Reading between the lines: Home Depot hints at more closings

Many were surprised when they heard that Home Depot was closing all 34 of its Expo Home Design Centers, but if you are a regular reader of its financial reports, you certainly would have seen signs of major financial stress. Home Depot (NYSE: HD) first discussed a "store rationalization plan" in its first quarter of 2008 report. At that point, it closed 15 stores and removed about 50 stores from the future growth pipeline.

In the third quarter report (December 2008), Home Depot said, "We recognized $564 million in total pretax charges for the first nine months of fiscal 2008 related to the store rationalization plan, including $3 million in the third quarter of fiscal 2008." Clearly, the store rationalization plan was not complete and more cuts were to come.

Another sign of more cuts to come was this warning in the Results of Operations section, "Our international businesses began to feel some of the economic pressure that we have experienced in the U.S. in the third quarter of fiscal 2008. Our comparable store sales for Canada and China were at the Company average for the third quarter of fiscal 2008. For the first nine months of fiscal 2008, comparable store sales for Canada were above the Company average and were positive for China. Our stores in Mexico posted double digit comparable stores sales in both the third quarter and first nine months of fiscal 2008."

Based on this information, it appears that Home Depot realized that with economic pressure on the international front, it could no longer use profits from there to prop up losses in U.S. operations. One of the most telling quotes from the Results of Operations was, "Operating Income decreased 25% to $1.3 billion for the third quarter of fiscal 2008 from $1.8 billion for the third quarter of fiscal 2007. Operating Income decreased 31.7% to $4.1 billion for the first nine months of fiscal 2008 from $6 billion for the first nine months of fiscal 2007."

Clearly, Home Depot was bleeding and it had to stop that bleeding, especially once it realized that the cushion from international sales was no longer going to be there. When Home Depot finally announced that it was closing Expos, it said the concept stores would lose $80 million in 2009. Its operating loss was $50 million in 2008. While this helps, given the level of the bleeding, the cuts based on the store rationalization plan probably are not yet done.

As an investor reading this report, you can see that Home Depot's future under current market conditions is not bright. In fact, Home Depot clearly states in its Management Discussion and Analysis that, "The slowdown in the global economy and weakness in the U.S. residential construction and home improvement markets negatively affected our Net Sales for the third quarter and first nine months of fiscal 2008. Our comparable store sales declines 8.3% in the third quarter of fiscal 2008 driven by a 5.5% decline in comparable store customer transactions, as well as 2.8% decline in our average ticket to $55.86."

Expect these numbers to look even more dismal when the annual report is released in April. In Can Home Depot Rebuild?, Jamie Dlugosch takes a closer look at this question.

Lita Epstein has written more than 25 books including Reading Financial Reports for Dummies (2nd edition published in January) and the Complete Idiot's Guide to Value Investing.


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