stores and in the Q1 we added PPG Speed Height series.

Speaker 2

This pro specific paint that is specked in the vast majority of multi housing and large commercial jobs giving us an entry point with our propaneter for larger scale projects. And this is now exclusive to The Home Depot and the Big Box channel. In spray paint, we launched PPG's GliddinMax Flex Spray Paint. PPG's proprietary industrial based technology is uniquely flexible covering and preserving the original look and feel of a wide range of surfaces, including leather and fabric. And with Masco, we've expanded their exclusive offerings to spray paint, caulk and sealants as as well as interior stains.

Speaker 2

Now let's turn our attention to spring and the exciting lineup of products we have for our customers. We are thrilled to showcase our new product offerings across We are seeing an industry wide shift from gas powered to battery powered mowers. Demand for cordless mowers has never been stronger and and our lineup of battery powered mowers including Ryobi's 80 volt 0 turn riding mower, Milwaukee's new M18 Fuel Walk Mower, DeWalt's FlexVolt Walk Mower and Makita's LXT walk mower is unmatched. This lineup offers something for everyone, building on an ecosystem of innovative tools powered by the same battery platforms. In patio, we have continued to add optionality and today customers can create their perfect patio set to transform their outdoor living space to an enhanced online experience and we expanded our assortment of grills.

Speaker 2

We are particularly excited about our new Traeger Timberline XL, which provides a larger cooking surface, easier maintenance and a side burner to enhance your cooking needs. And our new Nevo Next by Grill is the 1st propane powered grill controlled via an app or your mobile device. The Aptus late timers, grill temperatures and internal food temperatures providing a consistent cooking experience for hours. We're also excited about our lifeguests program. Each year, our merchants provide our customers with new and improved varieties to enhance the overall garden experience.

Speaker 2

We've expanded our disease and drought resistant products, offering superior performance. For example, Beacon and patients are disease resistant and our Easy Way petunias now require less sunlight and last up to 6 weeks longer. Adding these new hardier plants allows our customers to have a vibrant and healthier garden for longer. Our live good category looks incredible. We are ready for spring from everything from shrubs to a variety of flower and Edibles for every type of gardener.

Speaker 2

And with that, I turn the call over to Richard.

Speaker 3

Thank you, Jeff, and good morning, everyone. In the Q1, total sales were $38,900,000,000 an increase of $1,400,000,000 or 3.8% from last year. During the Q1, our total company comps were positive 2.2% with positive comps of 12.9% in February, essentially flat in March and negative 2% in April. Comps in the U. S.

Speaker 3

Were positive 1.7% for the quarter with positive comps of 12.5 percent in February, negative 0.3% in March and negative 2.9 percent in April. Recall that March reflects the anniversarying of stimulus and April was impacted by a delayed spring this year. Our results this quarter were once again driven by continued strength across the business. Spring temperatures broke late in all our geographies, but in particular impacted some of our northern regions. In local currency, both Mexico and Canada posted comps above the company average.

Speaker 3

In the Q1, our gross margin was 33.8%, a decrease of approximately 20 basis points from last year, primarily driven by supply chain investments and pressure from lumber. We continue to successfully offset significant transportation and product cost pressures, while maintaining our position as the customer's advocate for value. During the Q1, operating expense as a percent of sales remained essentially flat to last year at approximately 18.6%. We were pleased with our operating expense performance during the Q1, which reflected planned increases in wage and planned rollout of investments designed to drive efficiency in our store environment. Our operating margin for the Q1 was 15.2% compared to 15.4% in the Q1 of 2021.

Speaker 3

Interest and other expense for the Q1 increased by $36,000,000 to $369,000,000 due primarily higher long term debt levels than 1 year ago. Our effective tax rate was 23.9% in the Q1 of both fiscal 20222021. Our diluted earnings per share for the Q1 or $4.09 an increase of 6% compared to the Q1 of 2021. Our total store count at the end of the quarter was 2,316 and selling square footage was 240,000,000 square feet. Unfortunately, during the quarter, we lost a store in San Jose, California due to a fire.

