Home Depot, Inc. (HD) Management Presents at RBC Capital Markets Consumer and Retail Conference (Transcript)

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About: Home Depot, Inc. (HD)
by: SA Transcripts

Home Depot, Inc. (NYSE:HD) RBC Capital Markets Consumer and Retail Conference May 30, 2018 11:20 AM ET

Executives

Crystal Hanlon - President, North division

Paul Deveno - Regional Vice President

Lyndsey Burton - Investor Relations

Analysts

Scot Ciccarelli - RBC Capital Markets

Scot Ciccarelli

Senior Hard-Line Broad Line Analyst. I've been with RBC for about 15 years. I was with another company for about 11 to 12 before that, so I've done this for a long time, [indiscernible] Home Depot for a large chunk of my life span. So today, we have Crystal Hanlon, President of the North division; we have Paul Deveno, Regional VP; and my friend, Lyndsey Burton, who's with the IR team.

So Home Depot is a company that I've, a) long admired; b) it's one that we've recommended for probably 10 years straight. Make any recommendation changes in there? No, and that's actually been the right call, quite frankly. We started to see a turn happening, a, in the housing cycle about, call it, 9, 10 years ago. The company itself was making massive operational changes and improvements to its own structure. And at this point, sitting here in 2018, I personally think it's the best-run retailer in the entire country.

So I say that without trying to embarrass you guys.

Crystal Hanlon

Thank you.

Scot Ciccarelli

Certainly. So without further ado, I do have a series of questions, and then we'll try and open up it up at the end for the audience. So the dynamic in the first quarter was we had a lot of very large weather impact. Sales came in a little below expectations. It's kind of abnormal, particularly for your company, given the track record. And then Carol had also talked about comps running at double-digit rate through May. So I guess, the question is, do you think you can get fully back on plan or potentially even ahead of it in the first half? And then how does that cadence typically kind of play out? Do you capture most of it in the second quarter, some of it roll into the third quarter, et cetera?

Crystal Hanlon

Well, if you think about Q1, we actually estimated about $500 million of the loss from the seasonal categories. And as you heard on Carol's call, on the quarter call, we’re running double-digit comps in May and very excited about what we're seeing from a business perspective. As soon as the sun came out, we saw that we were going to have momentum in the business. And it shows up in our seasonal categories as well as the interior categories of the business. So we see broad-based strength across the interior and exterior sides of the business. And when you think about that, it's really a bathtub effect. We're going to make up the dollars. Majority of the dollars will be made up in Q2. So for the half, we'll make the number.

Scot Ciccarelli

Got it. And then especially given your operational background, can you talk to a little bit about the operational challenges when you see such a dramatic sales shift in terms of demand?

Crystal Hanlon

Sure, obviously, we're getting the sales now. And it's actually a much tighter window, so we have to be that much more operationally efficient in order to get those sales. So what we're doing is making sure that we are focused on our staffing, making sure that we're focused on the operational leverage from a receiving perspective and really embracing the connectivity with our associates to ensure that we meet the customer demand at that point in time. And if you think about the labor model for us, now our labor model is activity-based.

So we can be there for the demand of the customer. So instead, if you think about that activity, like if you're – in the past, when you'd sell 3 gallons of paint, you're using the same labor as you would when you're selling a paintbrush. Now our labor model is very activity-based, so we are there for the customer demand based on activity. So that allows us to adjust from a seasonal perspective.

Paul Deveno

Scot, the only other angle that I would add is we spent years building out this upstream model for logistics, and it's given us great flexibility. So we were able to really leverage that model and make sure that we had the product that was in demand as we saw the cycle really increase.

Scot Ciccarelli

Crystal, getting back to your question about the activity-based labor model. What changes do you implement where it's paintbrush versus three cans of paint? Like, what operationally happens?

Crystal Hanlon

Well, when you think about that, in the past, we would have staff regardless of the transaction. So we would have staff in place when we really needed the staff to do the mixing of the paint from an activity base. If you mix more paint in one store versus another store, you’d have more labor models to – labor hours to be able to adjust for that necessary task. So that helps from a staffing perspective to be there for the demand of the customer. It's very different with that activity base versus just staffing from open to close.

