Five years ago this month, Home Depot (NYSE:HD) was in need of an extreme makeover. CEO Robert Nardelli’s grand vision of a highly centralized, wholesale-focused building-and-supply colossus had collapsed, he’d bailed out — with a $210 million golden parachute — and the task of rebuilding had fallen to Frank Blake, Nardelli’s former associate at GE (NYSE:GE).
Blake could hardly be more different from the hard-charging Nardelli, who subsequently crashed Chrysler into the brick wall of bankruptcy, then lamented the sweetheart deal Fiat SpA got from the Obama administration. The low-key Blake, a Harvard-trained lawyer without retail experience who once clerked for Supreme Court Justice John Paul Stevens, had one quality that is absolutely essential to managing a makeover: He knew how to listen first, then act decisively.
Reinventing a franchise that had simply lost ground to rival Lowe’s (NYSE:LOW) would have been a tough task at any time, let alone while the country was headed into the worst housing bust since the Great Depression. But the revolutionary big-box home-improvement chain that was founded on giving the do-it-yourself market expert advice and great customer service had lost its way under the mercurial Nardelli, who was more military commander than CEO.
Nardelli had gone on an $8 billion spending spree to transform Home Depot into a wholesale building-and-contracting business. Customer service and in-store expertise fell through the cellar, and Nardelli’s top-down approach led to a dramatic drop in same-store sales.
Faced with these challenges, Blake resurrected the Orange Apron Cult — the nearly religious zeal for knowledgeable employees and high levels of customer service that was the secret of the company’s original success. Blake also divested Home Depot’s wholesale HD Supply unit for $8.5 billion.
While Nardelli had a reputation for being a computer-and-systems guy, Blake has used technology to better align the company’s centralized merchandising strategies with a revival of a local entrepreneurial focus. Home Depot’s supply-chain-management initiatives are now focused on helping to manage costs, reduce errors and free up staff for more face time with shoppers.
Since the company’s low-water mark in early 2009, the stock has risen by more than 145%, and Home Depot’s customer-satisfaction scores have risen every year since 2007. Same-store sales also increased — by a little over 4% last year.
Although some of last year’s biggest sales gains were in areas hit by Hurricane Irene, the chain also posted strong sales growth in its Western region. Gross margins were up over 34% in the third quarter of last year. The company hopes to continue driving margin gains through this year.
Home Depot generated positive returns for shareholders in 2011 — it has a one-year return of nearly 26% — and recently raised its dividend to 29 cents, delivering a current yield of nearly 2.4%. The company also is aggressively repurchasing stock. With a market cap of $67.5 billion, HD has a price-to-earnings growth (PEG) ratio of 0.8, indicating that the stock may be undervalued.
Like all retailers, Home Depot faces challenges in 2012. The housing market, while strengthening, will not drive substantial revenue and profit gains. Credit is still tight, inventory levels remain high and stores are under increased pressure to discount merchandise from budget rivals such as WalMart (NYSE:WMT). Blake believes customer service is the key to winning out over such competitors because it enables HD to differentiate itself on factors other than price.
Bottom line: Initiating a long position in Home Depot is a good play right now, even though at about $44, HD is about 40% pricier than the shares of head-to-head competitor Lowe’s. Home Depot’s fundamentals are solid, and Blake’s strategy is delivering results. While HD’s third-quarter earnings rose 12%, to $934 million, Lowe’s third-quarter earnings fell 44%, to $225 million.
As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.