Speaker 3

Thankfully, no one was injured and all of our associates has been reassigned to other nearby stores and the team has done a fantastic job continuing to serve our customers in the area. At the end of the quarter, inventories were $25,300,000,000 up $6,100,000,000 compared to The Q1 of 2021 and inventory turns were 4.4 times, down from 5.5 times last year. This level of inventory reflects outsized demand for home improvement projects, actions taken to improve in stocks and the impact of the delayed start to spring. While our in stock position is not back to pre pandemic levels, It is the healthiest it has been since the pandemic began. Turning to capital allocation.

Speaker 3

After investing in our business and paying our dividend, it is our intent to return excess cash to shareholders in the form of share repurchases. As we have mentioned on previous calls, we plan to continue investing in our business with CapEx of approximately 2% of sales on an annual basis. We also plan to maintain flexibility to move or slower depending on the environment. During the Q1, we invested approximately $700,000,000 back into our business in the form of capital expenditures. And during the quarter, we paid approximately $2,000,000,000 in dividends to our shareholders and we returned approximately 2,250,000,000 and we returned approximately $2,250,000,000 to shareholders in the form of share repurchases.

Speaker 3

Computed on the average of beginning and ending long term debt and equity for the trailing 12 months, return on invested capital was approximately 45.3%, up from 45.1% in the Q1 of fiscal 2021. Now I will comment on our updated guidance for fiscal 2022. As you heard from Ted, We are very pleased with the strong performance we saw during the Q1, which surpassed our expectations. Today, We are raising guidance for 2022. We now expect sales growth and comp sales growth of approximately 3% for fiscal 2022.

Speaker 3

We expect comps to be stronger in the first half of the year than the second half of the year. We expect our fiscal 2022 operating margin to be approximately 15.4% for the year and we expect mid single digit percentage growth in diluted earnings per share compared to fiscal 2021. While a number of uncertainties remain, we feel confident that we will be able to continue to manage through a dynamic environment while growing faster than our market and delivering exceptional shareholder value. Thank you for your participation in today's call. And Christine, we are now ready for questions.

Speaker 4

Thank you. We will now be conducting a question and answer session. Dech. Thank you. Our first question comes from the line of Michael Lasser with UBS.

Speaker 4

Please proceed with your question.

Speaker 5

Good morning. Thanks a lot for taking my question. Understanding that your overall results We're very strong. Are you seeing any signs that either inflationary pressure, rising interest rates or simply home Decks. Are starting to have a negative impact on the business.

Speaker 5

And if it gives you pause, the comp transactions were down high single digit in the quarter as maybe a leading indicator that the business could soften from here.

Speaker 1

Thanks, Michael. Good morning. So a lot in that question. As we said, we had a great Q1 in comp to comp from last year. As you recall, Q1 last decks.

Speaker 1

Our highest first quarter sales and our highest comp at 31% in a very, very long time. So as we went into this year, we were understandably conservative as to how we thought Q1 would But in fact, we saw that the consumer is very engaged. The pro is very strong and we posted those results with very much delayed spring. In Q2, it's early, but we're off to a strong start. We also think that the fundamentals, I mean these are all very short term in nature comments, but the fundamentals for Home Improvement remain incredibly supportive.

Speaker 1

So when you look at inflation and interest rates In any fatigue, if I take those in order, inflation is definitely higher than we thought. If you recall last year, we thought we'd have with a 5% growth in ticket. We're seeing obviously much higher than that with 11% in ticket. A lot of that is inflation driven, but our customers are resilient. We are not seeing The sensitivity to that level of inflation that we would have initially expected.

Speaker 1

On interest rates and Richard can talk a little bit more about interest rates and housing, but we have not seen that impacting Our business and the nature of housing, again Richard will cover in greater detail. And then the fatigue we're not seeing at all. We look at PCE and shifts in and PCE. And while we are seeing some shift to services in general, we're not seeing a big shift out of home improvement and we're not seeing fatigue with our customers given repair, remodeler intent and activity still tracking at and the highest levels that we've recorded. And then lastly on transactions, we do always look for a balance of ticket and transactions.

