Home Depot Inc. announced Feb. 12 it might sell or spin off HD Supply, its wholesale building-supply business, reversing a strategy that counted on sales to professional contractors and homebuilders to account for $25 billion of the retailer’s revenue in just three more years.

Home Depot Inc.announced Feb. 12 it might sell or spin off HD Supply, its wholesale building-supply business, reversing a strategy that counted on sales to professional contractors and homebuilders to account for $25 billion of the retailer’s revenue in just three more years.

"We are undertaking this action today because of our desire to increase our focus on our retail business,” said Frank Blake, the company’s CEO and chairman. With its retail store sales lagging and its stock going nowhere, Home Depot has been under pressure from investors to take a fresh look at its operations. Getting rid of HD Supply, if such a move were to go forward, represents a huge step away from the non-retail business strategy of Blake’s predecessor, Robert Nardelli.

Nardelli left the company last January after six years in charge. His $210 million severance package on top of $225 million in pay, bonuses and other incentives for six years got the most attention at the time, particularly considering that Home Depot stock was priced 8 percent lower on the day he walked out than on the day he walked in.

Blake has already taken a number of steps to distance himself away from Nardelli, including cutting his pay, getting rid of executives recruited by Nardelli and even putting an investor critical of the wholesale business strategy on his board of directors.

Renewed focus on retail is long overdue, say most analysts who follow the company. Without HD Supply, however, Home Depot would be getting rid of its fastest-growing business, which contributed practically all the company’s sales growth recently.

Wholesale Side

Home Depot actually launched its supply business in 1997, four years before Nardelli’s arrival. Its first acquisition within our industry was Apex Supply, Atlanta, in 1999. But it was Nardelli who went on to spend $8 billion on other distributors, much of it in just the last two years. Nardelli argued that Home Depot’s retail growth was limited by its past success. The company currently operates more than 2,100 stores, with around 1,800 in the United States. Growth prospects would be better in the wholesale market with some 22,000 distributors going after an annual $400 billion market.

The idea still has merit. Through consolidation, Home Depot could create a major “second” customer, the professional contractor. In other words, Home Depot would do to the fragmented wholesale-distribution industry what it had already done to the one-time fragmented DIY industry. Just ask yourself, how many mom-and-pop hardware stores there are today vs. 15 years ago.

“We have reached a defining moment in the history of this company as we broaden our market view from the traditional $200 billion retail market,” Nardelli told The Wall Street Journal last August. “What we really are doing here is repositioning our company so we can continue to have sustainable, predictable growth.”

Most notably for our industry was his $3.2 billion purchase of Hughes Supply, Orlando, almost a year ago. That move alone doubled its business to the professional trades. At the time, Nardelli called Home Depot and Hughes an “ideal strategic and operational fit.”

Last September, the company renamed its wholesale business, HD Supply. Nardelli predicted that HD Supply would account for 20 percent of Home Depot’s business by 2010. It didn’t have that far to go. In the third-quarter of 2006, for example, HD Supply sales were $3.5 billion, or about 15 percent of total quarterly sales.

Nardelli was so adamant about the growth of HD Supply that Home Depot separated out the wholesale financials from retail. For a short time last year, Home Depot even stopped reporting same-store sales, a standard for any retailer that measures sales from stores open at least one year.

The metric was outmoded, Nardelli insisted, since the company was no longer just a retailer. “We pose a real challenge for traditional retail analysts to understand our business model,” he told the Journal.

Home Depot, however, did relent after analysts and investors condemned the move. But when the company reported it again in the second quarter for 2006, same-store sales were down 0.2 percent and down 5 percent in the third quarter. (With a fiscal year ending in January, the company hadn’t announced its fourth-quarter results at press time.)

Retail Suffers

Not surprisingly, Wall Street never warmed up to Nardelli’s wholesale strategy.

“He blamed a lot of his problems on Wall Street,” Credit Suisse First Boston analyst Gary Balter told Business Week recently. “But Wall Street wanted to see results, and they just weren’t there.” People like Balter pointed out that the margins in wholesale were too small to have a dramatic effect to turnaround the entire company. In its third quarter for 2006, for example, Home Depot stores reported an operating profit margin of 11 percent vs. 7 percent for HD Supply.

