Home Depot targets professional market

Building on its recent focus on serving Pros particularly in the maintenance, repair and operations residential end-market, Home Depot’s acquisition of Interline Brands announced Wednesday morning will enable the company to accelerate its growth in this market.

Home Depot (ticker: HD ) is paying $1.625 billion in cash for Interline [of Jacksonville, Fla.] and expects the transaction to be accretive to 2015 earnings. Interline provides a well-established set of brands, customer relationships -- via a large, commissioned outside sales force of 1,160-plus associates -- and extensive distribution capabilities with 90-plus locations in the U.S., Canada and Puerto Rico. We believe this is a business Home Depot has had its eye on for some time as it has recognized this share-of-wallet opportunity for its Pro customers but has struggled to build these relevant capabilities internally. We look favorably on this accretive acquisition that should accelerate growth in this complementary market without distracting Home Depot from its core business.

Importantly, we note that this acquisition is more about serving existing customers and product categories, rather than expanding adjacent categories as the company did last decade under Chief Executive Bob Nardelli, only to reverse that move when Frank Blake took over as CEO in 2007. Home Depot currently has about $500 million of maintenance, repair and operations (MRO) sales and Interline Brands has about $1.7 billion of sales in the highly fragmented $50 billion market serving the multifamily residential, institutional and health and hospitality end-markets. W.W. Grainger ( GWW ) is the largest player in the broader $150 billion MRO market with 7% market share. Some 45% of Interline’s sales are in the janitorial/sanitation category, 18% in plumbing and the remainder in categories include hardware, tools and fixtures; heating, ventilation, air conditioning (HVAC); electrical and lighting; appliances and parts; and security in and safety.

Home Depot currently has nearly $30 billion of sales (about 35% of total) to Pros, and Pro sales have been growing faster than the core for the last few years with added company focus. This acquisition of Interline is by far the largest one since the Nardelli days (but is still only 1% of Home Depot market cap and 2% of Home Depot revenue) and signals Home Depot’s intentions under new CEO Craig Menear to more aggressively focus on the MRO business. It also may signal that the company sees fewer growth opportunities in its core DIY [do it yourself] business.

Home Depot continues to set the pace in home-improvement retail. While a rising tide in the category is benefitting the company, Home Depot continues to execute at the top of its game, driving market share gains and posting record results. We believe macro tailwinds are intensifying due to factors including easing mortgage credit. We also expect solid execution to persist in the near term, creating the potential for upside. However, with already lofty valuations not fully reflecting vulnerability to an interest-rate-rise shock, risk/reward for Home Depot shares is more balanced, keeping us Neutral on shares.

We value Home Depot on a blended multiple analysis backed by discounted-cash-flow analysis. We believe that Home Depot should trade at a premium to its medium-term normalized midteens growth rate given its market leadership, near-term momentum, strong cash flows and shareholder-friendly return of capital. Our $120 price target is 20 times our 2016 earnings-per-share estimate of $6.07.

Source: Online Barrons.com

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