Speaker 1

But again, with these inflation rates, it's a very unique year. Inflation in ticket is higher Decks. The norm for sure, but again the consumer is hanging in there. And Richard, why don't you touch on the interest rates? Sure.

Speaker 1

So Just first to start with who our customer is.

Speaker 3

You need to keep in mind our customers are homeowners. Virtually all sales to our pro customers are on behalf of the homeowner and over 90% of our DIY customers are homeowners as well. So let's talk about Home Improvement Demand and What Drives It. Over our history, we've seen that home price appreciation is the primary driver of home improvement demand. When your home appreciates in value, you view it as a smart investment and you spend more on it.

Speaker 3

So let's look at what's happened to home prices. We've seen appreciation of over 30% over the last 2 years. In fact, Home equity values over the last 2 years have increased by 40% or over $7,000,000,000 just in the last So the homeowner has never had a balance sheet that looks like this. They've seen the price appreciation and they have means to spend and in surveys our customers tell us that their homes have never been more important and their intent to do projects of all sizes has never been higher and our pros say the same thing about their backlogs. So let's talk about interest rates.

Speaker 3

I think it's important to remember that our addressable market is the 130,000,000 housing units occupied in the U. S. Plus probably call it $40,000,000 to $50,000,000 more in Canada and Mexico. Of those 130,000,000 housing units, On any given year, only about 4% or 5% are sold. That means that over 95% of our customers are staying in place.

Speaker 3

They're not shopping for a mortgage. Nearly 40% of those homes are owned outright. Of those who have mortgages about 93% of those mortgages are fixed rate. So when you think about our addressable market, The vast majority aren't really paying attention to mortgage rates. And what's interesting about that is What we've heard when they do look at moving, they're actually more and more tempted to stay in their low fixed straight mortgage and remodel their home instead.

Speaker 3

So these low locked in mortgages are probably a benefit to home improvement.

Speaker 5

Decks. That's all very helpful information. And in light of that, I hate to follow-up with such a negative question, but At an abundance of conservatism, I'll ask that historically Home Depot has talked about a 20 basis point margin change for every 1% increase or potentially decrease and its same store sales, recognizing that the environment hasn't necessarily been business as usual for quite some time. If we do want to take a conservative expectation on the overall macro, would it be reasonable to think that if comps were to decline 1% that, that would translate to a 20 basis point decline in operating margin or has the Business has advanced so much over the last few years through the deployment of technology, a greater sophistication of supply chain and other factors that Perhaps the deleverage wouldn't be as significant moving forward as it might have been in past.

Speaker 3

Well, Michael, first, We operate an activity based model with respect to payroll, which is our largest operating cost. And so that naturally decreases Decks. More importantly, we operate with a degree of financial flexibility in our P and L. And that financial flexibility allows us to manage as we think is appropriate in any given environment. So we have room to manage and we're confident that we can take share in any environment and manage this P and L wisely per the environment.

Speaker 3

With respect to any and the

Speaker 5

decks. That's helpful. Thank you so much and good luck.

Speaker 3

Thank you.

Speaker 4

Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

Speaker 6

Hey, everyone. My first question is if we could talk a More detail around the intent and the backlog that was just mentioned. Curious if you're seeing demand come through because supply was constrained, there's some pent up projects versus what the backlog or pipeline continues to build?

Speaker 3

Well, I think you can just start with Some survey results, these are public and these are published by the National Association of Home Builders. This is The survey that goes back to 2,001. And the survey, if you'll bear with me, just sort of says, Our conditions, are you optimistic or pessimistic, 50 being kind of the medium mark here. So for the 20 years up to 2020 that optimism index never got above a 58. Today it stands at an 86.

Speaker 3

So that is the sentiment of the remodeler. With respect to backlog that is also surveyed That number over the past 20 years never got above a 64. Today, it stands at an 84. Both of those sentiment numbers are all time highs.

