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  • 1. BUS 5440 Financial Management Group A The Home Depot Financial Management Project Company Financial AnalysisFor: Professor Ana MachucaSubmitted by Team A:Betcher, RhondaCammack, CherylDesai, ShekharBarnes, JohnBabatunde, LasisiAdamson, ChristopherSubmission Date: February 26, 2012 Page 1 of 33
  • 2. BUS 5440 Financial Management Group A TABLE OF CONTENTSEXECUTIVE SUMMARY: ...................................................................................... 3.COMPANY INTRODUCTION: ............................................................................... 5.FINANCIAL ANALYSIS: ......................................................................................... 8.WEIGHTED AVERAGE COST OF CAPTIAL (WACC): ........................................ 11.FUTURE CASH FLOWS: ...................................................................................... 16.HISTORICAL STOCK PRICE: .............................................................................. 22.SECURITY ANALYST’S REPORTS: .................................................................... 25.DIVIDEND and CAPITAL STRUCTURE: .............................................................. 26.CORPORATE GOVERNANCE: ............................................................................ 28.MERGER and INTERNATIONAL STRATEGY: .................................................... 29.REFERENCES: ..................................................................................................... 30. Page 2 of 33
  • 3. BUS 5440 Financial Management Group AEXECUTIVE SUMMARY:The attached report analyzes the financial position of The Home Depot. Home Depot (HD) is the largest U. S.home improvement retailer as well as the fastest growing retailer in U.S. history. The company was foundedin 1978 by four gentlemen who had a vision for a one stop shop for do-it-yourselfers. The company’sheadquarters is in Atlanta, Georgia and has stores in all fifty states as well as Canada, Mexico and China.The company is publicly traded on the New York Stock Exchange (NYSE).Home Depot offers many different products for the home improvement enthusiast or the do-it-yourselfer.Some of the products the company offers are: hardware, plumbing, electrical, building materials, lumber, paintand flooring to name a few. They also provide services such as flooring, carpeting and countertopsinstallation, as well as rental tools. Their customer base includes three different groups: Do-It-Yourselfers,Do-I-For-Me Customers as well as Professional Customers. Home Depot is open seven days a week, 24hours a day.Some of Home Depot’s largest competitors include companies such as Lowe’s, Ace Hardware and Sears.Lowe’s of course is Home Depot’s biggest competition because the two companies offer similar products andservices.The Home Improvement industry has had some ups and downs during the last few years mainly due to tougheconomic conditions. Home Depot found a decrease in the amount of new construction materials that werepurchased but did see increases in the amount of home improvement projects. Customers were not looking topurchase new homes but rather wanted to update and maintain their existing homes.This report summarizes Home Depots financial position from 2010 to 2011. Home Depot increased its salesfrom last year but was 41.3% lower than industry average. The debt to equity ratio increased by 14.8% from2010 which is still higher than industry average. Home Depot did increase its net profit margin from last yearbut was 1.3 points higher than the home improvement industry. Home Depot continues to outperform theindustry concerning investments with a Return on Equity (ROE) at 17.1% which is nearly double that of theindustry. Return on Assets (ROA) also increased by 7.9% which equates to 29% higher than the industryaverage. An analysis of Home Depot’s Weighted Cost of Capital (WACC) shows a rate of 9.10%. ThisWACC factor shows that Home Depot is competitive and in alignment with today’s marketplace.At the end of March, 2011, there were approximately 164,000 shareholders as investors of Home Depot stock.When looking at a trailing 12 month comparison of Home Depot’s stock prices, Home Depot outperformed theindustry competitors as well as the market indices for this period. Since rebounding from the past financialcrisis during the past few years, Home Depot for the last year has had a 52 week high of $48.07 and a 52week low of $28.13. Home Depot prices have certainly in the past year stabilized at high levels making it anattractive investment. Page 3 of 33
