HD Supply, the former industrial distributor business that Home Depot (NYSE:HD) sold for $8.5 billion in 2007, is going public next week between $22-$25 per share. Should investors go with the new kid on the block? Or stick with the tried and true? I'll look at the pros and cons of owning each stock. At the end I'll tell you which is the better buy. 
Deal Background
Home Depot originally agreed to sell its industrial supply business for $10.3 billion. Unfortunately, the credit markets tanked and it was forced to restructure the deal accepting $1.8 billion less for the business, putting up $325 million for 12.5% of the equity and guaranteeing a $1 billion senior secured loan. Home Depot essentially financed the sale of its own business at an 18% discount to what was originally agreed upon. 

SEE: What Makes An M&A Deal Work?
That doesn't sound like a very good deal. But the old saying, 'time heals all wounds' definitely applies here. First off, Home Depot received net cash proceeds of $7.9 billion (after deducting its $325 million investment) from the sale, which it immediately put to work repurchasing its shares. It then wrote off the $325 million investment over the next two fiscal years saving it approximately $150 million in taxes. Flash forward to today and its shares will be worth approximately $382 million at the mid-point offering price of $23.50 per share. Factor in a 12% return on HD Supply's first day of trading--the average first-day return in 2013 according to Renaissance Capital is 12%--and it's looking at a value of $428 million by some time next week. In the meantime the $7.9 billion was repurchased at approximately $37 per share; trading at $73.87 as of June 20, it effectively doubled its money in just over five years. 
While it's unfortunate the timing wasn't better (the shares dropped by 50% a year later) you have to give management kudos for putting the money to immediate use rather than licking its wounds. In the past five years Home Depot's stock's achieved an annualized total return of 24.5%. In hindsight, management made lemonade out of lemons. 

SEE: Active ETFs: Biggest Winners & Losers YTD
HD Supply Today
Having gone through the wringer in 2009 and 2010, it's come out the other side in better shape. Revenue in 2012 was $8 billion, only slightly lower than in 2008. More importantly its operating income over the past five years has gone from a loss of $824 million to a profit of $171 million, a $1 billion turnaround. Unfortunately, with $6.6 billion in total debt and an annual interest expense of $658 million, it's almost impossible for it to generate any profit. Even if you take into consideration some of the refinancing it's been able to do in 2013, it's still would have had $576 million in interest costs in 2012. 
On Page 65 of HD Supply's prospectus, it provides a brighter picture with adjusted EBITDA increasing by $207 million over the last four years and by 23% in the first three months of the year ended May 5, 2013. All indications point to it improving its profit picture little by little over the next 12-18 months at which point it could generate a profit by GAAP standards and not something manufactured by accountants and paper pushers. That's a long time to wait when there are so many other stocks you could buy in the meantime. Pick any of Fastenal (Nasdaq:FAST), W.W. Grainger (NYSE:GWW) or MSC Industrial Direct (NYSE:MSM) and you'd be buying a company on much stronger footing. I can assure you that Home Depot will be selling all of its shares as soon as its lock-up expires. 
Home Depot Today
Home Depot upped its 2013 guidance at the end of May when it announced Q1 earnings. Highlights in the quarter included U.S. comparable store sales growth of 4.8%, the average ticket increased by 5% to $57.24, the average weekly sales per store increased 7.5% and diluted earnings per share grew of 22.1% year-over-year. For the entire 2013 it expects earnings to grow by 17% year-over-year to $3.52 per share. With strong top-and bottom-line numbers, it's no wonder the company is repurchasing $6.5 billion of its stock this year. Where else can it get such a good return on its investment? Not with HD Supply that's for sure. 
Bottom Line
Although IPOs have been hotter than a pistol in 2013, I wouldn't invest in HD Supply for at least 12 months given its fragile state. Even then I'd be hard pressed to come up with a reason to own it over Home Depot. The former parent is the better stock by a country mile. 

Related Articles
  1. Home & Auto

    Top 5 Home Renos For Your Money

    Here are five renovations that return most of your investment when it’s time to sell your home.
  2. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  3. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  4. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  5. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  6. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  7. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  8. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  9. Investing News

    Corporate Bonds or Stocks: Which is Better Now?

    With market volatility high, you may think it is time to run for corporate bonds instead of stocks. Before you do take a deeper look into which is better.
  10. Mutual Funds & ETFs

    Using Short ETFs to Battle a Down Market

    Instead of selling your stocks to get gains, consider a short selling strategy, specifically one that uses short ETFs that help manage the risk.
  1. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  2. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!