Home Depot's 1Q Sales Come in Below Expectations

 Home Depot (HD) reported first-quarter results that, like  Lowe's (LOW) on Monday, reflected solid expense management amid a tough seasonal period. The company posted earnings of $0.50 per share, in line with our expectations and consensus, despite a weaker-than-expected top line. Comparable U.S. sales dipped 0.7% year over year as strength in "center of the store" purchases like tools, electrical products, and plumbing items were offset by a drop in garden/seasonal and big-ticket discretionary items (as the firm lapped tough comps in appliances and government stimulus, specifically). We plan to make minor updates to our 2011 sales, operating margin, and earnings expectations to reflect first-quarter results and management's updated full-year outlook, but we expect no change to our fair value estimate.

Total revenue was flat year over year at $16.8 billion and slightly below our expectations, as a 2% drop in transactions was nearly offset by a modest increase in the average ticket. Same-store sales were positive in February and March, and while cold weather in the North drove a 4% drop in April U.S. comp-store sales, management was quick to point out that sales trends have rebounded nicely in May. Gross margins were up 20 basis points year over year to 34.4%, aided by product mix and supply-chain gains, and operating margins jumped 80 basis points year over year to 8.5%, reflecting management's near-term expense controls and benefits from the company's ongoing supply-chain restructuring initiatives. The company repurchased $1.3 billion worth of shares in the quarter (which added $0.02 to earnings per share) and is on pace to meet our internal expectation for a total of $2.4 billion in buybacks this year.

Management stuck to its 2011 top-line growth target of 2.5%, despite the softer first quarter, and is still using U.S. gross domestic product growth as a general guide. We are comfortable with this range. And while the pace of spending is likely to tick up in the second quarter and beyond, owing to a subtle shift in the timing of advertising, we still view management's increased EPS forecast (to $2.24 from $2.20) as achievable. The company is well-positioned in home-improvement retail as a result of a wide economic moat based on meaningful economies of scale, and we continue to view it as a primary beneficiary as the economic environment improves during the next few years.

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