Housing Market Bolsters Home Depot Spinoff HD Supply

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When HD Supply went public over the summer, the thinking was that its stock would get a lift from a recovering housing market.

That has been true to a point, though the construction and industrial products supplier has run into more head winds than it likely banked on before its June initial public offering.

HD Supply ( HDS ), a former unit ofHome Depot ( HD ) that was sold to private equity firms in August 2007, bills itself as one of the largest industrial distributors in North America. It has around 500,000 customers and $9 billion in annual sales.

The company provides a wide range of products and services -- everything from countertops, plumbing fixtures and hardware to electrical transformers, storm drain solutions, power tools, drywall accessories, interior finish products and pool supplies.

HD Supply's business units include HD Supply Facilities Maintenance, HD Supply Waterworks, HD Supply Power Solutions and HD Supply White Cap.

Housing Market Links

The breadth of HD Supply's products puts it into a number of construction and industrial markets, not just residential.

Still, the company concedes in filings with the Securities & Exchange Commission that most of its business units "are dependent to varying degrees upon the new residential construction market."

That market has seen a nice rebound over the last year amid rising home sales and prices. This is one of the reasons HD Supply went public over the summer. The company opened at a price of $18 on its first trading day June 27.

While the stock has moved higher since then -- it currently trades near 24 -- there have been ups and downs along the way as the housing market recovery has been slowed by rising mortgage interest rates and some ongoing economic uncertainty.

HD Supply CEO Joseph DeAngelo addressed some of the housing market concerns on a fiscal third-quarter conference call last month, saying that "for the residential markets, the strength that we saw earlier in the year moderated."

He also said growth in single-family housing starts came in lower than expected during the quarter, which ended in October.

Those issues aside, housing end markets were still strong enough in the quarter to help HD Supply put up decent numbers.

Earnings came in at 38 cents a share, topping analyst consensus estimates for 35 cents. Sales rose 7% to $2.3 billion, matching views. The gross profit margin widened to 29.1% from 28.7% a year earlier.

HD Supply posted top-line gains across all of its business units. Its Facilities Maintenance unit, which provides products and services to the multifamily housing market, logged 8% organic sales growth during the quarter.

The Waterworks business, which supplies water and wastewater products, delivered 11% organic sales growth. The White Cap business, which provides specialty construction and safety supplies to professional contractors, also had 11% organic sales growth.

Power Lacks A Punch

Lagging those units was HD Supply's Power Solutions division, which provides services to power companies, utilities, construction firms and industrial clients. It had organic sales growth of just 1% during the quarter.

The unit's slow growth reflects "conservative practices among utility customers," Citigroup analyst Deane Dray noted.

"This is one of the more growth-constrained businesses due to a concentration of both large customers and suppliers," he said, "and is HD Supply's most direct overlap" with rivalWesco International ( WCC ).

Among publicly traded firms, HD Supply's rivals also includeW.W. Grainger ( GWW ) andFastenal ( FAST ).

For fiscal 2014, HD Supply guided midteens growth in residential end markets, modest growth in nonresidential markets, and a flat-to-down performance in the infrastructure businesses, largely due to sluggish municipal water and utility capital spending.

"In a worst case, slower end markets drive fewer profit dollars for growth reinvestment, which itself drives slower revenue growth," JPMorgan analyst Stephen Tusa noted in a Q3 earnings report.

"Because of this compounding dynamic, we continue to view HD Supply as more of a revenue story than a margin story," he added.

Most analysts reckon that HD Supply will post mid- to high-single-digit revenue growth in coming years. Over the near term, it should get a leg up from residential construction as growing demand for homes outweighs the rise in mortgage rates.

In a report last month, the Commerce Department said housing starts in November rose 22.7% from October to an annualized rate of 1.09 million. That topped economist forecasts and represented the highest level since February 2008.

Permits for future projects were near a five-year high, indicating that the momentum will continue this year. December data are due out on Jan. 17.

Commercial Construction

The prognosis for nonresidential markets is less optimistic, though some analysts figure that HD Supply can still find growth in these sectors by beating rivals for new business.

"Despite some uncertain end markets and recovery timing issues in nonresidential construction, utilities and power markets, we remain positive on HD Supply's ability to gain market share in its highly fragmented industrial distribution end markets," Citigroup's Dray said.

Analysts polled by Thomson Reuters expect HD Supply to post earnings of 54 cents a share for fiscal 2013 . The company's annual profit is seen rising to $1.35 a share in fiscal 2014 and $2.16 in 2015.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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