Morningstar DBRS Confirms The Home Depot, Inc. at “A”, Stable, Following SRS Acquisition Announcement

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and Senior Unsecured Debt rating of The Home Depot, Inc. (Home Depot or the Company) at “A” and the Commercial Paper ratings of Home Depot and Home Depot of Canada Inc. at R-1 (low), all with Stable trends. This action follows the Company’s announcement that it has entered into a definitive agreement to acquire SRS Distribution Inc. (SRS), a leading residential specialty trade distribution company in the U.S., through one of its subsidiaries for a total enterprise value (including net debt) of approximately $18.25 billion (the Transaction). SRS’ EBITDA was approximately $1.1 billion in 2023, reflecting a 16.1 times (x) multiple on the total transaction cost. Home Depot intends to fund the acquisition through cash on hand and incremental debt. The Transaction is subject to customary closing conditions, including regulatory approvals, and is expected to be completed by the end of F2024 (fiscal year ending in January 2025).

KEY CREDIT RATING CONSIDERATIONS
The rating actions reflect Morningstar DBRS’ expectations that Home Depot’s strong free cash flow generating ability and prudent financial management will support its deleveraging plan, such that debt-to-EBITDA leverage returns toward the Company’s publicly stated leverage target of 2.0x over a 24-month period, from pro forma leverage of approximately 2.5x at the close of the Transaction. Furthermore, Morningstar DBRS views the effects of the Transaction on Home Depot’s business risk profile to be moderately positive. SRS, with its 760-branch network across 47 states and a fleet of more than 4,000 trucks, serves professional (PRO) customers in three different verticals, including landscapers, roofers, and pool contractors. This scale and market position should help Home Depot to further consolidate its leading market position in the PRO segment. Home Depot believes the Transaction increases its total addressable market size by $50 billion to approximately $1 trillion.

On January 17, 2024, Morningstar DBRS confirmed Home Depot’s ratings at “A”/R-1 (low), all with Stable trends. Since then, Home Depot reported results for full year F2023 and the operating results as well as key credit metrics were broadly in line with Morningstar DBRS’ expectations.

CREDIT RATING DRIVERS
Looking ahead, Morningstar DBRS may take a negative credit rating action if weaker-than-expected operating performance and/or more aggressive financial management policies results in credit metrics to weaken on a sustained basis (i.e., debt-to-EBITDA leverage above 2.5x).

Conversely, and although highly unlikely given the economic climate and near-term increase in leverage, if Home Depot’s earnings profile were to improve considerably and/or capital allocation were managed such that key credit metrics improve to levels considered strong for the current rating (i.e., debt-to-EBITDA leverage is maintained structurally well below 2.0x), Morningstar DBRS may take a positive credit rating action.

EARNINGS OUTLOOK
Morningstar DBRS believes Home Depot’s earnings profile will improve modestly within the current “A” credit rating category, assuming benefits from a successful integration of the SRS business, which reported revenues and adjusted EBITDA of approximately $10 billion and $1.1 billion respectively in 2023. The effects of the Transaction aside, Morningstar DBRS’ base case forecast remains largely unchanged since the last confirmation of Home Depot’s ratings. Considering the Transaction is likely to close only towards the end of F2024, Morningstar DBRS now forecasts Home Depot’s total revenues to be around $162.0 billion in F2025 compared with Morningstar DBRS’ previous expectation of around $152.0 billion. With the consolidation of the relatively lower margin SRS business and excluding any synergy benefits in the very first year of business consolidation, EBITDA margins are expected to be lower at around 16.0% in F2025 compared with Morningstar DBRS’ previous forecast of approximately 16.3% to 16.4%. As such, Morningstar DBRS forecasts EBITDA to grow towards $26.0 billion in F2025, from approximately $25 billion forecast for F2024 and $24.4 billion in F2023.

FINANCIAL OUTLOOK
In terms of financial profile, Morningstar DBRS acknowledges a temporary increase in leverage post transaction close but expects key credit metrics to return to current levels, which are considered comfortable for the current rating category, within 24 months from the transaction close. Morningstar DBRS forecasts pro forma debt-to-EBITDA leverage to increase towards 2.5x at the close of the transaction from 2.0x in F2023, as the Company is likely to raise around $12.5 billion of acquisition debt in form of commercial papers and unsecured notes. Morningstar DBRS expects the Company to allocate majority of its free cash flow (FCF, before any working capital changes) of approximately $6.5 billion to $7 billion annually in F2025 and F2026 towards debt reduction in line with its deleveraging plan. The Company has approximately $5.8 billion of notes maturing through F2026. Over the last few years, Home Depot has used its FCF along with some incremental debt, within the bounds of its publicly stated leverage target (lease-adjusted debt-to-EBITDAR of 2.0x using an 8.0x multiple to capitalize operating leases), to fund share repurchases. Morningstar DBRS notes the Company’s announcement to temporarily pause its share repurchase program to prioritize debt reduction such that leverage ratio returns to its 2.0x target levels.

CREDIT RATING RATIONALE
Home Depot’s credit ratings are supported by its dominant market position, large scale, geographic diversification, and free cash-generating capacity. The credit ratings also reflect the intense competition and cyclicality of the home improvement retail industry as well as risks related to possible future growth strategies.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of BRA Factors
In the analysis of The Home Depot, Inc., the relative weighting of the BRA factors was approximately equal.

(B) Weighting of FRA Factors
In the analysis of The Home Depot, Inc., the relative weighting of the FRA factors was approximately equal.

(C) Weighting of the BRA and the FRA
In the analysis of The Home Depot, Inc., the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodology: Global Methodology for Rating Companies in the Merchandising Industry (July 21, 2023; https://dbrs.morningstar.com/research/417461).

The following methodologies have also been applied:
-- DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (February 24, 2023; https://dbrs.morningstar.com/research/410196); and
-- DBRS Morningstar Criteria: Guarantees and Other Forms of Support (March 28, 2023; https://dbrs.morningstar.com/research/411694

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/397223.

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 under Related Documents or by contacting us at [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at [email protected].

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