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Contributions from SRS Acquisition: The acquisition of SRS Distribution Inc. in June has proven to be a strong strategic addition to Home Depot's business, enhancing both sales and operational capabilities. In seven months since the acquisition, SRS contributed $6.4 billion to sales in fiscal 2024, aligning with expectations. Since the acquisition, the company has expanded its footprint by opening more than 20 new locations and completing four tuck-in acquisitions, further strengthening its market presence. Home Depot is also leveraging cross-selling opportunities, particularly through Quote Center, its platform for real-time pricing and bulk fulfillment. By expanding SRS' presence in nearly all markets, sales from Quote Center have more than tripled. Looking ahead, Home Depot remains committed to supporting SRS' growth, with organic sales projected to rise mid-single digits in fiscal 2025.

Integrated Retail Strategy: Home Depot remains committed to advancing its strategic initiatives, even amid economic uncertainty and a challenging high-interest-rate environment that affected home improvement demand. The company's key priorities include enhancing the interconnected shopping experience, expanding its Pro wallet share through a robust ecosystem of capabilities, and investing in new store development. HD is progressing well with its "One Home Depot" investment plan, which focuses on expanding supply-chain facilities, investing in technology, and enhancing the digital experience. The interconnected retail strategy continues to be a key driver of growth, ensuring a seamless shopping experience across digital and physical channels. In fourth-quarter fiscal 2024, online sales (excluding the extra week) grew 9%, reflecting higher engagement in faster delivery services. The company remains committed to enhancing its omnichannel capabilities. Investments in downstream supply chain improvements have expanded product availability at Distribution Fulfillment Centers (DFCs), allowing for faster delivery speeds across a broader assortment. Additionally, Home Depot has leveraged its store network to offer more delivery options, leading to the fastest delivery speeds in the company's history and increased customer spending.

Beyond fulfillment enhancements, Home Depot is strengthening its in-store experience, fulfillment options, and sales teams, driving incremental sales growth. The company's real estate footprint remains a competitive advantage, with strategic store expansions in high-growth markets and areas needing additional capacity. In fiscal 2024, 12 new stores were opened, 10 in the U.S. and 2 in Mexico, with strong early performance exceeding expectations. While macroeconomic uncertainties persist, investments in faster delivery, interconnected retail, and Pro ecosystem enhancements are expected to drive incremental growth. Home Depot plans to open 13 new stores in fiscal 2025, reinforcing its commitment to expanding reach and improving the shopping experience for both Pro and DIY customers.

Pro Customers: Home Depot continues to see strong growth in its Pro customer segment, with Pro sales outpacing DIY sales in the fourth quarter. Pro-heavy categories like gypsum, decking, concrete, and fencing performed well, reflecting the success of Home Depot's ongoing investments in its Pro ecosystem. The company has enhanced the in-store shopping experience by improving inventory availability, job-lot quantities, and dedicated customer service through CXMs (Customer Experience Managers). Additionally, the expansion of Fulfillment Distribution Centers (FDCs) has streamlined operations by removing excess deliveries from stores, leading to better in-stock levels, faster fulfillment, and improved order accuracy for job-site deliveries.

Beyond logistics, Home Depot has strengthened its Pro-focused offerings with dedicated sales teams, enhanced CRM tools, a more robust B2B website, and loyalty and preferred pricing programs. These efforts have resulted in over $1 billion in incremental annualized sales across 17 key markets, with further opportunities for growth through initiatives like trade credit, order management, and leveraging SRS capabilities. With high engagement from Pros across all project sizes, Home Depot remains committed to expanding its Pro market share by continuously enhancing convenience, service, and product availability.

Capital Allocation Strategy & Sustained Shareholder Returns: Home Depot has a disciplined capital allocation strategy focused on investing in growth, returning value to shareholders, and maintaining financial strength. In fiscal 2024, the company invested $3.5 billion in capital expenditures, prioritizing store expansions, supply chain enhancements, and technology improvements. For fiscal 2025, capital expenditures are expected to be 2.5% of sales, reflecting continued investments in new store openings, fulfillment capabilities, and interconnected retail enhancements. In addition to reinvesting in the business, Home Depot remains committed to shareholder returns. The company paid $8.9 billion in dividends in fiscal 2024 and recently announced a 2.2% increase in its quarterly dividend to $2.30 per share, bringing the annual dividend to $9.20 per share. While share repurchases were limited to $600 million in fiscal 2024, Home Depot continues to evaluate buybacks based on market conditions and cash flow generation. With a strong balance sheet and disciplined approach to capital allocation, the company aims to sustain long-term growth while maximizing shareholder value.