Speaker 6

Fair enough. And maybe a follow-up, you mentioned home price Decks. It looks like the home prices in Canada are starting to turn a bit and the business seems to be holding up well. Can you talk about if that relationship holds or if the same dynamic, the macro conditions for the customer exists and that's why that the business is Decks. Sort of breaking away from that trend.

Speaker 1

Well, yes, our Canadian business, I'm not as up to Deck, Simeon on the Canadian stats that Richard just went through for the U. S. But our Canadian business is in in terrific shape. I mean, remember, they had much more significant lockdowns last year, Ontario, in particular. Our stores were closed in the Q1 and we had curbside pickup only.

Speaker 1

So the business is very, very strong. I don't have this much detail on the relationship with home prices.

Speaker 3

Well, let's just sort of reflect on something. So last Q1 As a company, we reported a 31% comp. Canada was higher than that. So we had a tougher comp in Canada and this quarter our comp in Canada was higher than company average.

Speaker 6

Deck.

Speaker 4

Our next question comes from the line of Michael Baker with D. A. Davidson. Please proceed with your question.

Speaker 7

Okay. 2. 1, simply can you just quantify if there's any way to quantify the weather impact of the late spring, how much did that hurt April and what should we expect that to contribute into May? Deck. And then I'll have a follow-up question.

Speaker 2

So for the

Speaker 1

quarter, Michael, we think it was about 1% The negative impact to comp sales in Q1.

Speaker 7

And presumably most of that occurs in April.

Speaker 1

Yes, because February, it's not spring anywhere and it's our lowest volume month. So yes, that's April driven. As Richard said in his notes, March was more of a stimulus impact as well as a weaker Deck. And then as you started to move toward northern markets, particularly cold weather in April and For the quarter, 1%.

Speaker 7

Yes. We've all felt that, that cold weather up here in the Northeast, although it's getting better now. I also wanted to follow-up on the home price appreciation question. We've all looked at this For many years and I think most people get that home price appreciation is that important. How concerned are you that higher interest rates Eventually slowed out existing home sales and we've seen that decline 3 or 4 months in a row such that the Deck.

Speaker 7

Record home price appreciation that we're seeing eventually has to slow down, particularly as the Fed keeps raising rates. And so How big of a concern is that as you think about the rest of the year?

Speaker 3

Well, I think we're in a unique position now in recent housing history where we have built a chronic shortage of housing units in the U. S. Consistently and steadily for the last 10 years. Some economists assume that that shortage is a little less than $2,000,000 You hear numbers as high as $4,000,000 If you take other estimates of what will likely be built, We're looking at least 5 years, if not 7 or 8 years before we could actually get back to a point of equilibrium. So We believe that supply and demand are going to be the main drivers of support for home price appreciation and we know that that chronic undersupply is going to be a condition for quite some time.

Speaker 3

Okay.

Speaker 7

Yes, thanks. Appreciate your comments on that.

Speaker 4

Deck. Our next question comes from the line of Chris Horvers with JPMorgan. Please proceed with your question.

Speaker 8

Thanks. Good morning. So on the seasonality sort of lens as you think about the year, you mentioned and the Q2. It looks like the guide doesn't assume that this above average seasonality that you saw in 1st quarter despite a late spring holds, you're actually sort of degrading the seasonality going forward. So Decks.

Speaker 8

I guess my first the two questions are you expecting a full bathtub effect into the second quarter? And then Why is there any reason why you wouldn't think normal seasonality could hold through the back half?

Speaker 2

Good morning, Chris.

Speaker 1

Yes. I would we certainly don't think it's going to degrade. I would say, posting the results that we hosted with a very cold in wet spring certainly exceeded our expectations. And Dech. As commented earlier, we haven't generally raised guidance after the spring because we say bathtub effect And too early into Q2 at the time of this call to make a determination.