Scot Ciccarelli

Got it. And then I think everyone in here probably knows that you guys have ramped up your spending and investment profile this year. With the slower sales that you had in the first quarter, but already planning on spending more money, like how much flexibility is left in the model if sales don't necessarily – in situations where your sales don't necessarily run to plan?

Crystal Hanlon

Well, listen, we're very committed to our investments. We're not going to back off from our investment strategy. And the biggest expense that we can leverage is our payroll, our labor model. So we can adjust as necessary based off the demand of the customer, especially with our activity-based model based on demand. So if we don't have the demand, we can cut back on those hours as well as the part-time, full-time mix because we can adjust the part-time mix in order to satisfy the needs of the customers. We can tweak it. That's what we've done at in-season. We've tweaked our part-timers up, and we can also tweak down.

Scot Ciccarelli

Given the amount of construction activity that's happening because some people may go work at Home Depot, they may go work for a contractor, and given how tight the overall labor market is, are you finding it more difficult to hire folks? Or do you have to promise them more labor hours to – for them to commit to you?

Crystal Hanlon

Well, in actuality, we hired 80,000 associates in Q1, and we did not have a problem finding those associates. Really, in many cases, we had several applications to go through, and so we haven't found it an opportunity. I will tell you, once we do hire the associates, we talk about the benefits that we have at Home Depot, all the different benefits that we've got, the Success Sharing, different things to retain our talent, and we haven't seen the job pool decrease. If anything, in some markets, it may be a skilled labor opportunity across certain markets, but very, very seldom do we see an opportunity from a hiring perspective.

Once we bring them in, for retention, we talk about the benefits and why work at Home Depot versus any other competitor. Again, 90% of our leadership team started as an hourly associate on our sales floor. And really teaching them that they have every opportunity to move up in the company and achieve anything they want is a great story for our associates. So we're really working on telling that culture message and transfusing the culture to those 80,000 associates.

Scot Ciccarelli

Okay, thank you. So a couple of questions on the competitive environment. So there's always change. We know that. That's kind of a given in any kind of retail sector. But you've had continued deterioration from Sears. You've had rapid growth from somebody like Floor & Decor. You have, let's call it, various changes occurring with Lowe's. How would you assess today's competitive environment?

Crystal Hanlon

Well, when you think about the competitive environment of the product that we sell, the majority of the market share right now rests with the independents and the mom and pops throughout regional players. So a lot of times, that market share resides in those mom-and-pop areas where there's opportunity to be had. It's very fragmented. It's a very fragmented market share. There's opportunity for us to gain market share across. And we compete with many different competitors. We have for 40 years and will continue to do so to try to gain as much market share as possible.

Scot Ciccarelli

Are there certain areas or categories where – I mean, you can't do everything at once. It just doesn't work that way, right? So are there certain, let's call it, specific categories that you guys are trying to focus on, call it, over the next 12 to 24 months? I am assuming that you guys have some sort of target lists like that.

Crystal Hanlon

Listen, there are several categories that we focus on. We focus on the portfolio of the entire business. We lean in a lot on some of the interior projects that we did in Q1 to offset some of the weather pressure. If you think about appliances, we lean in heavily in appliances from a staffing and a training perspective to make sure we gain that foot traffic with our appliance customer. Market share in 23 – or flooring, we've focused a lot. We're seeing some good momentum in vinyl plank and some of the assortment that we've got in flooring. And then paint, obviously, interior paint did well in Q1. We're focused on how do we drive that paint interaction to really drive that experience from a Pro and a DIY perspective, feel really good about that business, but there are several categories we focus on. One of the biggest wins is where we're focusing our time.

Scot Ciccarelli

So, taking that to the online competition version. I guess, one of the question is, what do you think you're seeing from online competitors? Let's call it Amazon. Let's call a spade a spade, right? So what are you seeing from Amazon today as they try and penetrate most retail verticals? And then how are you guys thinking about continuing to battle back against it? Because for a very large retail category, Amazon doesn't seem to have had a major impact on home improvement yet, but who knows what happens in the future? So I'm trying to figure out what have you seen, a? And then b, how do you continue to battle back and kind of make sure they don't take share over time?

