Will HD Supply Holdings Reach Sky-High Profits?

Source: Thinkstock

Source: Thinkstock

HD Supply Holdings Inc (NASDAQ:HDS) caught my eye as it approaches is new 52-week high. The company operates as an industrial distribution company primarily in North America. It operates in four segments: Facilities Maintenance, Waterworks, Power Solutions, and White Cap. The company distributes maintenance, repair, and operations products, including electrical and lighting items, plumbing products, HVAC products, appliances, janitorial supplies, hardware, kitchen and bath cabinets, window coverings, textiles and guest amenities, healthcare maintenance products, and water and wastewater treatment products. It also distributes fasteners, builders hardware, ropes and chains, and plumbing accessories; and kitchen cabinets, windows, plumbing materials, masonry, electrical equipment, lumber, flooring and tools, and tool rentals. It also provides power solutions, including pole line hardware, wires and cables, gears and controls, power equipment, fixtures and lighting, and meters. It offers water and wastewater transmission products, such as pipes, fittings, valves, fire protection, metering systems, storm drains, and hydrants, as well as offers fusion machine rental, and valve testing and repair services.

In addition, the company provides specialty construction products, such as concrete accessories and chemicals, tools, engineered materials and fasteners, safety products, and erosion and waterproofing products. Finally it offers floorings, cabinets, countertops, and window coverings, as well as provides design center services. It serves contractors, government entities, maintenance professionals, home builders, and industrial businesses in the maintenance, repair, and operations; infrastructure and power; and specialty construction markets. As building and home maintenance has resurged since the Great Recession, the stock has risen 48 percent in the last year and is currently just below its 52-week high of $28.87. Can the stock continue to push higher? An analysis of the company’s recent earnings suggests it can.

Net sales for the first-quarter of fiscal 2014 ended May 4, 2014 were $2.2 billion, an increase of $113 million, or 6 percent, as compared to the first-quarter of fiscal 2013. The first-quarter performance represents the sixteenth consecutive quarter of year-over-year average daily sales growth. The company believes its sales performance represents growth of approximately 400 basis points in excess of its market growth estimate. Gross profit increased $38 million, or 6 percent, to $631 million for the first-quarter of fiscal 2014 compared to $593 million for the first-quarter of fiscal 2013. Gross profit was 29.2 percent of net sales for the first-quarter of fiscal 2014, up approximately 20 basis points from 29.0 percent of net sales for the first-quarter of fiscal 2013. Gross profit improvement was driven by execution of the company’s category management initiatives and mix of products and services.

Operating income increased $18 million, or 18 percent, to $119 million for the first-quarter of fiscal 2014 compared to $101 million for the first-quarter of fiscal 2013. Operating income as a percentage of net sales increased approximately 60 basis points during the first-quarter of fiscal 2014 as compared to the first-quarter of fiscal 2013. The improvement was primarily driven by a reduction in selling, general and administrative expenses as a percentage of net sales, and improvements in gross margins. Adjusted earnings increased $25 million, or 15 percent, to $190 million for the first-quarter of fiscal 2014 compared to $165 million for the first-quarter of fiscal 2013. The increase in adjusted earnings was driven by Facilities Maintenance, Waterworks, and Construction & Industrial – White Cap, and reflects the continued focus on initiatives execution to drive growth in excess of the company’s estimate of market growth. Adjusted earnings as a percentage of net sales increased approximately 70 basis points to 8.8 percent in the first-quarter of fiscal 2014 as compared to 8.1 percent in the first quarter of fiscal 2013.

Net loss improved $119 million to $12 million for the first-quarter of fiscal 2014 compared to a net loss of $131 million for the first-quarter of fiscal 2013. Net loss per diluted share was $0.06 in the first-quarter of fiscal 2014, as compared to a net loss per diluted share of $1.00 in the first-quarter of fiscal 2013. Adjusted net income increased $53 million to $39 million for the first-quarter of fiscal 2014 as compared to an adjusted net loss of $14 million in the first-quarter of fiscal 2013. The increase in adjusted net income is attributable to sales growth, improving gross margins, and a reduction in interest expense. Adjusted net income per diluted share was $0.20 in the first-quarter of fiscal 2014, as compared to an adjusted net loss of $0.11 per diluted share in the first-quarter of fiscal 2013.

Turning to segment specific earnings, Facilities Maintenance saw net sales increase $43 million, or 8 percent, to $604 million in the first-quarter of fiscal 2014 as compared to $561 million in the first quarter of fiscal 2013. Adjusted earnings increased $9 million, or 9 percent, to $109 million during the first-quarter of fiscal 2014 as compared to $100 million in the first-quarter of fiscal 2013. Adjusted earnings as a percentage of net sales increased approximately 20 basis points in the first-quarter of fiscal 2014 as compared to the first-quarter of fiscal 2013.

The waterworks segment saw net sales increase $28 million, or 5 percent, to $551 million in the first-quarter of fiscal 2014 as compared to $523 million in the first-quarter of fiscal 2013. Adjusted earnings increased $3 million, or 8 percent, to $41 million during the first-quarter of fiscal 2014 as compared to $38 million in the first-quarter of fiscal 2013. Adjusted earnings as a percentage of net sales increased approximately 10 basis points in the first quarter of fiscal 2014 as compared to the first-quarter of fiscal 2013.

The Power Solutions segment saw net sales declined $1 million, or less than one percent, to $461 million in the first-quarter of fiscal 2014, as compared to $462 million in the first quarter of fiscal 2013. Adjusted earnings were flat at $18 million during the first-quarter of fiscal 2014 as compared to the first-quarter of fiscal 2013. Adjusted earnings as a percentage of net sales were flat in the first-quarter of fiscal 2014 as compared to the first-quarter of fiscal 2013.

Finally, in Construction & Industrial – White Cap, net sales increased $34 million, or 11 percent, to $344 million in the first-quarter of fiscal 2014 as compared to $310 million in the first-quarter of fiscal 2013. Adjusted earnings increased $8 million, or 57 percent, to $22 million during the first-quarter of fiscal 2014 as compared to $14 million in the first-quarter of fiscal 2013. Adjusted earnings as a percentage of net sales increased approximately 190 basis points during the first quarter of fiscal 2014 as compared to the first-quarter of fiscal 2013. Net sales for February, March and April were $609 million, $659 million and $893 million, respectively. Average year-over-year daily sales growth for February, March, and April were 4.1 percent, 4.2 percent, and 7.5 percent, respectively. Joe DeAngelo, CEO, stated:

I am pleased with our solid performance this quarter, despite the adverse impact of the severe weather we experienced throughout February and March. We remain cautiously optimistic that our end markets will continue to build on the emerging strength that we are seeing in select geographies. We remain focused on controllable execution to deliver profitable growth in excess of our market.

Can it continue? Well, the company anticipates net sales in the second-quarter of fiscal 2014 to be in the range of $2.350 billion to $2.450 billion, Adjusted earnings in the range of $240 million to $250 million, and adjusted net income per diluted share in the range of $0.42 to $0.49. The second-quarter fiscal 2014 adjusted net income per diluted share range assumes a fully diluted weighted average share count of 200 million. Although the company continues to lose money in off peak seasons, it has cut those losses dramatically and is showing great growth potential. As such, I rate the stock a buy and assign a $35 price target.

Disclosure: Christopher F. Davis holds no position in HD Supply Holdings and has no plans to initiate a position in the next 72 hours. He has a buy rating on the stock and a $35 price target.

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