Speaker 1

But The Q1 beat our expectation by such an extent even with the poor weather we felt and the rest of the year. We haven't taken a specific of a view of Q2, I mean, we know at least the 1% is going to flow into Q2. We generally get back all of our spring sales in Q2, even tracking back to the 2 or 3 worst early spring since I've been at Home Depot. But it is still just so early in our largest weeks are ahead of us. So we don't want to get too far over our Deck's, but we're certainly not anticipating a degradation of that normal bathtub effect.

Speaker 8

Got it. And then my follow-up question is a number of vendors have indicated more price increases are coming. Can you talk about How much of the ticket increase was inflation? How are you expecting inflation to play out over the year? Like, we just sort of flatten out As we lap through more price, as the over the next year and do you expect units to turn positive as the year progresses?

Speaker 8

Thank

Speaker 1

you. Right. So I'll start and then Jeff will give a little bit more detail. Yes, as I mentioned earlier, Inflation is higher than we had expected to the extent about 2 times. The 11 odd percent ticket was the vast majority of that was inflation driven.

Speaker 1

It is impacting transactions, but as we said not to the extent that we would have thought. So that's all good. We have taken costs this year and there is more on the table. Transportation. We've just finished up our ocean contracts.

Speaker 1

That's Decks. It's a global contract cycle that goes into effect in May. So those are in place for the next 12 months. Those are certainly higher on a contract basis from 2021. So we think inflation doesn't go up necessarily from where we are, but that it would hold steady at this call it double digit low 10 ish percent in our product categories through the balance of the year.

Speaker 1

In terms of the impact on transactions, we're going to have better transaction results in Q2 just given spring. When you think of the number of transactions in our Garden business in the springtime. That's just a tremendous amount of transactions and we feel very good that we'll get those in Q2 and then lumber was, it's been on a bit of a seesaw and was high on average to last year in Q1 and we saw that in negative transactions in lumber. But now we're down quite a bit and we're down about 35% in lumber prices year over year. So we expect to pick up in Q2 in particular in lumber activity.

Speaker 1

In terms of the balance in the year and How we think about managing through this, I'll let Jeff provide some more color.

Speaker 2

Yes. Thank you, Ted, and good morning. Look, we are to Ted's comments, we are managing through an inflationary environment about 2 times what we expected in the Q1 and we see some continuation of that. Decks. We are working with our supplier partners on managing through this inflationary environment.

Speaker 2

We've had long standing relationships with many of our suppliers and it's a partnership to understand the ongoing complexities of the inflation we're seeing. What we are doing is we are still the customers advocate for value in our business. And if

Speaker 1

you look at the value

Speaker 2

that we're offering across the spring categories across the entire business, it is exceptional. If you look at the project business, we are pleased with what we're seeing in project related demand, inclusive of some of the inflation that we have experienced across the organization. And again, as the customers advocate for value, we have the tools and the capabilities to manage our broader portfolio strategy and manage the inflationary environment. So very pleased with the partnership across the business to manage This inflationary environment.

Speaker 9

Thank you.

Speaker 4

Our next question comes from the line of Scot Ciccarelli with Truist. Please proceed with your question.

Speaker 10

Good morning, everyone. So With the 1 Home Depot supply chain strategy, you guys are effectively moving into some new markets or certainly expanding your presence in certain verticals and expanding your TAM. Is there any way to potentially size the impact that some of these new markets are having on your results, be it whether it's MRO, large Pros, etcetera, maybe places where you weren't as competitive just a couple of years ago.

Speaker 3

Generally speaking, we are excited about what we're building out in terms of capability and our ability to go after the repair and remodel or planned purchase occasions that we haven't necessarily been able to in the past, but when you start thinking about contribution to results, we're building an ecosystem here for the Pro. It's not just about fulfillment and delivery. It's about an online experience that we think is second to none that's seen incredible traction over the very short term. Decks. We have a relationship with our pros in the store that we think is second to none.

