updated 11/18/2008 4:45:58 PM ET 2008-11-18T21:45:58

Home Depot Inc. gave investors a welcome surprise Tuesday, posting a better-than-expected third-quarter profit and offering Wall Street a second straight day of good news for the battered home improvement sector.

But the 31 percent drop in earnings still shows just how badly the chain has been pummeled by the economic meltdown — which executives warned was unlikely to abate anytime soon as they predicted a steeper drop in full-year sales.

"This is a difficult environment," Chief Executive Frank Blake said. "The view we had at the start of the quarter, that we might be nearing the bottom ... gave way to the financial crisis in September and beyond."

Same-store sales — a retail industry metric of sales at stores open at least a year — fell 8.3 percent during the period as shoppers eschewed everything from custom kitchens to hardwood floors amid fear of a prolonged recession and the turmoil affecting the financial markets.

But the decrease was more pronounced in October, when they fell more than 10 percent, and they are already shows signs of dropping at similarly dismal levels this month.

Home Depot's results came a day after a surprising third-quarter report from competitor Lowe's Cos. Inc., which topped Wall Street analysts' profit estimates, even as earnings skidded more than 24 percent because shoppers were postponing big-ticket purchases.

"While consumers will continue to undertake smaller repair projects, larger big-ticket projects that drive sales and margin are likely to remain under pressure until delinquency and default rate trends improve," BMO Capital Markets analyst Wayne Hood told investors Tuesday of Lowe's results, although similar trends were evident at Home Depot.

Meanwhile, Stifel Nicolaus & Co. analyst David Schick said the back-to-back beats may show signs of "resilience, albeit with sustained significant top-line pressure" in the sector.

At Home Depot, executives said there were "fractional improvements" in sales in some regions of the country, such as Miami, California and New England, although results there were far from positive. And other previously resilient regions — such as the Pacific Northwest — were also showing new signs of trouble.

"We're generally seeing continued softness in tough markets and erosion in previously strong markets," Blake said.

More news about the troubled housing market came Tuesday. According to the National Association of Realtors, home prices fell in a record four out of five U.S. cities during the third quarter, due to low-cost foreclosures flooding markets. Meanwhile, overall home sales fell by nearly 8 percent and slid in all but four states.

Home Depot's profit tumbled to $756 million, or 45 cents per share, for the three months ending Nov. 2, down from $1.09 billion, or 60 cents per share, in the same period last year. Revenue sank 6 percent to $17.78 billion. Analysts polled by Thomson Reuters expected earnings of 38 cents per share on revenue of $17.74 billion.

"We had a good earnings quarter in the third quarter," said Chief Financial Officer Carol Tome. "Our earnings were better than our plan."

Overall, the average value of customers' purchases fell about 3 percent during the period to $55.86. The number of transactions in the quarter also dropped by about 3 percent, and executives said shoppers are finding it harder to obtain credit — a trend that could further constrain sales.

Still, shoppers were making purchases for paint, plumbing, hardware and their gardens.

"For most of us, even in this crazy housing environment, our home is still our biggest investment," Tome said. "And most of us like to upgrade our house. "

Home Depot still expects earnings per share from continuing operations to decline 24 percent for the fiscal year. The guidance does not include a charge from closing 15 stores and removing 50 stores from its growth plans.

But the company now expects a sharper drop in sales for the year. Home Depot said its sales could drop by as much as 8 percent. Previously, the company had said it expected a decline of 5 percent for the year.

Home Depot shares climbed 71 cents, or 3.6 percent, to $20.71 on Tuesday.

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