DBRS Confirms Home Depot, Inc. at “A” and R-1 (low) with Stable Trends

DBRS has today confirmed the long- and short-term ratings of the Home Depot, Inc. and Home Depot of Canada Inc. (combined, Home Depot or the Company) at “A” and R-1 (low), respectively, with Stable trends. The confirmation of the ratings is based on Home Depot’s solid operating results, balanced by the Company’s focus on returning value to shareholders, including the use of debt-financed share repurchases, while maintaining stated leverage targets considered acceptable for the current rating category. DBRS notes that the rating action also incorporates Home Depot’s recent announcement that its payment data systems had been breached putting customer card information at risk. Despite the magnitude of the breach and the expected increase in one-time expenses necessary to protect customer data and to help restore consumer confidence, DBRS does not believe this event will have a material impact on the Company’s profitability going forward. Home Depot’s ratings continue to be supported by its dominant market position, scale and geographic diversification as the largest home improvement retailer in North America. The ratings also reflect the highly competitive and cyclical nature of home improvement retailing.

Home Depot’s earnings profile remained stable in F2013 and H1 F2014 benefiting from its strong market position and geographic diversification, which helped to offset the effect of harsh winter weather in certain regions in Q1 F2014. Net sales improved to approximately $80.7 billion for the last 12 months (LTM) ended Q2 F2014 based primarily on solid comparable store sales, which continued to indicate improvement in market share and outperformance of major competitors, helped by an improving U.S. housing market, despite continuing to lap high comparable store sales in recent periods. EBITDA margins expanded 50 basis points in H1 F2014 based primarily on operating leverage from higher comparable store sales and reduced costs, while gross margins remained flat. As such, Home Depot’s EBITDA increased to approximately $11.4 billion for the LTM ended Q2 F2014, versus $10.8 billion in F2013 and $9.3 billion in F2012.

Home Depot’s financial profile remained stable and adequate for the current rating in F2013 and H1 F2014 based on the Company’s strong and growing free cash flow-generating capacity and consistent target leverage levels. Cash flow from operations continued to track rising operating income, while capital expenditures (capex) increased modestly as the Company continues to invest in its interconnected retail platform (IT and online business). Home Depot announced a 21% increase in its quarterly per-share dividend in Q1 F2014, in line with the Company’s targeted payout ratio of 50% of earnings. Despite the increase in capex and dividends, free cash flow before changes in working capital increased to nearly $4 billion for the LTM ended Q2 F2014. Home Depot used free cash flow generated, cash on hand and incremental debt of approximately $6 billion to complete approximately $12 billion of share repurchases in F2013 and H1 F2014. As a result, total balance sheet debt increased to approximately $16.7 billion at the end of Q2 F2014 versus approximately $10.8 billion at year-end F2012; nevertheless, combined with the increase in earnings, credit metrics remained in line with the Company’s stated leverage target at a level considered acceptable for the current rating category.

Going forward, Home Depot’s earnings profile is expected to remain well placed in the current rating category on a through-the-cycle basis based on the Company’s dominant market position and geographic diversification. DBRS forecasts that the Company’s net sales should increase in the low- to mid-single digits through the end of F2014 and in F2015 based primarily on low- to mid-single digit comparable store sales, in line with DBRS expectations for the sector, supported by an improving housing market in the U.S. EBITDA margins should remain relatively stable but could continue to expand modestly over the longer-term as the Company gains operating leverage from positive comparable store sales growth, as well as a focus on improving efficiency and reducing costs. In the near-term EBITDA margins could be somewhat pressured by elevated expenses related to the breach of the Company’s payment systems. As such, DBRS expects EBITDA could increase toward the $12 billion level in the near term.

DBRS expects that Home Depot will maintain a financial profile consistent with the current rating category on a through-the-cycle basis, based on the strength of its free cash flow-generating capacity and stated target financial leverage (i.e., lease-adjusted debt-to-EBITDAR of approximately 2.0 times (x) using an 8.0x multiple to capitalize operating lease expense, or approximately 1.85x using a 6.0x multiple). Cash flow from operations is expected to continue to track operating income, rising toward the $8.5 billion level, while capex should remain relatively stable in the $1.5 billion range and the dividend policy will remain consistent targeting the payout of 50% of earnings. Free cash flow before changes in working capital should therefore remain relatively stable in the $4 billion to $4.5 billion range. DBRS believes that Home Depot will continue to use free cash flow generated and cash on hand to increase shareholder returns. The Company may also continue to use incremental debt to complete share repurchases (as earnings grow) but not to a level beyond Home Depot’s stated leverage target (lease-adjusted debt-to-EBITDAR of 1.85x), which is considered acceptable for the current rating category.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers and Rating Companies in the Merchandising Industry, which are available on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The Commercial Paper rating of Home Depot of Canada Inc. is based on a guarantee from The Home Depot, Inc.