Speaker 3

And Hector, I'll I'll turn to you for a second with some detail. But again, with respect to results, we're quite pleased that we grew by $40,000,000,000 over the last 2 years. We were really pleased that we were able to comp the comp and enter into a second quarter and I think over the coming years, you're going to see every element of our model add up to our ability to take market share in any environment. But Hector, maybe you'll talk a little bit about Yes,

Speaker 11

Richard and Scott. We are building capabilities to attract more of the Pro Plan purchase. Every one of those Pro Plan purchase across all channels, to remove friction from the transactions and experiences from our pros in every instance. We are Decker. We're super encouraged from the early signs that we're seeing on the commercialization of the supply chain investments that we're making and the team is super encouraged and involved and and Engaged.

Speaker 9

Okay. Thanks guys.

Speaker 1

And Scott, I would add on the MRO piece in the TAM, we couldn't be happier with the combination of our legacy Interline HD Pro business with Home Depot Supply. So not only did we combine the number 1 and 2 players in that industry, but Decks. The Home Depot supply had additional verticals that our business didn't participate in. So we think the TAM in that MRO market essentially doubled to about $100,000,000,000 And we still sit with less than 10% share. The capabilities that we're building combining those two businesses, We're well on our way of combining sales forces, getting customers oriented to one legacy customer sales force or the other.

Speaker 1

We're beginning to integrate the supply chains. What we're able to do now in MRO for multifamily housing is incredibly robust. And the new verticals, hospitality in particular as travel has come back and the hospitality Occupancy rates are going up. That business is just booming. So we love our position in MRO and the verticals we're in.

Speaker 1

And Shane O'Kelly and his team are just doing a great job of that business.

Speaker 3

I think just to the TAM point, We talked about the 130,000,000 households in the U. S. About 30,000,000 of those households actually occupy Deck. And so that HD Supply acquisition opened up that TAM for us and is a unique attribute of the Home Depot. Decks.

Speaker 4

Our next question comes from the line of Karen Short with Barclays. Please proceed with your question.

Speaker 12

Hi, thanks very much. Wondering if you could just give a little bit more color on puts and takes for 2Q to 4Q with respect to gross margin and SG and A, I guess in the context of assuming inflation remains at the current level and then also a bit more context on how you think traffic and ticket will shake out for the full year. And then I have one other question.

Speaker 3

Sure. So for the year, we believe that Gross margin, if you just sort of stay mix neutral, gross margin will see slight pressure from the investments we're making in 1 supply chain. Those have been planned all year and we've expected that for a while. With respect to operating expense leverage, as we have taken our sales guidance up, we've also raised our operating margin guidance that reflects the operating expense leverage we expect to generate on those incremental sales. With respect to ticket and transaction, we assume that comps in the back half are positive.

Speaker 3

If inflation persists for the year, persists at current levels, We expect ticket could be in the range of 10% to 12% for the year offset by transactions to net out to a 3 comp for the year.

Speaker 12

So I guess the question on that, my follow-up would be, I mean, investors are focused on your 2, 1 year, 2 year, 3 year traffic trends. And appreciate there is a labor efficiency component with negative traffic to some extent, but At what point does the traffic on a multiyear basis maybe start to concern you?

Speaker 1

Well, this is definitely a unique year for sure in our ticket and transaction dynamic. As I stated earlier, we do look for a balance Decks. And we usually plan that growth will come from more or less an equal mix of Ticket and Transaction. With the 2 fundamental things going on, Karen. 1, we're To your point on 2 3 year stacks, we're comping off the $40,000,000,000 of sales decks growth that Richard commented on and in Q1 at a 31% comp, the highest comp in the longest time at Home Depot.

Speaker 1

And to This time at Home Depot. And to comp that, we didn't plan on to comp that, it is a huge positive. Now the balance isn't the norm for sure, again a unique year with this level of inflation, at 10 odd percent. But the customers engagement is much more resilient than We would have thought, that's why we had we knew the inflation going into the year and we knew the potential impact to transactions. Deck.

Speaker 1

The level of activity in our space and we've talked about the backlog and the intents is really and the consumer staying more engaged. Now as we lap through these extraordinary comps from the $40,000,000,000 of growth and certainly hopefully lap through the inflation we would get back to the balance that we would certainly prefer.

