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Morningstar | HD Supply Beat 1Q Guidance but Cut Full-Year Outlook Due to Soft May Sales and Tariff Uncertainty

HD Supply’s stock price swooned on June 11 following the company’s fiscal first-quarter earnings release. While the narrow-moat industrial distributor’s results beat management’s guidance and consensus expectations, the market was not pleased with the firm’s downward-revised full-year outlook.

HD Supply started its fiscal 2019 on solid footing. Indeed, sales increased 7.5% year over year to $1.5 billion (6% organic growth) driven by 7% sales growth from the facilities maintenance segment and more than 8% sales growth (5% organic) from the construction and industrial segment. However, consolidated adjusted operating margin slipped 20 basis points year over year to 11.8%. This modest margin contraction was due to the C&I segment, which was burdened by higher rebar costs, lower margin mix from the acquired A.H. Harris business, and lost volume and operating leverage from unfavorable weather. Still, adjusted EPS increased 20% year over year to $0.84 due to solid pretax earnings growth and a lower average diluted share count compared with the year-ago quarter.

However, markedly slower sales growth in May and tariff uncertainty led management to walk back the firm’s 2019 guidance. Management now expects sales and adjusted EPS to grow approximately 4% and 6% in 2019, respectively, versus previous guidance of over 5% sales growth and 8% earnings growth (as calculated using the midpoint of guidance). Consolidated organic daily sales growth in May was just 0.2%, which management blamed on construction delays and lower-than-expected air conditioner sales due to inclement weather, a software issue at the firm’s new distribution center that delayed order fulfillment, and the timing of customer orders.

While we tempered our near-term sales growth and margin expansion assumptions, the unfavorable valuation effect from these changes was offset by the time value of money since our last update. As such, we’ve maintained our $47 per share fair value estimate.

Management cited uncertainty surrounding tariffs as one reason for its more conservative outlook. However, based on the data provided by management during the earnings call, we’re not overly concerned about HD Supply’s tariff exposure. We’ll walk through the math to explain this assertion. HD Supply disclosed during its 2018 analyst day that approximately 17% of facilities maintenance sales are generated from proprietary brands. During the earnings call, management said that 75% of proprietary brands are sourced from China, but only 50% of Chinese proprietary brands are subject to Section 301 tariffs. Therefore, we calculate that proprietary brands subject to Chinese tariffs account for just 6% of facilities maintenance sales and 3% of consolidated sales, which seems manageable to us. That said, higher tariffs will still likely result is some gross margin pressure for HD Supply.