September 5, 2017 / 1:32 PM / a year ago

Fitch Rates The Home Depot, Inc.'s Proposed Sr. Unsecured Notes 'A'

(The following statement was released by the rating agency) NEW YORK, September 05 (Fitch) Fitch Ratings has assigned an 'A' rating to The Home Depot, Inc.'s proposed issuance of senior unsecured notes, which Fitch expects could be for up to $1 billion. The proceeds from the issue will be used for repayment of $500 million of maturing debt and general corporate purposes, including share repurchases. 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 will maintain leverage (adjusted debt/EBITDAR) in line with its publicly stated target of 2x over the forecast horizon. With $95 billion in 2016 sales, Home Depot holds the leading position in the U.S. home improvement industry, which is in the midst of a recovery from the prior housing recession. Fitch's rating anticipates a continued recovery as well as a benign competitive environment. However, should the housing recovery stall, Fitch believes 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 600bps from 2009 to 16.6% in 2016. Operating momentum has been supported by improvement in home improvement industry fundamentals, especially in regard to 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 (we 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; capital allocation; 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 2015 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 over time. EBITDA margins are expected to remain around 17%, 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 billion-$4.5 billion after dividends of $4.5 billion-$5 billion. Disciplined Capital Allocation: Home Depot's scale and stable growth have allowed it to comfortably manage to its adjusted leverage target of 2.0x for several years (1.9x at year-end 2016). To the extent EBITDA continues to grow over the next two to three years, Fitch expects Home Depot to issue debt to maintain leverage within its target. Excess cash flow, including proceeds from debt issuance, is expected to be used to support the company's dividend and share repurchase program. 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. DERIVATION SUMMARY Home Depot's 'A'/Stable rating reflects its leading position in the U.S. home improvement industry, its substantial cash flow and commitment to its financial policy. The home improvement industry has been shown to be resilient to discount and online competition but is highly cyclical, in line with the housing market. At $95 billion in 2016 sales, Home Depot is significantly larger than closest peer Lowes Companies ($65 billion) and has a modestly lower leverage profile. AutoZone Inc. (BBB/Stable) is a market leader in the U.S. autoparts retail industry, which has similarly benign competitive characteristics as home improvement and has limited economic cyclicality, but is much smaller than Home Depot. Best Buy Co., Inc. (BBB-/Stable) is a market leader in the competitively and secularly challenged consumer electronics industry. Finally, The Kroger Co. (BBB/Stable) is a leader in the highly competitive, though not cyclical, grocery space. Each of these retailers has a more aggressive financial policy than does Home Depot and therefore a higher leverage profile. KEY ASSUMPTIONS --Fitch expects Home Depot to produce comps in the 3%-4% range 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 17%, yielding approximately 3%-4% EBITDA growth; --Fitch expects $4 billion-$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 to its adjusted leverage target of 2x. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive 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. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action 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. LIQUIDITY Home Depot has a strong liquidity position supported by a cash balance of $4.8 billion at July 30, 2017, 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 six new stores in 2017. Low levels of capital expenditure (less than 2% of sales) have resulted in strong FCF after dividends, which are expected to total 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 currently rates Home Depot as follows: The Home Depot Inc. --Long-Term Issuer Default Rating (IDR) 'A'; --Senior unsecured notes 'A'; --Bank credit facilities 'A'; --Short-Term IDR 'F1'; --Commercial paper 'F1'. The Rating Outlook is Stable. Contact: Primary Analyst David Silverman, CFA Senior Director +1-212-908-0840 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Monica Aggarwal, CFA Managing Director +1-212-908-0282 Committee Chairperson Michael Weaver Managing Director +1-312-368-3156 Date of Relevant Rating Committee: Feb. 21, 2017 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and exclude any one-time charges. In fiscal 2016, Fitch added back $267 million in non-cash stock-based compensation to its EBITDA calculation. --Fitch has adjusted the historical and projected debt by adding 8x yearly operating lease expense. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates - Effective from 27 September 2016 to 10 March 2017 (pub. 27 Sep 2016) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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