Why Home Depot is getting hammered

By Robert Walberg

You can't accuse Home Depot CEO Frank Blake of not trying. Since assuming the top spot from the imperious and unpopular Robert Nardelli back in January, he has unloaded undesirable assets, increased hiring to improve customer service and launched a huge stock-buyback plan.

Normally, investors would cheer such steps. So why is the company's stock down 11% this year, while the S&P 500 Index ($INX) is up 3.9% and rival Lowe's (LOW, news, msgs) is down a mere 3%?

• Talk back: Has Home Depot changed its ways and improved customer service?

Here's why: Because you can pull all the investor-friendly triggers you want as a CEO, but if you don't fix the core business, customers and investors won't be fooled. As long as Home Depot (HD, news, msgs) continues to disappoint contractors and do-it-yourselfers with bad service and homely stores, don't expect its stock price to revive.

No fit, no finish

None of Home Depot's shareholder-appeasing moves has delivered. The sale of HD Supply, the company's wholesale-distribution business, ended up netting $8.5 billion, down from the original price of $10.3 billion. To get the deal done, Home Depot retained 12.5% of the business and agreed to guarantee $1 billion of debt that the buyers assumed in the transaction. So while most investors applauded the decision to refocus attention on the main consumer business, they weren't happy with the end terms.

• Video: Recent news about Home Depot

Similarly, while share buybacks are usually greeted with enthusiasm by folks on Wall Street, Home Depot's stock lost ground after Tuesday's announcement that it will buy back nearly 290 million shares for $10.7 billion. The buyback will bring Home Depot about halfway to its goal of repurchasing $22.5 billion in stock.

It's not often that a company buys back 15% of its common shares outstanding in one move (not to mention 30% overall), so why weren't investors excited about the news? First, Home Depot will use about $2.7 billion in cash to complete Round 1 of its recapitalization plan rather than dipping into a $2 billion line of credit. The cash outlay reminded investors of the poor terms of HD Supply sale, the primary source of funding for the buyback. Draining cash reserves in today's turbulent marketplace is a suspect decision.

Another concern was timing. If business conditions are going to remain soft, as Blake has said, why use all that money to buy back shares now? Is that really the best use of the funds?

Home Depot has as much as admitted that earnings growth will be driven primarily by the reduced number of shares, not strong sales. That brings us to Home Depot's core problem: Management has little clue how to run a retail business.

In need of Mr. Fix-It

Streamlining operations and buying back stock is all well and good, but it doesn't solve the customer-service problems that columnist Scott Burns outlined on MSN Money in March. Home Depot's inability to solve its customer-service woes will continue to plague the company and the stock.

Take my own recent Home Depot experience. We're redoing our kitchen and had started the project using a contractor chosen by Home Depot. When we grew unhappy with the contractor, the salesperson several times refused to change the contractor, and ultimately my wife and I took our business to Lowe's. It wasn't our first bad experience with Home Depot, though it will be our last.

Such tales are hardly unique, as witnessed by a flood of responses to Burns' article earlier this year. Instead of spending $3 billion to buy back stock, Home Depot could have helped right its public-relations (and stock-price) nightmare by fixing its customer-service problems.

It's the kind of bold move a strong management team would make even in the face of a woeful housing market. Blake would do well to follow the lead of executives at Best Buy (BBY, news, msgs) and focus like a laser beam on enhancing the customer experience. Otherwise, it won't just be a case of being in the wrong place at the wrong time; it'll be another example of wrong man for the job.

At the time of publication, Robert Walberg did not own or control shares of any companies mentioned in this column.