Fitch Ratings has rated The Home Depot, Inc.'s proposed senior unsecured notes issuances, which it expects could be in the $3 billion to $4 billion range, 'A'.
Proceeds will be used for general corporate purposes, including share repurchases.
Home Depot's 'A'/Stable Long-Term Issuer Default Rating (IDR) reflects its scale and cash flow generation, coupled with its solid track record of comparable store sales (comps) growth and margin expansion. The ratings also reflect management's publicly stated long-term leverage target of 2.0x on an adjusted debt/EBITDAR basis, capitalizing leases at 8.0x.
Key Rating Drivers
Strong 2020 Performance: Home Depot's 2020 performance was strong, despite macroeconomic challenges, with revenue up 20% as consumers increased spending on their homes amidst the coronavirus pandemic. Momentum has continued in 1H21 with revenue up 19% compared with 1H20. Fitch believes performance has been supported by government stimulus and consumer savings from spending declines on services like travel and entertainment. Consumer behavior, including more time spent at home, has led to increased remodeling activity.
Given its current momentum, Fitch forecasts Home Depot could generate around $147 billion in 2021 revenue, up approximately 11% from 2020. EBITDA could be up around 15% to $24 billion given strong topline expansion and some moderation of pandemic-related expenses.
Fitch expects that Home Depot strengthened its already leading industry position in 2020 given its ability to serve customers through its robust omnichannel model. Fitch believes Home Depot's omnichannel offering is a key competitive differentiator which should allow it to gain share through the remainder of the pandemic and longer term.
Solid Long-Term Track Record: Home Depot has grown EBITDA and posted mid-single-digit comps every year since 2010 with 5.0% average annual comps through 2019. EBITDA margins grew 500bps from 11.4% 2009 to 16.7% in 2019. Operating momentum has been supported by positive 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 Companies) 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).
Investing in One Home Depot: At its December 2017 investor meeting, management announced its intention to double its strategic investments over the next three years by deploying approximately $11 billion toward core capability improvements across the business. At the time, the company viewed the current macro environment and housing backdrop as an opportunity to proactively invest in cutting-edge capabilities to streamline its supply chain (both upstream and downstream), enhance its online/omnichannel capabilities and more broadly build upon its leading position in the home improvement retail space.
The company's growth initiatives are designed to leverage Home Depot's existing scale to broaden its customer base and share of wallet. Meanwhile, Home Depot is using its online infrastructure to expand online product assortment and offer customers increased product knowledge, while promoting its in-store pickup capability.
In its December 2019 investor meeting, management indicated that progress on its plans has been modestly slower than expectations, though expressed confidence in the company's ability to fortify its competitive advantages through accelerated investments. Management believes it may have underestimated the complexity of executing on its goals, leading to a longer pathway than originally anticipated.
HD Supply Acquisition: On Dec. 24, 2020, Home Depot closed its acquisition of HD Supply, a company which Home Depot owned prior to a 2007 sale. Following a recent business sale, HD Supply's business focuses on maintenance, repair, and operations (MRO) products within the home improvement and construction segment. Key customer verticals include multifamily dwellings and the hospitality industry. Home Depot has recently invested into this space, including the 2015 acquisition of Interline Brands. The MRO business allows Home Depot to capitalize on its existing strengths as a leader in the home improvement space, generate additional revenue opportunities, and diversify its business modestly away from the highly cyclical housing market.
The purchase price was approximately $8 billion in enterprise value. Fitch calculates HD Supply's pro forma 2020 revenue and EBITDA at $2.8 billion and approximately $500 million and thus Home Depot paid a 16.0x multiple. This assumes around 10% declines in revenue and EBITDA from 2019 pro forma levels, in line with first-half results, given HD Supply's exposure to the challenged hospitality industry.
Disciplined Capital Allocation: Home Depot's scale and stable growth have allowed it to comfortably manage to its adjusted debt/EBITDAR target of 2.0x for several years. Fitch expects management to continue to balance its leverage targets against its goal to return cash to shareholders over the longer term, with incremental debt issuance expected to support share purchases and upcoming debt maturities.
Derivation Summary
Home Depot's 'A'/Stable rating reflects its scale, with over $132 billion in 2020 revenue, leading position in the U.S. home improvement retail space, and cash flow generation, coupled with its solid track record of topline growth and margin expansion. The ratings also reflect management's publicly stated financial policy of targeted adjusted debt/EBITDAR (capitalizing leases at 8.0x) of 2.0x over the long term.