Crystal Hanlon

We're doing several things. We've been competing against Amazon with our strategy for some time. On the online channel itself, we're focused on the entire interconnected business. So when you think about the online channel, we have 45% of our online orders where customers come into our stores to pick up the product. We have to be the best of the best when we have that experience inside the store from a customer experience because Amazon can't offer that. They can't offer the 400,000 associates that we have on the sales floor to be able to sell product to our customers as well as they're not nearly as skilled from a complex labor perspective. When you think about our projects, we have complex projects in our stores. We have kitchens. We have electrical jobs.

People need – consumers need to understand how to do those jobs, and the complex projects are critically important, but that means they’re coming into our stores to ask those questions. So on the online segment that online order gets the customer to the store, and then we make sure that we've got the interconnected experience there. As far as investments, when you think about the $1.2 billion we put into the supply chain investment, that's going to allow us to make sure that we have delivery capabilities like we've never had before.

We'll have market delivery centers in certain areas. We're going to really expand for the next 3 to 5 years, which will help us from a delivery schedule. We want to be the best delivery agent in home improvement. It's going to allow us to offer next day, in some cases, same-day delivery. So it's going to be a game changer for us from a delivery supply chain perspective. So those are the areas we're really saying we're going to spend some time investing, and I believe it'll be a game changer for our customers.

Scot Ciccarelli

So the next day, same day versus what today and how much has today changed versus, say, 3 years ago, just so people can understand the trajectory.

Crystal Hanlon

Well, obviously, we have the 2 and 4 hour window for the Pro. But when you think about the delivery in the future, think about delivery market centers throughout our regions to where we can get product delivered to your home on the Pro job site next day or today. And the benefit of that is if you think about Amazon, they haven't really got a model where they can deliver the big, bulky products that we deliver. They don't have the model for lumber. They don't have the model for different categories of business that we have. In many cases, our deliveries are big and bulky. And in some cases, we have to have a forklift out there to deliver the product. And Amazon really hasn't honed into that and how to manage that delivery mechanism. We're going to be able to have that model with what we're doing from a delivery perspective.

Scot Ciccarelli

So you really need specialized DCs and logistics and equipment for a big chunk of your products is what you're saying.

Crystal Hanlon

Absolutely, yeah, we have got to have specialized DCs, and that's what we're going to have in the next 3 to 5 years with our investments.

Lyndsey Burton

Yes. I mean, right now, our coverage is about 30% of the U.S., I would say, with 2 – same-day, next day. We're going to 90% there.

Scot Ciccarelli

Okay.

Lyndsey Burton

Over 90% or plus 90% of [indiscernible] day or less. So we're just scanning towards where the customer is taking us in terms of their increased desire from an options and at a faster rate.

Scot Ciccarelli

Got it. Thank you.

So one of the things that's characterized the company over the last, call it, two years, a lot of the comp growth has come from average ticket – rising average ticket, more than number of transactions. Just having been with the company for a long time, et cetera, would you have expected it to play out this way based on kind of where we are in the cycle, number one? And number two, how sustainable do you think the comp growth is since it is coming from ticket as opposed to more and more transactions on a regular basis?

Crystal Hanlon

I believe on average ticket and comp, for the last few years, we've been very healthy if you think about it. We've had a very healthy average ticket and transaction comp. I think that when you think about the average ticket, obviously, it's impacted by weather and different variables. But we're focused on making sure that we talk about innovation. And a lot of our customers are trading up on products. They're looking at the innovation we're offering from a product assortment perspective, and they're buying into that and they're trading up from – which improves our average ticket. So I think that's a big win. And I think when you think about the comp trajectory, it'll be 4.5%, basically half from transactions and half from average ticket. So we see strength.

Lyndsey Burton

That's how we – when we built the model, [indiscernible] we're not – we always say we're not that good, right? We do half transactions, half ticket, there's a lot of, to Crystal's points, variables that could come in and influence that, depending on where you are weather-wise. And if you get a hurricane, obviously, that's an impact. So but we've been very pleased with the strength and what we're seeing across both.

