Home Depot's acquisition of building-products maker SRS is complementary, but not transformative, analysts say

By Ciara Linnane

The $18.3 billion deal extends company's leadership over rival Lowe's in the professional contractor segment but both have room to grow

Home Depot's $18.3 billion acquisition of building-products provider SRS Distribution announced Thursday will extend its leadership over rival Lowe's Inc. in the larger professional customer space, but there's room for both companies to grow in that segment, according to D.A. Davidson.

The deal, Home Depot's biggest ever, is complementary to its business, but not transformative, as it will account for just 6% of overall sales, analysts led by Michael Baker wrote in a note to clients. D.A. Davidson has a neutral rating on Home Depot's stock (HD).

But the deal is pretty straightforward and unlikely to face major antitrust issues, as the customer base for both companies is very different. Even combined, they would have less than a 20% share of a $1 trillion market. That's based on Home Depot's assumption that the acquisition will boost its market by $50 billion.

For more, read: Home Depot seals biggest-ever deal by buying building-products provider SRS for $18.25 billion

Still, regulatory pushback can't be fully ruled out given some recent decisions, said the note. The Federal Trade Commission recently sued to block the planned merger between grocery-store chains Kroger Co. (KR) and Albertsons Cos. (ACI), saying the deal would stifle competition, raise grocery prices and harm workers and product quality.

The Justice Department, meanwhile, ruled against a merger between low-cost airline JetBlue Airways Corp. (JBLU) and ultra-low-cost Spirit Airlines Inc. (SAVE) on the grounds that it would hurt competition.

The main risk in the deal is to Home Depot's Ebitda margins, said the note, which the company conceded on Thursday would shrink by about 30 basis points. The deal is expected to be modestly dilutive to per-share earnings in the first year after close but to be accretive to cash earnings.

The company will also assume about $5.5 billion SRS's debt, and will fund the deal with $12.5 billion of debt. But it is committed to maintaining its investment-grade credit ratings and expects to have an adjusted debt-to-Ebitda ratio of about 2.5 times when the deal closes.

That's above its 2.0 times target, but it will aim to reduce leverage over the next two years through a combination of debt paydown and Ebitda growth, Chief Financial Officer Richard McPhail told analysts on a Thursday call to discuss the deal. The company will continue to pay its dividend but pause share buybacks for that period, he said.

D.A. Davidson estimates that buybacks have accounted for 2.8 percentage points of Home Depot's 8.8% EPS compound growth rate over the last five years, or about one-third.

Home Depot has agreed an $894.24 million breakup fee if the deal does not materialize. The analysts expect a fairly muted market reaction in that event.

If the deal does close, they expect little expense synergies but some revenue synergies if Home Depot can sell products to SRS customers and vice versa. Home Depot did not include revenue assumptions in its deal financials.

SRS, which has a 760-branch network across 47 states and a fleet of more than 4,000 trucks, serves professional customers such as landscapers, roofers and pool contractors. The company had sales of about $10 billion in 2023.

Other building-materials suppliers' stocks may be dinged if SRS becomes a bigger competitor, said the note.

"But longer term, this could point to Home Depot's acquisition appetite and help valuations for smaller players," said the note.

Home Depot's stock closed Thursday down 0.6%, but has gained 35% in the last 12 months, while the S&P 500 SPX has gained 30%.

Lowe's (LOW) closed up 0.6%. D.A. Davidson downgraded that stock to neutral from buy on Thursday and said it's due a pause after gaining 33% in the last 12 months.

-Ciara Linnane

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03-29-24 0853ET

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