That retail margin could be fattened up, too. As Home Depot’s share price stagnated, most investors and analysts figured that the billions spent on the supply side could have been better spent reinvigorating the retail stores.

Here again, some of policies Nardelli put into place at the retail stores didn’t win any popularity contests either.

As part of a cost-cutting program, Nardelli cut rank-and-file employment hours at the stores from a 60/40 ratio of full-time to part-time staff to a 50/50 ratio as well as trimming total store employment.

Out went the experienced help and in came the teen-aged novices. That turned the typical do-it-yourself customer into a “find-it-yourself” customer – no small task given the typical cavernous Home Depot store. Meanwhile, other Nardelli policies alienated upper-management resulting in massive turnover at corporate headquarters. Amazingly, almost all of Home Depot’s top 170 executives are new to their positions since 2001; more than half are from outside the company. Business Week recently reported that so many of these new executives are, like Nardelli, from General Electric that insiders dubbed the company, “Home GEpot.”

For a company that once prided itself on customer service, Home Depot found itself in last place among specialty retailers in a 2005 American Consumer Satisfaction index, a well-regarded benchmark done by the University of Michigan.

That news must have meant a lot to executives at archrival Lowe’s. In that same study, Lowe’s came in second. What’s more in 2001, as Nardelli’s tenure began, Lowe’s and Home Depot received the same scores.

At Lowe’s, the aprons aren’t orange, but investors aren’t seeing red over its financial performance. Lowe’s stock price has gone up more than 200 percent since 2000. With about 450 fewer stores and half the sales of Home Depot, Lowe’s has slowly, but surely taken business away from its biggest competitor. Most consider Lowe’s store design to be much brighter, less of a warehouse and more appealing to women shoppers. As Home Depot went from a friendly helper to a cold corporation, Lowe’s store outpaced its rival in same-store sales for much of this decade.

Not All Bad

Nardelli didn’t deserve all this bad press, say others in the Wall Street community. He did nearly double sales to $81.5 billion in 2005 from $45.7 billion in 2000. During that same time, profits more than doubled to $5.8 billion from $2.6 billion.

While same-store sales fell flat early on his watch, they increased from 2003 onward. They have stumbled lately, but so has Lowe’s as both contend with an economic slowdown.

The bright spots weren’t reflected in the company’s stock price, but one reason may be that the shares were as over-priced when he took the job as they are under-valued when he left.

Get rid of Home Depot and the company still faces the same problem Nardelli faced when he started acquiring wholesalers: how to grow the business. In the third quarter of 2006, for example, HD Supply contributed $2.1 billion of the $2.3 billion in sales growth over the third quarter of 2005.

“Without HD Supply as a growth vehicle, we are concerned that investors will soon start to focus more intensely on the core retail segment, which, in our opinion, is close to reaching the saturation point in the U.S.,” Prudential Equity Group analyst Mark Rowen told MarketWatch.

Analysts believe HD Supply could be worth between $8 billion to $13 billion. While Blake’s announcement added the company might decide to do nothing at all, the announcement also mentioned that the move “is a continuation of a strategic review we did in November.”

In related news, Home Depot is shutting down its Floor Store concept as it shifts resources back into regular stores. Home Depot opened its first Floor Store in 2000 in Plano, Texas, and later added five satellite showrooms in that area and added another store in Margate, Fla.

The Floor Store sold carpet, tile, wood flooring to professional and consumers. Floor sales will continue in the regular stores.

PHCC May End Talks With HD Supply

With the fate of HD Supply undecided, the Executive Committee of the Plumbing-Heating-Cooling Contractors-National Association has recommended that PHCC discontinue further talks with HD Supply concerning a possible business relationship.

The committee made the recommendation to the board of directors after news that Home Depot Inc. is considering possibly selling HD Supply. The committee also reported “the concern members expressed about being affiliated with Home Depot” as another reason to stop discussions. The recommendation and reasons appeared in a weekly report sent during the week of Feb. 12 to various PHCC leaders.

The board will discuss the recommendation on Feb. 27. Home Depot announced that it is considering selling or spinning off HD Supply, although it also added that it might keep the business.