And we keep a watchful eye as we look to the last kind of mile recession of not the housing one. But if you go back to 2001, what you saw was average ticket actually turned downward, and so we keep a watchful eye on that. We also watch transactions of course, that we’ve been really pleased with – in terms of what we've been seeing on both.

Crystal Hanlon

Yes. And we see consumers trading up based on innovative products across the store. It's a win.

Scot Ciccarelli

Well that actually Lyndsey started to touch on it. So what else you got – I mean one of the big topics obviously in the sector is the housing market. The health of the housing market where are we in a cycle, especially in an environment where interest rates are starting to creep up. What is it on maybe it's the top three guideposts in terms of what you guys are looking at to say what we're starting to see a bit of a change here?

Lyndsey Burton

Yes. I mean, we're – at this point, we're seeing incredible strength. I mean, there's been great strength in terms of just the macroeconomic backdrop being supportive from a housing standpoint. We still view that as a tailwind. So at this point…

Crystal Hanlon

Yes we see great strength. When you think about the economic environment we're very pleased with what we're seeing. When you think about the housing indicators, all look up from an assortment – from a household formation, housing inventory basics on the housing industry who we feel really good about what we're seeing. So we think there's momentum in the business. We don't see anything from…

Paul Deveno

I think the only thing I would add is when you think about the rising interest rates, you can't think about it in the back end, right? And you have to – you really have to look at housing affordability, right. And so if you think through today the affordability index is still at around 152%, average is 126%, 127%, somewhere in that neighborhood. So there's still upside there. I think Carol has talked about it and said really don't see any kind of impact until you get to about 7%. We think there's a lot of runway still ahead because the other factors are so strong.

Scot Ciccarelli

Okay. And that clearly all makes sense. I guess what I was kind of wondering is, are there certain things you're looking for – and real estate is very localized, right? So I don't know if there's certain markets that you're kind of looking at as maybe it's overheated or we're starting to see a bit of a change in California or what have you, and you guys have all the data. We don't have that.

Lyndsey Burton

Yes.

Scot Ciccarelli

From a regional perspective I'm just curious if there was a certain guidepost and maybe the answer is no.

Lyndsey Burton

Yes. I mean, to be honest with you, for ex weather, take that out of the conversation. I mean, in terms of variability across our stores what we see in our regions, it's been narrowing, so to speak. We're not seeing wide swings in variability.

Crystal Hanlon

Yes if you take out weather out of the equation, you see good performance across all regions, all geographies. Weather impacted the North, obviously. But across, the fundamentals of the business is very strong.

Scot Ciccarelli

Okay. So moving on to some of the investments that you guys are making. You have invested – you're accelerating investments in stores. You're investing more into supply chain. You started to reference that already. Can you just kind of outline for the group some of the, let's call it, maybe the top three investments you guys are kind of moving forward over the next three years?

Crystal Hanlon

Absolutely. So $11.1 billion of investment we're making over the next three to five years, which is a big win for us. I do believe it's going to be a game changer seriously when you think about it because the supply chain is $1.2 billion of that. So it's going to allow us to be the best-in-class from a home improvement retailer to be able to do delivery. We also are focused on half of those dollars going back to our stores.

If you think about our stores, our stores are the hub of our business. They always have been. And we're investing and making sure that we listen to the customer on what they're asking for. When you think about the two primary things the customer is asking for, it's speed to checkout and wayfinding. So we're spending a lot of our dollars to make sure that a customer feels a good, seamless experience from a speed-to-checkout perspective. We're spending money on the front ends of our stores. We're spending money to make sure that we give a quick exit from a checkout perspective. On the wayfinding, to make it easier for them to shop inside the box, we're spending money there.

As well as if you think about what we're leaning into from an online channel and the interconnected experience, we were purchasing lockers so that when a customer comes into the store, they can go and get the product from an online perspective right out of the locker. They don't even have to interact with an associate if they don't want to. But obviously, they also are shopping the store. So we're spending more than 50% of our investment to make sure that we get back to the stores as the hub of our business.