Speaker 12

Okay, that's helpful. Thank you.

Speaker 4

Our next question comes from the line of Zach Bateum with Wells Fargo. Please proceed with your question.

Speaker 10

Hey, good morning. Ted, following up On your comment that Q1 beat your expectations, could you talk about the extent that was pro driven versus Deck's, DIY or other pockets of your business. And then as you think about the second half of this year, to what extent Do you incorporate stable pro trends and could they offset a more variable DIY if the macro or inflationary environment softens from here?

Speaker 1

Sure. I would start by saying Decks. Even our pro traffic is consumer driven, right? I mean all projects fundamentally on the home, we certainly have trades in our business, buying product for servicing other spaces than the home, but the vast The majority of our activity is supportive of the home and whether it's a consumer buying themselves or a pro, the pros buying Ultimately for a consumer's home. So with that being said though, yes, Pro is stronger than we would have thought.

Speaker 1

I mean that's where the beat came from. Our Pro is incredibly strong and we're so optimistic of as Hector outlined the ecosystem we're building. We just continue to gain momentum with that pro customer and certainly offset more of an as expected consumer. When you think of spring, Decks. When you think of spring as a consumer business in terms of garden, We don't have large penetrations in Pro in our Garden business, so that is consumer driven.

Speaker 1

And then the stimulus is really I mean, we all heard plenty of anecdotes about consumers getting their check last March and truly going to buy a new power tool or a new lawnmower. So that was what was unique about the consumer. In terms of the trend over time, not just the intent that Richard talked about in the ecosystem that Hector talked about. But what we love with our pro customer And the confidence we continue to build in what's happening is when we look at our comps from what we call an unplanned purchase in store, which is still a strong comp, But sequentially going up to higher and higher comps as we get to a planned delivered purchase. So think of that pro who's just coming to the store to do cash and carry in an unplanned purchase versus one who we know is Staging out a project and getting that project delivered.

Speaker 1

The sequence of comps of that engagement gets higher and higher and higher with the highest being planned delivered. Also, when you think about the engagement with our loyalty models in our engagement with our sales forces, again, while still positive, our pros who are not in our loyalty program, buying a cash and carry unplanned purchase while positive that is the lowest comp going all the way through to a pro who's in the loyalty program, who is purchasing with us on an interconnected basis and is managed by an outside sales contact. Those by far have the highest comp within the Pro. So we just love this ecosystem that we're building, The engagement that we're starting to see, the sequential strength of comps as these pros get more engaged with us. And yes, we think those pro trends are going to keep powering the business.

Speaker 10

Thanks, Ted. That's helpful. And then for Richard, With your inventory growth outpacing sales growth for the past 4 quarters by a pretty wide margin, How do you think about your position here in terms of having enough inventory or too much inventory? And with the slower start to spring that you've called out, How should we think about the potential impact of higher promo on the gross margin line?

Speaker 3

So first of all, we took steps as Ted had said earlier in the call To invest in improving our in stock position and while we're not we're quite where we were Pre pandemic, we are the healthiest we've been in the last few years. So if you think about sort of that pull forward of inventory making sure that we landed inventory early because in this business customer service starts with being in stock and you also consider the impact of a late spring that really makes up about half of the increase in inventory and the other half is simply the impact of inflation. So as we think about this through the year, obviously, we're as spring kicks in, We'll see that inventory begin to reflect the seasonality. And we work hard. Our merchants and our supply chain team and our vendor partners work hard to make sure that we have an advantaged position.

Speaker 2

Decks. Thanks, Ted. Just a comment on the promotional activity. We did shift an appliance event into May, driven by the Easter following

Speaker 11

in mid

Speaker 2

April. As I commented, thrilled with the performance of our appliance business as we finish the event in May. At this point, we don't focused on promotions at all. Our focus is providing everyday value for our customers. That has been multiple years of progression and we're thrilled with The value we're providing every single day in terms of being priced right every day, driving great innovation and driving a great experience for our customers.