  • 4. BUS 5440 Financial Management Group AAnalysts estimate that Home Depot’s earnings will raise from a January 2011 EPS of $2.01 to $2.32 inJanuary 2012 and $2.75 in 2013 which is 70% higher than Lowe’s. Annualized projected EPS growth rate forHome Depot is to have an EPS growth rate of 14.30% compared to the industry average of 14.00%. Whencompared to Lowe’s, Home Depot has twice the market capitalization. Home Depot has a high gross marginat 34.4% which is comparable to Lowe’s at 34.8%. With all things considered, there is a “bullish” consensuson Home Depot’s stock.In summary, it is our recommendation that investing in Home Depot’s stock is a good decision. The companyconsistently out performs its competition while earning a good return for its investors. The company has alower risk than the industry and the S&P 500 when it comes to their betas. The company has a slightly higherdebt to income ratio which may make it more expensive for the company to borrow. However, its return onequity shows a good use of equity Home Depot has remained successful due to its mission to always knowwhat the customer wants and to provide what the customer wants. Page 4 of 33
  • 5. BUS 5440 Financial Management Group ACOMPANY INTRODUCTION:Company HistoryThe Home Depot was founded in 1978 by Bernie Marcus and Arthur Blank who partnered with Ken Langone,an investment banker, as well as, Pat Farrah, a merchandising guru. All four men had a vision to build storeswith one stop shopping for the do-it-yourselfer. The first Home Depot store was opened in Atlanta, Georgia onJune 22, 1979. The stores started off smaller than they are today at 60,000 square feet per store, stocking25,000 SKUs. They even placed empty card board boxes to the ceiling to give the impression of having moremerchandise.Home Depot is the fastest growing retailer in U.S. history. The company in 1981 went public on NASDAQ andthen in 1984 they moved to the New York Stock Exchange. They realized their fastest growth between 1980and 2000 but are continually finding ways to make their company more favorable with the consumer. Theypride themselves in developing their employees and it shows in their product knowledge.Home Depot is the largest home improvement retailer in the United States. They have stores in all fifty (50)states as well as Canada, Mexico and China. Home Depot’s corporate headquarters is located in Atlanta,Georgia.StrategyHome Depot proposed in 2010, a three-pronged initiative in order to fuel more business. The three areas thatwere reviewed are: supply chain transformation, merchandise transformation and customer service.· The supply chain initiative includes the roll out of the company’s new Rapid Deployment Centers (RDC).These centers should keep the stores serviced faster and more effectively.· The merchandise transformation initiative includes the company’s commitment to “great value and re-establishing product authority.”· The customer service strategy is summed up as “taking care of their associates” and “taking care ofcustomers.” Both of these two parts of the initiative help with easier return process, guaranteed price matchingas well as other bonuses.Main Product and ServicesHome Depot stocks and has available to consumers between 30,000 to 40,000 products during a year. As ofJanuary 30, 2011, the product mix was as follows:· 30.0% Plumbing, electrical and kitchen items· 29.4% Hardware and seasonal· 21.7% Building materials, lumber and millwork· 18.9% Paint and flooring Page 5 of 33
  • 6. BUS 5440 Financial Management Group AHome Depot continually strives to offer the products that the do-it-yourselfer is looking for. They continuallyform strategic alliances and exclusive agreements with their suppliers in order to provide a large variety ofrecognizable brands for the consumer. Some examples of the brands they carry are Behr Premium Plus®paint, Hampton Bay® lighting, Vigoro® lawn care products, and Husky hand tools. Martha Stewart Livingproducts have been well received by Home Depot customers.Home Depot also offers several different services for the consumer. Some of the services they offer includeinstallation services for carpet, cabinets, flooring, water heaters and countertops. Home Depot also offers toolrentals.Primary Markets and CustomersHome Depot characterizes their customers into three groups:· The Do-It-Yourself (“D-I-Y”) Customers – This type of customers are homeowners who purchase theirproducts and go home and do their own projects and installation.· The Do-It-For-Me (“D-I-F-M”) Customers – This type of customers are homeowners who purchase a productbut would like for Home Depot to assist them with an installation or just completion of a project.· Professional Customers – This type of customers are general contractors, small business owners,tradesmen, and repairmen. These customers often take advantage of Home Depot’s delivery and will callservices.Major CompetitorsLowe’s, Ace Hardware and Sears are some of Home Depot’s major competitors. Lowe’s is Home Depot’sbiggest competition because they offer similar product offerings as Home Depot. Sears is similar to HomeDepot because it sells Craftsman Tools as opposed to Home Depot’s line of tools. Ace Hardware comescloser to Home Depot’s offerings because of the variety in their stores. Ace Hardware Stores are usuallymuch smaller in size than Home Depot thus they cannot offer the number of different items that Home Depotcan.Industry OverviewThe Do-It-Yourself or Home Improvement industry is beginning to recover from the housing crisis that hasoccurred in recent years. Consumers are beginning to invest in more renovations and remodeling. Thehousing crisis was very tough for the do-it-yourself market as consumers were not spending as much moneyas they had before. Until 2016, the home improvement industry is expected to grow by at least 1.4% annually.The U.S. GDP is expected to grow at a rate of 1.8% signifying that the home improvement industry is in amature phase of its life cycle because the rate of growth within a ten year period (2006-2016) is less than theU.S. GDP. Page 6 of 33
