Housing woes hammer Home Depot

Retailer cuts outlook, expects earnings per share for fiscal year to fall by 15 to 18 percent due to ongoing weakness in the housing market.

By Parija B. Kavilanz, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- Home improvement retailer Home Depot cut its 2007 profit outlook Tuesday, citing continued weakness in the home building market and the sales of its supply business.

Atlanta-based Home Depot, the No. 1 home improvement retailer, said it now expects earnings per share to fall by 15 to 18 percent to between $2.30 or $2.36 a share for the fiscal year.

The company had previously estimated EPS of $2.54 a share for the year, but it said Tuesday that estimate included 18 cents a share that the HD Supply unit had been expected to contribute and which will now be missing from full-year results.

Analysts surveyed by earnings tracker First Call were looking for earnings of $2.59 a share, although that forecast included earnings from the company's HD Supply unit, which it announced an agreement to sell to a group of private equity firms in June.

It also warned it now expects its operating margin to shrink by 1.2 to 1.5 percent, due to the weaker sales and its continued investment in its core retail operations.

In a conference call with investors and analysts to discuss the company's financial update, CEO Frank Blake said he felt it was reasonable to project that there was still more of " [a housing correction] ahead of us." "That's the bad news," Blake said. "The good news is that a lot of the correction is done already."

Still, Blake warned that the housing market woes could stretch beyond 2007.

"Housing turnover is one of the key determinants of our business and activity related to it drives about 20 to 25 percent of [customer expenditure]," Blake said. "Housing inventory is now at about 5 million units. It will take time to burn that off. Therefore we expect to see continued headwinds into 2008."

Progress report

Despite the sour news, shares of Home Depot (Charts, Fortune 500) traded marginally higher on the New York Stock Exchange.

Investors may have been comforted by Blake's comments that Home Depot was making gradual headway with its "five point" plan to improve its core retail business.

Blake said recently implemented employee incentive plans, new product launches, efforts to reduce store clutter and improve staff assistance to customers was bearing fruit.

"Our direct feedback from customers shows we have made some progress. We are still very early [in the plan] but we are moving in the right direction," Blake said.

Home Depot, which is the nation's No. 2 retailer behind only Wal-Mart Stores (Charts, Fortune 500) in terms of sales, said those sales are expected to fall 1 to 2 percent.

Sales at stores open at least a year, a closely watched retail measure known as same store sales, are expected to decline in the mid-single digits. In its fiscal first quarter that ended in April, same store sales fell 7.6 percent from a year earlier.

Growing pains of a mature company

Home Depot is not the only company being hurt by the slowdown in home building. Rival Lowe's (Charts, Fortune 500), the nation's No. 2 home improvement retailer, saw same store sales fall 6.3 percent in the first quarter as its net income fell 12.1 percent. Last month, major home builders Lennar (Charts, Fortune 500) and KB Home (Charts, Fortune 500) reported unexpected losses.

To try to support its share price and earnings per share, the company Tuesday also announced the launch of a tender offer for 250 million shares of its common stock at a price range of $39 to $44 per share.

The offer was part of the company's previously announced $22.5 billion increase in its share repurchase program for the year. The earnings per share guidance from the company does not include any impact from the share repurchase.

Blake said the sale of Hone Depot supply combined with the share recapitalization simplified Home Depot's business model, allowing it to intently focus on its retail operations.

'We're now a mature business with strong cashflow. A mature model supports a capital structure that facilitates capital distribution, invest in our retail stores and return excess cash to our shareholders," Blake said.

Blake said the company's long-term vision for 2008 to 2010 was to grow retail sales by 5 percent, match or exceed earnings by 5 percent "based on Home Depot's investments in its retail business and its supply chain," and grow earnings per share by more than 10 percent.

"This is a very exciting but challenging time," said Blake. "The market is very difficult but we feel very good about investing in our core business."

Carol Tome, Home Depot's chief financial officer, said that those investments would "put short-term pressure" on the retailer's earnings.

Goldman Sacks analyst Matthew Fassler, agreed. He wrote in a research note Tuesday that Home Depot's revised guidance "is modest in the grand scheme to the extent that the macro backdrop is tough and aggressive retail investment continues, [therefore] guidance is taking a minor hit."

--CNNMoney.com senior writer Chris Isidore and staff writer Grace Wong contributed to this report. Top of page