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Morningstar | HD Supply Closes Out a Strong Fiscal 2018 and Issues Solid 2019 Guidance; FVE to $47 Per Share

HD Supply ended its fiscal 2018 with quarterly results that yet again exceeded management's and Wall Street's expectations. The narrow-moat-rated industrial distributor reported a 22% (7% organic) year-over-year increase in sales to $1.45 billion, which came in about 2% above the consensus estimate and was above the high end of management's guidance ($1.375 billion to $1.425 billion). Adjusted EPS of $0.70 increased 43% year over year, beating the $0.67 consensus estimate and management's guidance of $0.63 to $0.68.

HD Supply's full-year sales grew 18% (9% organic) to $6.05 billion, and its adjusted EPS increased 47% to $3.40. Overall, HD Supply had a great year, in our view, and management sees that momentum continuing in 2019. Indeed, management expects sales to grow 7% and adjusted EPS to increase 10% in fiscal 2019. Both sales and EPS growth projections are the midpoint of management's guidance range and exclude the impact of an extra selling week in 2018, which added $104 million to the firm's top line and $0.07 to adjusted EPS. Management's 2019 guidance generally met both the sell-side consensus and our expectations, although the firm's adjusted EBITDA margin guidance (14.3% to 14.7%) was a tad lighter than we had expected. Still, HD Supply's fourth-quarter performance and 2019 outlook gave us no reason to materially revise our key valuation assumptions. However, we did increase our fair value estimate about 2% to $47 due to the time value of money since our last update and a lower share count.

HD Supply's free cash flow grew 15% year over year to $469 million. Management used free cash flow plus approximately $500 million of cash on hand to acquire A.H. Harris ($362 million purchase price) and repurchase 15.8 million shares for $600 million. Management expects the firm to generate approximately $550 million of free cash flow in 2019 despite exhausting its net operating loss carry-forward and other federal tax credits during the first half of 2019.

In terms of segment performance, HD Supply's facilities maintenance segment reported a 15% increase (6% organic) in fourth-quarter sales, and segment EBITDA margin expanded 90 basis points to 16.8%. Full-year facilities maintenance sales grew 9% year over year (7% organic), with adjusted EBITDA margin expanding 20 basis points to 17.7%. The construction and industrial segment grew fourth-quarter sales 31% (9% excluding the A.H. Harris acquisition and the effect of an extra sales week and holiday schedule shift), but segment adjusted EBITDA margin contracted 30 basis points to 8.9%. On a full-year basis, C&I sales grew 30% (12% organic) with adjusted EBITDA margin expanded 80 basis points to 11%.