  • 7. BUS 5440 Financial Management Group AFor Home Depot however, the reverse can be said for their business during the housing crisis. Their salesturned around during the crisis and they found that more consumers were working on do-it-yourself projects,home maintenance and small furnishings. However, consumers were not doing any expensive remodelingduring this period. Home Depot was able to stand out from the rest of the industry because of their friendlyand knowledgeable people (known as the “orange-blooded” associates) by offering some of the freeworkshops and services that they offered.SummaryWhy has Home Depot been so successful in the past? Home Depot knows what the consumer wants andprovides what they want. Home Depot is open seven (7) days a week, 24 (twenty-four) hours a day in order toprovide everyone the opportunity to get what they want any time that they want. Home Depot prides itssuccess on the following factors: “know your customers, scale your operation so it can grow rapidly, marketheavily and keep an eye on your financial model.”References: 2011Fletcher, Fran July 11, 2011 http://blog.highbeambusiness.com Page 7 of 33
  • 8. BUS 5440 Financial Management Group AFINANCIAL ANALYSIS:Financial Ratio Analysis for the Home Depot GROWTH RATES % COMPANY INDUSTRY S&P 500 2010 Sales (Qtr vs. year ago Qtr) 4.4 7.5 11 3.8 Net Income (YTD vs. YTD) NA NA NA 121.9 Net Income (Qtr vs. year ago Qtr) 12 -2.4 11.2 95 Sales (5-Year Annual Avg.) -2.46 -0.77 7.84 -2.46 Net Income (5-Year Annual Avg.) -9.96 -8.45 7.53 -9.96 Dividends (5-Year Annual Avg.) 18.76 21.97 5.13 18.76 PRICE RATIOS COMPANY INDUSTRY S&P 500 2010 Current P/E Ratio 19.5 19.2 61.6 18.8 P/E Ratio 5-Year High NA 8.9 14.7 23.7 P/E Ratio 5-Year Low NA 3.2 3.4 8.2 Price/Sales Ratio 1.01 380.98 2.2 0.89 Price/Book Value 3.94 3.26 3.76 3.25 Price/Cash Flow Ratio 13.3 12.1 9.6 12.2 PROFIT MARGINS % COMPANY INDUSTRY S&P 500 2010 Gross Margin 34.4 33.95 38.79 34.3 Pre-Tax Margin 8.4 6.96 17.76 7.8 Net Profit Margin 5.32 4.29 12.85 4.9 5Yr Gross Margin (5-Year Avg.) 33.8 34.7 39.4 33.8 5Yr Pre Tax Margin (5-Year Avg.) 7.7 7.3 15.9 7.7 5Yr Net Profit Margin (5-Year Avg.) 4.9 4.5 11.4 4.9 FINANCIAL CONDITION COMPANY INDUSTRY S&P 500 2010 Page 8 of 33
  • 9. BUS 5440 Financial Management Group A Debt/Equity Ratio 0.61 0.53 0.99 0.52 Current Ratio 1.5 1.4 1.2 1.3 Quick Ratio 0.4 0.4 0.7 0.3 Interest Coverage 12 10.7 24.1 11.2 Leverage Ratio 2.3 2.2 3.4 2.1 Book Value/Share 11.53 12.02 20.86 11.64 INVESTMENT RETURNS % COMPANY INDUSTRY S&P 500 2010 Return On Equity 20.04 10.08 22.16 17.4 Return On Assets 8.9 6.4 6.9 8.2 Return On Capital 12.1 4 9.4 11 Return On Equity (5-Year Avg.) 17.3 9.6 20.5 17.3 Return On Assets (5-Year Avg.) 8 7.1 6.4 8 Return On Capital (5-Year Avg.) 10.9 7.1 8.7 10.9 MANAGEMENT EFFICIENCY COMPANY INDUSTRY S&P 500 2010 Income/Employee 19,515 14,434 73,059 17,625 Revenue/Employee 367,005 346,090 500,724 359,032 Receivable Turnover 51.9 34.5 13.2 66.4 Inventory Turnover 4.2 6.2 8.2 4.3 Asset Turnover 1.7 1.6 0.7 1.7Dupont AnalysisROA for 2011 was 8% and 6.2% for 2010 and ROE for 2011 was 18.68% and 14.38% for the year prior. Thesetwo ratios can give a good signal to investors that the company is performing well against 2010. Page 9 of 33
  • 10. BUS 5440 Financial Management Group AFinancial ratio analysisThe company has experienced an increase of sales from last year but is 41.3% lower than the industry. Its 5year annual sales average is 1.69% lower than the industry and 1.51% lower in Net Income compared to theindustry. Dividends remained the same from last year ,however lower than the industry. The current P/E ratiois higher than the industry average Book value and Cash Flow ratios are higher than the industry average.Gross Profit Margin is higher than last year and higher than the industry. More importantly Home Depotincreased its Net Profit Margin from last year and is 1.3 points higher than the industry.The debt to equity ratio had increased 14.8% from last year and is 13.2% higher than the industry. Thisincrease may raise concern for lenders in the upcoming year. The Current ratio increased by 13.4% from theyear prior and remained 6.7% above the industry. The Leverage ratio for the Home Depot increased by 8.7%from last year this is 4.3% higher than the industry average. The company had a 1% decrease in its BookValue/Share ratio which is 4.1% lower than the industry. This may raise concern for some investors as thebook value of the stock has performed lower than the industry.The company had outperformed the industry considerably for its investments. The company’s Return onEquity was nearly double of the industry. Its ROA had increased from the year prior by 7.9% which is 29%higher than the industry. The Return on Capital is nearly 3 times that of