DBRS Limited (DBRS Morningstar) 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. The rating actions reflect sustained momentum in Home Depot's operating performance during the last 12 months, despite inflation-driven pressures and a transition to a high interest rate environment, and are supported by DBRS Morningstar’s view that the earnings growth over the last two years has helped the Company to build up an ample cushion and given it the ability to absorb some demand moderation as well as inflationary pressures, within the context of the current rating category. Furthermore, the Stable trends reflect DBRS Morningstar’s expectation that the Company will continue to balance investment spending and shareholder returns, such that leverage remains relatively stable and appropriate for the current rating category. Home Depot’s ratings continue to be supported by its dominant market position, large scale, geographic diversification, and free cash-generating capacity. The ratings also reflect the intense competition and cyclicality of the home improvement retail industry as well as risks related to possible future growth strategies.
During the nine months ended October 30, 2022 (9M F2022), Home Depot's earnings benefitted from a resilient demand in the project-related categories as the professional (Pro) segment continued to outpace do-it-yourself (DIY) customer activities and helped to offset deceleration in some of the more discretionary categories such as seasonal, decor, or high-ticket appliances. Net sales for the 9M F2022 increased 5.3% year over year (YOY) to $121.6 billion versus $115.4 billion in the prior period, reflecting comparable sales growth of 4.2%, and were primarily driven by 9.7% YOY increase in average ticket size (reflecting price increases), while total customer transactions (reflecting lower traffic) declined by 5.1% YOY. EBITDA increased 5.6% YOY, roughly on par with the sales growth, to $21.1 billion during this period versus $20.0 billion in 9M F2021 as the Company was able to maintain margins at existing levels through price increases and operational efficiencies despite persistent inflationary pressures.
Although Home Depot's earnings performance has been stronger than expected since the start of the Coronavirus Disease (COVID-19) pandemic, its financial profile has remained stable within the rating category as the Company continued to finance its capital investment program, fund steadily growing dividend payments through internally generated cash flow, and effectively used incremental debt to further finance acquisitions and/or share repurchase activity to maintain leverage at or below the Company's publicly stated leverage target.
DBRS Morningstar expects Home Depot’s earnings profile to remain well placed in the current “A” rating category despite DBRS Morningstar’s expectation that demand will moderate for home-improvement products and that rising input costs are likely to pressure margins in the near term. While shrinking consumers’ wallets, higher interest rates, and a correction in home prices are likely to negatively affect demand for large home-related projects, demand for repair and remodelling projects is expected to remain high on account of the ageing housing stock and increased focus on home livability as consumers stay in place rather than upgrade. As such, DBRS Morningstar expects revenues to decline to $154 billion in F2023 (fiscal year ending in January 2024) from $157 billion forecast for the full-year F2022, remaining considerably higher than pre-pandemic levels of $110 billion in F2019. Despite inflationary pressure on margins, DBRS Morningstar expects the Company to continue to manage its product/price mix and operating expenses leverage, such that EBITDA margins remain relatively stable, with EBITDA forecast to stay more than $26 billion in F2022 and more than $25 billion in F2023 versus pre-pandemic levels of $18 billion in F2019.
Despite moderating earnings, DBRS Morningstar expects Home Depot’s financial profile would continue to be supported by its strong free cash flow-generating ability and disciplined financial management. DBRS Morningstar forecasts cash flow from operations of around $19 billion in F2023 and F2024 to continue to remain more than sufficient for relatively higher capital expenditure outflow of $3.1 billion to $3.2 billion and dividend payments of around $8 billion during this period. While DBRS Morningstar forecasts Home Depot to continue to issue incremental debt for share repurchases, DBRS Morningstar expects the Company to do so within the bounds of its publicly stated leverage target (i.e., lease-adjusted debt-to-EBITDAR of 2.00 times (x) using an 8.00x multiple to capitalize operating leases) and remain relatively stable with a DBRS Morningstar-calculated Debt-to-EBITDA ratio of 1.87x at the end of Q3 F2022 on a last 12 months basis.
Looking ahead, if an economic downturn were to pressure medium-term earnings beyond DBRS Morningstar’s current expectations, such that Home Depot were to experience a fundamental long-term deterioration in profit, cash flow generation, and/or a sustainable rise in leverage above 2.5x (as calculated by DBRS Morningstar), DBRS Morningstar may take a negative rating action.
Conversely, although highly unlikely given the economic climate, if Home Depot’s earnings profile remains elevated (i.e., the demand surge in earnings growth persists for a sustained period) and/or capital allocation is managed so that financial leverage is maintained structurally well below 2.0x, DBRS Morningstar may take a positive rating action.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929 (May 17, 2022).
All figures are in U.S. dollars unless otherwise noted.
The principal methodologies applicable to the ratings are Global Methodology for Rating Companies in the Merchandising Industry (September 2, 2022; https://www.dbrsmorningstar.com/research/402334); DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 1, 2022; https://www.dbrsmorningstar.com/research/393065); and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022; https://www.dbrsmorningstar.com/research/394683). The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.
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