Speaker 11

Deck.

Speaker 4

Our next question comes from the line of Steven Zaccone with Citi. Please proceed with your question.

Speaker 9

Great. Good morning, everyone. Thanks for taking my question. Maybe a follow-up about consumer spending toward the home since it's been Discuss in detail here. Clearly, you're seeing strong demand from ongoing projects.

Speaker 9

I think investors are trying to grapple with the fact that home spending may slow at some point because of the macro, But the home also has increased importance post pandemic. What's your take on that debate? Do you think that makes home improvement spending more recession resistant than it's been in the past?

Speaker 3

Well, we really just have to look at the health of our customer today, which is strong. And we also have to listen to our customer those same surveys where the pro survey, there's also one with respect to Consumer intent to do projects, homeowner intent to do projects of small, medium and large sizes has never been higher than right now.

Speaker 9

Got it. Very helpful. Then just shifting, could you talk about capital allocation priorities if the macro environment were to get a bit choppier? How do you balance capital investment, share buyback and the potential for M and A? And I guess specific to M and A, it's been 18 months since you did the

Speaker 11

HD Supply acquisition. Would you be open to additional M and A in

Speaker 9

the next few years to reach your higher Would you be open to additional M and A in the next few years to reach your higher TAM? How best to think about the criteria?

Speaker 3

Well, with respect to capital allocation, we generate strong free cash flow and so have returned significant capital shareholders over the last decade plus. With respect to CapEx and investment in the business. We take a long term view. We are always going to invest ahead of a customer. We are always looking years ahead to make sure that we build the best customer experience in home improvement.

Speaker 3

And so that would likely be our stance, but we always have to take circumstances into consideration and we do that in any event.

Speaker 1

On M and A, we've always maintained an active strategic business development group and they're always looking in the marketplace for companies really regardless of size, generally on the smaller size that and Ad capabilities. So you've heard us talk about some various data shops we've acquired. Certainly the larger acquisition of supply helped us into a market space and that is an ongoing review that we're active looking at capabilities in market spaces that an acquisition can help accelerate our development in that space.

Speaker 9

Great. Thank you very much.

Operator

Christine, we have time for one more question.

Speaker 4

Thank you. Our final question will come from Chuck Grom with Gordon Haskett. Please proceed with your question.

Speaker 13

Hey, good morning. Thanks for fitting me in. Great results and congrats. On the inflation front, curious if you're seeing any unit demand destruction as you've been taking retails higher Or if there's any signs of trade down in the basket Walmart called that out this morning and I know your basket is obviously very different than theirs. Just wondering if you're seeing anything on that front?

Speaker 2

Chuck, good morning. We're seeing no trade down in the environment and we're thrilled with the innovation that we're offering to our customers. Dech. As I commented earlier, we're seeing trade up for innovation. We're seeing a lot of activity around Our consumers looking to improve their homes, to adopt new innovations.

Speaker 2

I talked about the electrified lawnmower business Decks and the opportunity there. That's just one example of many examples of trade up. And then on the project business, We're seeing great demand as we commented earlier on the project business both for the pro and for the consumer.

Speaker 13

Okay. That's great to hear. And then one for Richard. Can you flush out the expectation for comps in the front half to be better than the second half? If I look at your compares on a 3 year GeoStack, they're pretty consistent.

Speaker 13

Just wondering if you're being conservative there or I guess the expectation for the trend to slow a little bit in the last 6 months of the year?

Speaker 3

It's early. What I would say is we do expect Q2 to be the highest comp quarter of the year and expect first half to be higher than the second half, but we do expect positive comps

Speaker 4

Ms. Jantze, I would now like to turn the floor back over to you for closing comments.

Operator

Thank you, Christine, and thank you everybody for joining us today. We look forward to speaking with you on our Q2 earnings call in August.

Speaker 4

Ladies and gentlemen, this does

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Earnings Conference Call
Home Depot Q1 2023
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