the industry. The company’sInvestment performance shows the company’s rate of return on its investments has outperformed the industryand is and for the company.The company has a 26.1% higher income/employee average and had experienced a 10.7% increase from lastyear. The company’s revenue/employee was 3.2% higher than the year prior and 5.7% higher than theindustry. This is a good sign than the management is maximizing its productivity of the workers. InventoryTurnover is 33.3% lower than the industry this may be a signal that the inventory is staying in the stores toolong before being sold or the company is buying too much merchandise beyond the demand of its customers.The company has performed better then the industry on key ratios for 2011 while improving their performancefrom 2010. The company’s improved performance can be credited to good management decisions. In 2011the company had experienced high performance while becoming more profitable.References: 2/10/2012 2/10/2012 Page 10 of 33
  • 11. BUS 5440 Financial Management Group AWEIGHTED AVERAGE COST OF CAPITAL (WACC):An accurate analysis of a firm’s WACC requires a complete data set of “inputs” to ensure proportionate andprecise figures are utilized to establish the baseline costs for Equity, Debt & Preferred Stock. All inputsrequired are indicated below utilizing several financial models to calculate the required Inputs. Models such asthe discounted cash flow (DCF) method and the Capital Asset Pricing Model (CAPM) are utilized in lock stepwith the analysis of Home Depot’s financial statements to generate an accurate (and benchmarked) WACCfactor.Calculated Beta(Using regression analysis of daily data over 2 year fiscal period)To ensure alignment with current Home Depot Form 10K filings (last published January 2011; with fiscal 2012filings due in a week or two) and the current year now in year-end closing processes, 2 years of data has beenselected as the data sample for calculating Home Depot’s beta utilizing regression analysis.Table 4.1 Regression Analysis Using slope function to Calculate Beta(Sample of two (2) previous fiscal years of data, total data file contains 506 lines of daily stock data)The published beta estimates from the recorded sources (i.e. Yahoo Finance published beta) and theregression analysis produced beta drawn from the historic stock and market data analysis do yield figuresthat do differ, but only slightly by a factor of 0.01 as indicated in the table below. Page 11 of 33
  • 12. BUS 5440 Financial Management Group ATable 4.2 Home Depot BetaThe published beta vs. the beta that can calculate using a scatter diagram and regression analysis will dependon the Analyst completing the assessment. In our case, we are using 2 full fiscal years of stock closing pricesas our data sample to establish a sample size large enough to be utilized.The published beta is typically calculated against 10 years and in some cases aged historical data even furtherback in time. The resulting industry calculated/supplied beta figure captures a larger variance sampling ofdata to establish the beta coefficient factor used in calculating Home Depot’s beta vs. the market.The data selected for the regression analysis reflects the most recent 2 fiscal years, which is utilizing historicdata since the impact of the global financial crisis, reflecting some of the hardest times since the greatdepression (though in 2012, we are still not out of the woods) in the calculation of the 0.88 beta figure.Weighted Average Cost of Capital Inputs(Note: Colour highlight linkages for data sources & calculations can be followed through the attached tables)Table 4.3 Calculating Home Depot Stock Expected Growth RateTable 4.4 Summary of Home Depot Current Market BondsThe above table illustrates the current Home Depot Bond activity and is being referenced to permit aneducated approach in assessing and analysing the firm’s internal cost of debt for today’s market and theproposed cost of debt rate to be applied in the WACC calculation. Page 12 of 33
  • 13. BUS 5440 Financial Management Group ATable 4.5 Summary of Calculation Model “Inputs”As indicated in the above inputs table, the cost of equity as calculated using the CAPM model as Table 4.7indicates is 10.16% for the value of rs. The table reflects a debt rate for internal cost of debt estimated to be5.5%. The resulting cost of debt after tax factor applied in the WACC formula as 3.67%; as expected the rateis less than the expected rate of return for cost of equity.Table 4.6 Corporate Tax Deduction FigureYields an approximate 33% corporate tax rate (T).Table 4.7 Capital Asset Pricing Model - Required Return = rSThe Expected Market Return of shareholders and future investors has been calculated using actual HomeDepot stock data, growth rate forecasts and ROE figures (as indicated in table 4.5 - “Inputs”). Page 13 of 33