The long-term targets of a dividend payout ratio of about 55% of earnings and return on invested capital (ROIC) of more than 40% highlight its focus on this strategy. Based on the average of beginning and ending long-term debt and equity for the trailing 12 months, ROIC at the end of fourth-quarter fiscal 2024 was 31.3%. Home Depot has a dividend payout ratio of 59%, an annualized dividend yield of 2.5%, and a free cash flow yield of 4.6%.

Bear Case

Stock Looks Overvalued: Considering the price-to-earnings (P/E) ratio, Home Depot looks overvalued compared with the broader industry and the S&P 500. The stock has a trailing 12-month P/E of 23.73x compared with 22.47x for the industry and 24.14x for the S&P 500. The company's trailing 12-month P/E ratio is above the median level of 25.07x and below the high level of 28.95x, scaled in the past year. These factors profess that the stock's valuation is quite stretched.

Weakness in Larger Remodeling Projects: Despite positive comps in fourth-quarter fiscal 2024, Home Depot continues to see soft engagement for big-ticket discretionary categories, such as kitchen and bath remodels, as higher interest rates discouraged financing-dependent projects. While categories like appliances, building materials, and lumber performed well, larger renovation projects remained under pressure due to homeowners delaying major upgrades. With no major improvement expected in interest rates or housing turnover in 2025, the company anticipates continued pressure on big-ticket renovations, such as kitchen and bath remodels. While Pro sales have remained strong, the shift in consumer spending towards smaller-scale repairs and maintenance projects suggests that larger project demand may not rebound meaningfully in the near term, limiting growth potential in high-margin categories.

Soft Margins: Despite a top-line recovery, Home Depot's margin performance remain soft due to increased operating expenses and costs related to the SRS acquisition. In fourth-quarter fiscal 2024, gross margin was 32.8%, down 25 bps year-over-year. This decline was primarily due to the mix impact from the SRS acquisition. For fiscal 2024, the full-year gross margin was 33.4%, up 5 bps year-over-year. Moreover, operating expenses, as a percentage of sales, grew 30 bps year over year to 19.5%, which along with soft gross margin, dented operating margin. The adjusted operating margin of 11.7% contracted 40 bps year over year. The decline in the operating margin resulted from SRS acquisition mix impact, higher expenses in operating costs and investments, and natural deleverage from lower comps. HD's adjusted operating margin contracted 70 bps year over year to 13.8%.

For 2025, the company expects gross margin to remain flat at 33.4%, with the SRS mix impact offset by supply chain productivity improvements, merchandising efficiencies, and better shrink performance. HD estimates an operating margin of 13%, with an adjusted operating margin of 13.4%. The adjusted operating margin is expected to reflect 20 bps of natural deleverage due to lower comp sales growth, 15 bps from the fiscal 2025 impact of the SRS acquisition, and 5 bps due to 53rd-week comparison from 2024. Our model predicts a gross margin of 33.4%, with adjusted operating margin expected to decline 40 bps to 13.4%.

Higher Interest Expense: Apart from weighing on consumer demand, the higher interest rate environment has been pulling down Home Depot's profitability. In fourth-quarter fiscal 2024, HD's interest and other expenses increased by $150 million year-over-year, reaching $608 million. The increase was primarily driven by higher debt balances compared to the prior year. The company's long-term debt of $48.5 billion increased 13.6% year over year in fiscal 2025. For fiscal 2025, net interest expense (Interest and Other Income/Expense, Net) is projected to be $2.2 billion. The company acknowledged that higher interest rates continue to pressure larger remodeling projects, as many customers use HELOCs (Home Equity Lines of Credit) or cash-out refinancing to fund these projects. While there was a slight increase in cash-out refis and HELOC draws, Home Depot does not expect a significant shift in 2025 mortgage rates that would spur larger project spending. We anticipate interest and other (income) expense, net of $2.2 billion, up 3.8% year over year.

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Conclusion

Although Home Depot expects total sales growth of 2.8% in fiscal 2025, comparable sales growth is projected at just 1%, reflecting a cautious outlook. The company does not anticipate any major improvements in the macroeconomic environment, including housing turnover or lower interest rates, which could continue to limit consumer spending on home improvement. Additionally, fourth-quarter fiscal 2024 sales were boosted by $220 million in hurricane-related demand, which will not fully repeat in fiscal 2025, further dampening the sales trajectory. Given the flat gross margin forecast and rising operating expenses, Home Depot's ability to drive meaningful EPS growth remains uncertain. Home Depot anticipates GAAP earnings per share to decline 3% year over year for fiscal 2025. HD expects adjusted earnings per share to fall 2% year over year. Our model predicts sales growth of 2.7% year over year, with a 2% decline in adjusted EPS.

This article first appeared on GuruFocus.