Walmart, Inc. (AA/Stable) is around 4.0x the size of Home Depot from a revenue standpoint with leverage expected to trend in the low-2.0x over time. Target Corporation (A/Stable) has also managed leverage around 2.0x over time, though is smaller than Home Depot, generating $94 billion in sales in 2020. Target has seen market share improvement in recent years as it invests in omnichannel capabilities, while sharpening its price message relative to discount peers.
Each of these peers competes against each other as well as the online channel. However, the home improvement industry's bulky product array, heavy service component and need to source inventory rapidly for current jobs make the category somewhat protected against online incursion relative to many other consumer products categories. As such, prior to significant digital growth in 2020, Home Depot's online penetration was around 10%, well below the 20% to 30% seen across much of the consumer space. Home Depot effectively leverages its website to drive in-store sales as approximately 50% of online U.S. orders are picked up in their stores.
Amazon.com, Inc.'s 'AA-'/Stable rating reflects its strong positions in global e-commerce and cloud computing services, close customer connections, strong FCF generation and reasonable leverage profile with adjusted debt/EBITDAR (capitalizing rent at 8.0x) expected to trend near 2.0x. The rating considers the company's impressive track record of strategic vision and execution and its flexible operating platform, which provides growth opportunities across numerous verticals.
Key Assumptions
Fitch expects 2021 revenue growth could be around 11% to the $147 billion range, given 19% topline expansion through 1H21 and assuming more modest growth in 2H21 as consumers refocus budgets on services like travel and entertainment. The HD Supply acquisition is expected to add around $2.8 billion to Home Depot's 2021 revenue. Sales in 2022 could decline mid-single digits on a challenging two-year comparison and as consumer continue to refocus budgets toward other services, and resume low-single digit growth in 2023;
EBITDA in 2021 could expand around 15% to the $24 billion range, with EBITDA margins improving to the mid-16% range, near pre-pandemic levels, from 15.8% in 2020, which was impacted by pandemic-related operating expenses. Given expectations of sales declines in 2022, EBITDA could decline to the mid-$22 billion range and expand with sales beginning 2023;
FCF (after dividends), which was $9.8 billion in 2020, could be in the $8 billion range in 2021 as EBITDA growth is mitigated by a partial reversal in positive working capital trends from 2020. FCF could be between $7 billion and $8 billion annually beginning 2022. Historically, Home Depot deploys FCF and proceeds from debt issuance for share buybacks, in line with its public adjusted leverage target of 2.0x. Fitch expects this proposed issuance of $3 billion to $4 billion could be used to support share buybacks, which were nearly $7 billion in 1H21. Longer term, Fitch would expect Home Depot to continue to manage its FCF and balance sheet such that adjusted leverage is sustained close to 2.0x.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Continued positive operating trends together with a sustained reduction in adjusted debt/EBITDAR (capitalizing leases at 8.0x) to below 1.5x could lead to a positive rating action. This is not expected given management's 2.0x adjusted debt/EBITDAR target.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Weaker operating trends or a move by management to more shareholder-friendly policies that cause adjusted debt/EBITDAR to increase to the low 2.0x range on a sustained basis could lead to a negative rating action.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Solid Liquidity Position: As of Aug. 1, 2021, Fitch estimates Home Depot's total liquidity at approximately $7.6 billion, supported by cash on hand of $4.6 billion and availability on its various revolving credit facilities totaling $3.0 billion, net of letters of credit. The company's $3.0 billion CP program is fully backstopped by a $2.0 billion credit facility maturing December 2023 and a $1.0 billion 364-day facility maturing December 2021. Total debt following the transaction is expected to be in the range of $36.4 billion to $37.4 billion. The company's closest maturities are $300 million and $700 million of notes due March 2022.
The company has significant financial flexibility through internally generated FCF, which has averaged above $6.0 billion the past few years, and potential adjustments to share repurchases, which have averaged almost $8 billion annually for the last four years.
Issuer Profile
With over $130 billion and $20 billion in 2020 revenue and EBITDA respectively, Home Depot is the leader in the U.S. home improvement retail industry. The company scale and strong cash flow allows it to reinvest in its business and defend or expand share over time. The company's credit profile is supported by its financial policy of maintaining adjusted debt/EBITDAR at 2.0x over time.
Summary of Financial Adjustments
Summary of Financial Statement Adjustments - Fitch adjusts for non-cash stock-based compensation and M&A related transaction expense. For example, stock-based compensation and transaction expense for the LTM period ended August 2021 totaled $381 million and $110 million respectively. Additionally, Fitch treats interest on lease liabilities and amortization of lease assets as operating costs in accordance with Fitch's lease criteria at the time of committee.
Date of Relevant Committee
17 November 2020
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
RATING ACTIONSENTITY/DEBT RATING
Home Depot, Inc. (The)
senior unsecured
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THE HOME DEPOT, INC. 