  • 14. BUS 5440 Financial Management Group ATable 4.8 Capital Structure Weighting - Debt, Preferred Stock and EquityHome Depot has not offered nor has any preferred stock in the market; effective FY10 the figures reflect $0.00cost of rps.Table 4.9 The Weighted Cost of Capital (WACC) CalculationHome Depot may actually have a competitive WACC situation; however, opportunities for improvement alwaysexist in today’s business marketplace. The ratio of debt is a little light if optimal value in Home depot is to beachieved. The agents could increase the organizations value while decreasing the WACC percentage with adifferent capital structure.Home Depot’s operations could be maximized while reducing their WACC factor by increasing the debt ratio ofthe firm’s capital structure by 20% to 25% to lower the WACC factor by 17%. If the HD’s debt ratio wasincreased to 40%, therefore maximizing the value of operations, then the firm’s WACC would drop to 7.57%from the current 9.10%; but this may make the market unsettled with such a dramatic shift. To ensure not toomuch risk or uncertainty was “injected in to the business”, simply doubling the current ratio from 16% to 32%would still have a positive impact on WACC and the firms operations by generating a WACC (all thingsremaining unchanged in rs and rd) of 8.09%, a full percentage point lower.Understanding that increasing debt also increases the potential of bankruptcy, but not likely a situation forHome Depot to face with their current cash reserves and large ratio of the company’s assets being highlyliquid inventory which can be converted to cash quickly being the company is a retail operation. In addition, Page 14 of 33
  • 15. BUS 5440 Financial Management Group Ainterest rates are low, very affordable and could be financially leveraged to maximize the cost operationswithout significant increasing fixed monthly costs through debt repayment schedule. The cost of debt ismuch lower than the cost of equity; and in Home Depot’s situation, investor expectations for investmentreturns, the potential cost of equity in a bond strategy to raise investment capital are dramatically greater thancurrent debt costs; after all, the agent’s responsibility to increase the firm’s value and maximize shareholdervalue – initially being achieved with a slightly modified capital structure and ratios.The two primary components of capital include the cost of equity and cost of debt to provide or fund thecapital. WACC is the rate that a firm is expected to pay to finance its assets and potentially future investmentsin their operations. The minimum return benchmark that a company must earn on their existing asset is equalto or greater than the WACC percentage to meet and ideally satisfy its shareholders, creditors, and business“partners” like the financial institutions that provide capital.When evaluating the company’s current WACC and benchmarking our calculations of Home Depot’s WACCfigure, the investment resources available online have suggested that our 9.10% results is fairly accuratebased on the value referenced in the table below.Benchmarking Home Depot’s WACC and a few other factors against other companies in the sameindustry/sector is a fair approach to assessing if Home Depots WACC is appropriate for the company to usetoday and in the future. There are several companies listed in the industry segment; however there is reallyonly one direct competitor – that being Lowes.Table 4.10 Industry Side-by-SideComparatively, Lowes current capital structure is not dramatically different with ratios similar to that of HomeDepot. When judging if the WACC factor is applicable and in alignment with today’s marketplace, then theabove data table results would suggest yes, Home Depot is competitive and in alignment.Reference: Page 15 of 33
  • 16. BUS 5440 Financial Management Group AFUTURE CASH FLOWSThe Home Depot is a conservative company that has weathered the storm from the collapse of the housingmarket and credit bubble. The future looks good for The Home Depot as inflation is predicted to be modestover the long run and the Federal Reserve’s target is about 1.9%. (Wall Street Journal) (Economic Projectionsof Fed)The company is using interest rate swaps and hedging conservatively to manage risk and keep thecost of debt down. HD has 29 million dollars of debt maturing in 2012 (Home Depot 10K pg. 44) and is usinghedging tactics to insulate against volatility in the market as it prepares to issue more long term debt. HD hasbegun to buy back stock through a repurchase program and will continue the repurchase of 9.9 billion sharesunder the program. There is no expiration date and The Home Depot seems to be transferring some of theirdebt from equity to long term bonds. (Home Depot 10K, pg. 15) This is an excellent strategy because it willlower the cost of capital and increase shareholder value.The home improvement market is competitive and mature. HD realizes that their market share depends oncreating an advantage through customer service and innovation. The company is developing their customerbase by concentrating on their image as well as their service and the greatest asset is the employees of HomeDepot. (10K, pg. 7) The threats that might affect growth range from supply chain woes to failure to innovate.(10K pg. 6)Table 5.1 – Financial Ratios “Snapshot” INPUTS 2012 ValuesOperating RatiosGrowth Rate in Sales 3%Op costs except deprn/Sales 23%Deprn/Net plant & equip. 6%Cash/Sales 1%Account Rec/Sales 2%Inventory/Sales 2%Net plant& Equip/Sales 16%Accounts Pay/Sales 7%Accruals/Sales 2%Tax Rate 37%Financing DataNotes payable/Investor-sup cap 3%LT bonds/Investor-sup cap 26%Comm equity/Investore sup cap 55%Interest rate on notes payable 5.50%Interest rates on LT bonds 5.50%The housing and credit bubbles could not continue in an artificial state of growth and are now in the processingof correcting and normalizing. In the calculations for sales growth, if we were to use the post bubble figures wewould have a negative growth rate of - 1.56% (Table 5.2). Negative growth in sales is not the goal of any Page 16 of 33