Question-and-Answer Session

Q - Unidentified Analyst

And so how is that so different than what you've done over the last several years, where you would try and revamp, let's call it, a third of the store? Or was it always a third of a merchandise category? So maybe I didn't understand that part, right?

Lyndsey Burton

Yes we touched a third of the merchandising categories a year.

Unidentified Analyst

Merchandise.

Lyndsey Burton

Now I think on the merchandising assortment side, what we're doing is we're getting faster in terms of just doing full line of these vertical to do more quick business line reviews that's tied in the merchandising team. I've talked about before that we're just able to touch more categories quicker to prevent some that what you used to see. And you'd see degradation once you touch the category, it would kind of see the lift once you touch the category, it would kind of see the lift and then slowly to the degradation. We've been working toward shortening that degradation curve by touching more of our categories and our assortments.

Crystal Hanlon

And truly we’ve increased our investment. And that's a great decision to make at this time because, I'll tell you, having been with Home Depot for 33 years, to make the commitment that we're making to our stores, to make sure that they're relevant for the customers and what they need is a big win. It is going to change us for three to five years. Also, the supply chain. I mean, to get to a best-in-class supply chain for a home improvement product is going to be an incredible win for Home Depot.

Lyndsey Burton

And we've been – I would say to add to that, we've been investing in the business for years. I mean, you've seen what we've done in the – to the to the supply chain on the upstream portion of it in recent history. But we're not positioning the business – of the investments that we're making and doubling down. Simply doubling the investment over the next thee years wasn't to position the business for the next three. It's to position the business for the next 10, 15, 20 years, just given the rapid pace of change that we're seeing in the retail environment. We think that we're operating from a position of strength. And as Crystal says, it's a very exciting time to be at the company.

Crystal Hanlon

And also, we're really focused on the interconnected customer, the interconnected business. We're not just focused at one segment of the business. We're not just focused on Pro. We're focused on all aspects and the investments across, Pro, different pieces, the front end, ease of shoppability for the customer. We're really focused from end-to-end that customer, where are they shopping to make it seamless across all channels. We don't want to focus just on one channel. We want to focus on the entire experience, and that's going to be a big win from this investment perspective.

Unidentified Analyst

I’m really bad at math, but you said $11.1 billion, and we said $1.2 billion and then another $5.5 billion for the stores. Where is the rest of the money going?

Lyndsey Burton

It's $11.1 billion over the next three years. The $1.2 billion is…

Crystal Hanlon

Is part of that supply chain.

Lyndsey Burton

Is part of that supply chain and that’s over the next five years.

Unidentified Analyst

Okay.

Lyndsey Burton

The supply chain investment is…

Scot Ciccarelli

I think it was other categories.

Lyndsey Burton

IT, there's investments in people and associates, yes.

Crystal Hanlon

[Indiscernible]

Scot Ciccarelli

Okay.

Unidentified Analyst

It just seems like a lot of dollars unaccounted for. You said $11.1 billion...

Crystal Hanlon

We didn't break down the entire investment.

Lyndsey Burton

No. I mean...

Crystal Hanlon

50%.

Unidentified Analyst

That's why I was hoping you could give some granularity on the rest of the investment you're making.

Lyndsey Burton

Yes, over 50% is going to stores. The – I think it's – 18% is going to IT and the online digital experience. I believe if you break it down, 17% goes to supply chain, and then the balance of that goes to a bucket that I would consider to be other.

Scot Ciccarelli

Any other – because we're about five minutes away. Any other questions from the field? Sure.

Unidentified Analyst

So the supply chain investment, does it enable you to do things in other categories that you weren't able to do? And so in my head, I'm just thinking shingles, right? Those are complex. You sell them, but you don't deliver them today. But will this enable you to move into a category [indiscernible] for example?

Paul Deveno

So we sell them and deliver them today.

Unidentified Analyst

Okay, sorry.

Unidentified Analyst

It's okay. It makes it easier and more convenient for both the stores and the customer. So what do I mean by that? Today, if we were to sell a delivery of shingles, you're going to pull those shingles off of the shelf in the store potentially during business hours, right, disrupting the customer experience who wants to be in that aisle shopping shingles. You're going to bring it to the back, you're going to load it on a truck, that truck's going to go out to the customer.

