NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A' long-term Issuer Default Rating (IDR) for The Home Depot, Inc. (Home Depot). The Rating Outlook is Stable. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
The rating reflects Home Depot's strong track record of comparable store sales (comps) growth, margin expansion and cash flow generation. Fitch expects the company to maintain leverage (adjusted debt/EBITDAR) in line with its publicly stated commitment of at or modestly below 2.0x over the forecast horizon.
With $89 billion in 2015 sales, Home Depot holds the leading position in the U.S. home improvement industry, which is amidst a recovery from the prior housing recession. Fitch's rating anticipates a continued recovery as well as a benign competitive environment. However, Fitch believes that should the housing recovery stall, Home Depot has the willingness and ability to use its cash flow generation to maintain its leverage commitments.
Solid Track Record
Home Depot has grown comps and EBITDA margin every year since 2010, with 5% average annual comps and EBITDA improvement of over 500bps from 2009 to 15.8% in 2015. Operating momentum has been supported by improvement in home improvement industry fundamentals, especially regarding repair and maintenance projects. Home improvement retailers have further benefited from benign industry square footage growth (including very modest unit expansion from Home Depot and chief competitor Lowes) and competitive resilience to the discount and online channels.
Success in the home improvement industry requires significant investments in inventory breadth and customer service, and discounters generally focus on categories with narrow assortment needs and limited customer service. Online competition, meanwhile, has been limited due to short purchase windows and the bulky/heavy nature of home improvement inventory (note that nearly half of Home Depot's existing online sales involve in-store merchandise pickup).
Continued Growth Expected
Fitch anticipates continued sales and EBITDA growth over the forecast horizon, predicated on a continued U.S. housing market recovery and Home Depot's focus on its strategic pillars of customer service, product leadership, and interconnected retail. The company's growth initiatives are designed to leverage Home Depot's existing scale to broaden its customer base and share of wallet. For example, the recent acquisition of Interline Brands gives Home Depot access to the underpenetrated residential facility maintenance and repair market. Meanwhile, Home Depot is using its online infrastructure to expand product assortment and offer customers increased product knowledge, while promoting its in-store pickup capability.
Fitch believes successful execution of its initiatives, coupled with industry tailwinds, will allow Home Depot to generate 2-4% annual comps and revenue growth. EBITDA margins are expected to remain around 16% though Home Depot could leverage fixed expenses at the high end of its comps range. Modest annual EBITDA growth is projected to yield annual free cash flow (FCF) of $4.0 - $4.5 billion after dividends of approximately $3.5 - $4.0 billion.
Disciplined Capital Allocation
Home Depot's scale and stable growth has allowed it to comfortably manage to its adjusted leverage target of at or below 2.0x for several years (1.9x at year-end 2015). Fitch expects management to continue to balance its leverage target against its goal to return cash to shareholders, with incremental debt issuance expected to support share purchases. Given Home Depot's leverage commitment, Fitch believes management could pull back on share repurchase to maintain or reduce debt levels should economic or operating headwinds limit EBITDA growth.
--Fitch expects comp sales to grow approximately 3% over the next two years, supported by a continued recovery in the housing market and the company's strategic investments;
--EBITDA margin is expected to remain close to 16%, yielding 3 - 4% average EBITDA growth;
--Fitch expects $4.0 - $4.5 billion of annual FCF after dividends going forward;
--Fitch expects FCF and some incremental borrowings to be directed to share repurchases, as the company manages its adjusted leverage at or under 2.0x.
Weaker operating trends or a move by management to more shareholder-friendly policies that cause adjusted leverage to increase to the low 2x range on a sustained basis could lead to a negative rating action.
Continued positive operating trends together with a sustained reduction in adjusted leverage to below 1.5x could lead to a positive rating action.
Home Depot has a strong liquidity position supported by a cash balance of $2.2 billion at Jan. 31, 2016, together with an undrawn $2 billion credit facility. The company also benefits from owning 90% of its stores.
Home Depot is maintaining a very slow pace of new-store expansion, with plans to build only five new stores in 2016. Low levels of capital expenditures (less than 2% of sales) have resulted in strong FCF after dividends, which is expected to track more than $4 billion annually going forward. Fitch expects Home Depot would remain FCF positive in an economic downturn, as it did through the last recession.
FULL LIST OF RATING ACTIONS
Fitch has affirmed Home Depot's ratings as follows:
--Long-term Issuer Default Rating (IDR) at 'A';
--Senior unsecured notes at 'A';
--Bank credit facilities at 'A';
--Short-term IDR at 'F1';
--Commercial paper at 'F1.'
The Rating Outlook is Stable.
Additional information is available on www.fitchratings.com.
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
Dodd-Frank Rating Information Disclosure Form