  • 17. BUS 5440 Financial Management Group Acompany so the data range for sales growth must encompass a greater time period. Overall growth tends totrend at a more stable pace when covering a greater time period.Table 5.2 – Short term Revenue Movement Year Revenue (millions) Period Difference 2009 71,288.00 2010 66,176.00 -7% 2011 67,997.00 (forecasted) +3% 2 Year Growth Average: 2% 71,288(1+g)^3 = -1.56% 10 Year Growth Average: 3.78% 53553(1+g)^10= 2.42%Using a greater time period evens out the growth and gives us a growth rate of 2.42%. This is an excellentplace to begin forecasting the sales growth for the next three years. The home improvement market is amature industry and has projected growth of about 1.4%. The GDP has a projected growth rate of about1.69% and Home depot’s growth in sales exceeded 3% in 2010. (See Table 5.3 - 10 Year Growth Rates)Taking the average of the past growth base and the most current growth we have a growth rate of 3.11% , ifthe home improvement industry does grow by about 1 to 1.4% it would not be unthinkable for The HomeDepot to achieve between 4 and 4.5% in growth over the next year. This is actually a very conservativeestimate if the market and the domestic economy continue their slow recovery.Table 5.3 - 10 Year Revenue Achievement TableYr. 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Rev $ 53553 58247 64816 73094 81511 90837 77349 71288 66176 67997 G% - +8% +10% +13% +12% +11% -8% -9% -8% +3%Source: Thomson Business ONELowe’s ranks second after Home Depot and in terms of sales HD did 1.5 times the revenue of Lowe’s. WhileHD has been the leader in the industry since 2005 there is always the threat that your competitor will overtakeyou in market share. Lowe’s had more growth over the last five years for EPS, and gross revenue compared toHD. The firm has a very aggressive customer relations strategy that includes online, contact centers and evenpersonal representatives that will visit the customer on site. The store expansion strategy for the companyconcentrates on underpenetrated urban markets. As Sun Tzu said, “Go where your enemy isn’t.” (Lowe’sInvestor Relations, 10K) Lowe’s does trail behind HD’s market share but sales and market share are not static.There is always the threat that the number two competitor could become the market leader.In 2007 HD realized that its supply chain management was inferior. The company undertook an ambitiousproject to bring the firm into the modern age of inventory deployment. Beginning in 2007 and continuing to2010 HD rolled out 20 Rapid Deployment Centers that seriously streamlined the inventory delivery process. Atthe time of inception HDs inventory turnover was 4 and the goal of the project was to get that number up to 5. Page 17 of 33
  • 18. BUS 5440 Financial Management Group AThe Senior Vice President of Supply Chain Management, Mark Holifield, estimated that the project couldpossibly give the company an extra 1 billion dollars in cash flow improvement. As of today the inventoryturnover ratio is 4.2. This is not disheartening because the system still needs debugging and the economy willalso impact the efficiency of the system if it continues to recover. (Supply Chain Digest)Developing a comprehensive Statement of Future Cash Flows first requires forecasting future sales. Futuresales are based on past growth and influenced by industry growth, GDP, inflation, competition, thecorporation’s current market share, and future market share growth. The Home Depot has experiencednegative overall growth over the past five years. The collapse of the housing market and the credit debaclecontributed to the decline in sales and the decline in growth from 2007 to 2009.Table 5.4 – Summarized: Current and Projected Income Statement and Balance SheetPart1 - ISPart2 - BS Page 18 of 33
  • 19. BUS 5440 Financial Management Group AThe Home Depot has positioned itself for growth in the market through Contact Relationship Management,Supply Chain Management, and a strategy to leverage debt and hedge conservatively against the risk. Theeconomy shows a slow but steady growth and the market should see not only a recovery from the collapsesbut an increase from possible pent up demand from unfulfilled need. (Bloomberg Business week) If the marketexperiences a greater than projected growth and the demand increases while the market stays stable HomeDepot could see sales numbers as high as 10% above last year’s numbers. Page 19 of 33