Paul Deveno

If you think about the future state, the future state involves essentially what we'll call a warehouse for ease of understanding, where those are already staged. And so now we're not disrupting the experience in the store. We're also centralizing where all of those delivery trucks are going to. So it becomes much more efficient, gives us greater capacity and makes the experience better.

Scot Ciccarelli

Does that actually make your stem miles to whatever the delivery spot is longer, though, if it's all going to be centralized?

Paul Deveno

So it's going to depend on the market, right? So we have a couple different models that we are essentially piloting, right, as we go through this because it's new for us. If you think about the top 40 market, where you have high concentration and density of stores, high concentration of density of population, having a centralized location actually makes us more efficient. I may have to drive past where our store used to be, but I'm so much more efficient because of my loading and my cycle time. So it works out. If we go to a more remote market, we may continue to deliver from the store because it just makes more sense in that market. So it'll be market-by-market specific.

Scot Ciccarelli

So when you say centralized, you're not talking a single hub for the U.S. You're talking about 5 markets that's going to be centralized?

Crystal Hanlon

No, it's market delivery centers. So to be specific to certain markets.

Paul Deveno

That's correct, yes

Scot Ciccarelli

Got it, yes.

Unidentified Analyst

Analyst Just as the specialty players[indiscernible] go after certain categories that's getting skewed, that's getting square footage, how do you compete in your store with that [indiscernible] the customer wants to see [indiscernible]? Are there certain – is there a changing focus in-store to get bigger in certain areas or shrink certain areas?

Crystal Hanlon

Well, we've been competing with several competitors for years. And when you think about the flooring industry as a whole, we're seeing good momentum. We've changed our assortment in some categories. We've upgraded the assortment. Vinyl plank is doing extremely well for us. So we focus on the assortment of the product as well as the specialty staffing for that particular product because you can have any product you want. But if you don't have the staff to sell it or you don't have somebody really telling the story of that product, it doesn't really help you.

So we're focused not only on the assortment and really upgrading assortment, adjusting as necessary based on market demand. We're also focused on the staffing piece to make sure we've got the best training and the best associates ready for the customer demand in that particular category. So we really are honed into what the competitors are doing. We don't focus much on them as focus on how do we improve our assortment to have the best in retail.

Paul Deveno

I think we're very competitive. We like to win. And I would tell you that in tile and hard surface, we have done some pilots. We're doing some expansions in certain stores where it makes sense. And so I was in a store just the other day, where we've expanded the line of tile. We've expanded what we're bulked out on. We're being very fashion-forward. We leverage our online capability to understand what is it that the customer is looking at today that we may not have in the store, but it's on online. And then we'll take and we'll leverage that knowledge and move it into a store.

So that we're putting all of that together. What I'm trying to say is that we're going to be very competitive in the space regardless of what the competition does.

Scot Ciccarelli

We probably have time for one more quick question.

Unidentified Analyst

On the most recent call you mentioned expanding service levels. The example implies faucet [indiscernible] you guys would do that. Would you be doing – is the Home Depot employee doing that level of service? [Indiscernible]

Lyndsey Burton

It would depend on the category.

Unidentified Analyst

Category?

Paul Deveno

Yes. Most of it's – most of the small jobs, faucet, for example, is a sub.

Lyndsey Burton

Yes third party.

Unidentified Analyst

How do you decide – like how do you work with inside with the third party?

Paul Deveno

There's an entire vetting process that they go through. They are all licensed, bonded, insured, background checked. I mean, it is….

Unidentified Analyst

Market-by-market?

Paul Deveno

Yes, market-by-market. Very extensive process.

Scot Ciccarelli

And unfortunately, I think that's about all the time that we have, but thank you very much team that was always…

Lyndsey Burton

Thank you.

Paul Deveno

Thank you.

Lyndsey Burton

I appreciate it.

Scot Ciccarelli

I think there was new few points, thanks.

Paul Deveno

Thanks.

Lyndsey Burton

Thank you.