  • 20. BUS 5440 Financial Management Group ATable 5.5 – Future / Projected Cash Flow Statement Future / Projected Cash Flow Statement 2012 2013 2014Operating Activities (Millions) Net Income before preferred dividends $ 3,469.6 $ 3,677.8 $ 3,953.6Noncash adjustments Depreciation and amortization $ 1,687.0 $ 1,788.2 $ 1,922.3Due to changes in working capital Increase in accounts receivable -$ 336.1 -$ 356.3 -$ 383.0 Increase in inventories -$ 478.2 -$ 506.8 -$ 544.9 Increase in accounts payable -$ 257.0 -$ 272.4 -$ 292.9 Increase in accruals -$ 58.1 -$ 61.5 -$ 66.1Net cash provided (used) by operating activities $ 4,027.3 $ 4,268.9 $ 4,589.1Investing activities Cash used to acquire fixed assets -$ 801.4 -$ 849.5 -$ 913.2 Sale of short-term investments $ 0.4 $ 0.4 $ 0.4Net cash provided (used) by investing activities -$ 801.0 -$ 849.1 -$ 912.8Financing Activities Increase in notes payable -$ 29.6 -$ 31.4 -$ 33.7 Increase in bonds -$ 580.0 -$ 614.8 -$ 661.0 Payment of common and preferred dividends -$ 1,665.4 -$ 1,765.3 -$ 1,897.7Net cash provided (used) by financing activities -$ 2,275.0 -$ 2,411.5 -$ 2,592.4Net change in cash and equivilents $ 951.2 $ 1,008.3 $ 1,083.9Cash and securities at beginning of the year $ 545.0 $ 1,496.2 $ 2,504.5Cash and securities at end of the year $ 1,496.2 $ 2,504.5 $ 3,588.4Home Depot could reap the benefits of an increase in sales far above its projected numbers and this alongwith a well leveraged debt to assets and debt to equity ratio would make Home Depot an excellent investment.After reading the latest report the company looks like it will meet and exceed all of its projected numbers. HDjust announced a quarterly dividend of .29 cents per share, and a forecast of 2012 earnings of 2.79 per shareis totally reasonable along with a 4.4% increase in revenue.Table 5.6 – Projected Cash Flows at Current Growth Rate Corporate ValuationLONG TERM GROWTH RATE WACC = 9.1%S(1+g)n=Sn 4.4%Projected Free Cash Flow: FY1x = FCF x (1+g)/WACC(1-g)Year Projected Cash CFFY PV of CF (m illion s ) (1,000s ) (1,000s )FY 12 $ 1,496 $ 17,173 $15,741FY 13 $ 2,505 $ 28,747 $24,151FY 14 $ 3,588 $ 39,355 $30,306 Page 20 of 33
  • 21. BUS 5440 Financial Management Group AIn consideration of the current economic conditions and the market projects as highlighted in the sourcesreferenced below, it can be expected that Home Depot will continue to experience growth over the next coupleof years. No one has a crystal ball, but a conservative, yet confident position is to believe that HD will continueto experience growth over the next few fiscal periods.References:The Wall Street Journal, Atlanta Fed Survey Finds Long-Term Inflation Worry by Michael S Derby, February23, 2012 retrieved from the world wide web, February 25, 2012 http;//blogs.wsj.comEconomic Projections of Federal Reserve Board Member and Federal Reserve Bank Presidents, January 2012retrieved from the world wide web February 25, 2012 Home Depot Financial Report 10K’s Investor Relations, 10K Investor Relations, http://phx.corporate-irSupply Chain Digest Aggressive Supply chain Transformation at Home Depot by Dan Gilmore, June 11, 2009,retrieved from the World Wide Web February 25, 2012 www.scdigest.comBloomberg Business week, Construction Jobs Rebound Amid U.S. Home Remodeling Pick-Up, by Anna-Louiseand Anthony Feld, February 22, 2012 retrieved from the world wide web on February 25, Washington Post Home Depot 4th-quarter net income rises 32 percent as revenue improves, byAssociated Press, February 21, 2012 retrieved from the world wide web, February 25, Washington Post, Associated Press) Page 21 of 33
  • 22. BUS 5440 Financial Management Group AHISTORICAL STOCK PRICE:A trailing 12 month comparison of HD stock prices as compared with Lowe’ and the market indices show thatHD has outperformed both its industry competitors as well as the market indices over this period. The HDstock appreciated very well and reached its peak market price during the financial and housing boom of theearly 2005 through 2007. However s the financial crisis hit the building industry, the entire industry had adownward slope. HD stock hit its lows in March-April of 2009 when it fell below $ 18.00.It competitor Lowe’s fared just as bad with it slows in March-April 2009 being below $ 15.00, since then theindustry has slowly but sure rebounded and for the last one year HD has had a 52 week high of$ 48.07 and a52 week low of 28.13. Similarly Lowe’s has had a 52 week high of $ 28.06 and a 52 week low of $ 18.07.Graph 6.1 HD PERFORMANCE COMPARED TO MARKET INDICESSplits: Sep 22, 1987 [3:2], Jul 3, 1989 [3:2], Jul 6, 1990 [3:2], Jun 26, 1991 [3:2], Jul 2, 1992 [3:2], Apr 14, 1993[4:3], Jul 7, 1997 [3:2], Jul 6, 1998 [2:1], Dec 31, 1999 [3:2] Page 22 of 33
  • 23. BUS 5440 Financial Management Group AGraph 6.2 HD PERFORMANCE COMPARED TO LOWE’SComparing its performance against the benchmark indices an investment in HD 1985 would have appreciated14,500% by February 2012 today, while returns in the S&P 500, NASDAQ and DOW would have respectivelyappreciated somewhere between 2000% and 2500%. Using its close industry competitor Lowe’s asbenchmark, the return would have been approx.14,500% for HD and 4300% for Lowe’s.Splits: Sep 22, 1987 [3:2], Jul 3, 1989 [3:2], Jul 6, 1990 [3:2], Jun 26, 1991 [3:2], Jul 2, 1992 [3:2], Apr 14, 1993[4:3], Jul 7, 1997 [3:2], Jul 6, 1998 [2:1], Dec 31, 1999 [3:2] Page 23 of 33
  • 24. BUS 5440 Financial Management Group AGraph 6.3 LONG TERM COMPARISON OF HD, LOWE’S AND MARKET INDICESReview of historical data charts beginning August, 1984 the shares started trading at a price of $ 15.13. Overthe course of last several years it has undergone a total of seven 3:2 splits, one 4:3 split and one 2:1 split.Splits: Sep 22, 1987 [3:2], Jul 3, 1989 [3:2], Jul 6, 1990 [3:2], Jun 26, 1991 [3:2], Jul 2, 1992 [3:2], Apr 14, 1993[4:3], Jul 7, 1997 [3:2], Jul 6, 1998 [2:1], Dec 31, 1999 [3:2]In summary HD prices have overcome the downs of the financial and housing crisis and now have stabilized athigh levels making it an attractive investment. Although past performance is not a guarantee for futureperformance, based on its historic price trends HD has returned more value to the shareholders than itscompetitors in the industry.Reference:http// Page 24 of 33
  • 25. BUS 5440 Financial Management Group ASECURITY ANALYST’S REPORTS:The overall analyst recommendation summary for HD is 2.0 (strong buy=1.0, sell=5.0). The current share price$ 44.52 with a median target of $ 45.00, a high target of $ 50.00 and a low target of $ 32.00. Analyst’sestimates of Earnings estimates are raised from Jan 2011 EPS of $ 2.01 to $ 2.32 in Jan 2012 and 2.75 in2013. This is an estimated EPS growth rate of 17.70% for 2012 and 15.10% for 2013. Annualized theprojected EPS growth rate is 14.30 % for HD as compared to 14.00% for the industry and more important a-0.95 for HD for the last five years. Reviewing the analysts’ reports from Credit Suisse, Thomson Reuters andStand & Poor’s reveals a positive rating and a “buy” recommendation. This is based on its Beta (.0.89), EPS($2.32) with a retention ratio of 50% and ROE of 17.1%Compared to its industry competitor Lowe’s, HD has twice the market capitalisation, HD has a gross margin of34.4% which is comparable to Lowe’s (34.8%). The two companies P/E ratio are also comparable and in the19.25 t 19.75 range. HD reported 2011 EPS at $ 2.01 and analysts projected 2012 EPS of $ 2.32. This isalmost 70% higher than Lowe’s. All things considered there is a generally “bullish” consensus on HD stockHowever the caveat is that the stock is currently near its 52 week high and with the housing market still in aslump our recommendation would be a hold rather than a buy. Although this stock has handsomely rewardedthe long term investors, past performance is not a guarantee of future.Table 7.1 RECOMMENDATION TRENDS Page 25 of 33
  • 26. BUS 5440 Financial Management Group A Current Month Last Month Two Months Ago Three Months Ago Strong Buy 11 10 10 10 Buy 7 7 7 8 Hold 11 11 11 11 Underperform 0 0 0 0 Sell 0 0 0 0Reference:http// Page 26 of 33
  • 27. BUS 5440 Financial Management Group ADIVIDEND and CAPITAL STRUCTURE:HD pays currently pays a dividend of 29 cents per quarter which is $ 1.16 per year. At the current market priceof HD shares that is a yield of 2.57%. HD has been paying steady dividends for the last four years. Its currentspending pattern and payout ratio suggest that this policy is sustainable and will be a good strategy in today’seconomic environment where shareholders expect dividends as a form of income.Table 8.1 Dividend Historical Data - Calculations 2000 to Present(Sample of dividend payout data beginning 2007)Capital Structure OverviewThe company has a total Value of $ 66, 444 million. This includes Short term debt of $44 million, Long termdebt of $ 10,739 million and has no preferred equity. The market Capitalisation (value of Shareholders equity)is $ 55,661 million. This gives HD a Wd=16.23% and a Ws= 83.77%. Taking into consideration the Market riskpremium (approx.9.2%) the Risk free return (currently quoted at 1.98%), the company’s Beta quoted at 0.89)and the business risk premium its cost of Equity is 10.16% while the cost of Debt is 3.67%. WACC (Wd*3.67%+ Ws*10.16%) is 9.10%.This is in our opinion is a fair WACC because it does not obligate the company to pay a significant amount ofearnings towards interest obligations. Also the book value of its Net Debt (Total Debt – Cash and near cashequivalents) on the balance sheet is $ 8549 million ($ 10,739 million + $ 44 million - $ 2234 million). The bookvalue of its Total Equity is $17, 769 giving it a Net Debt to Equity ratio of 48.12%.It has operating leases with total liability of $ 8181 million and Capital leases (long and short term) with liabilityof $ 452 million. The reason most companies have operating leases is because these listed off balance sheetand we do not see anything unusual with this practice. Page 27 of 33
  • 28. BUS 5440 Financial Management Group AUsing Insider activity (buys and sells by management) as well institutional activity as reported to the SEC as abenchmark HD scores a neutral on the S&P analysts report suggesting that there is not much informationalasymmetry. A very high degree of insider buying (apart from exercising stock options) or a high degree ofinsider selling would be a reflection of information asymmetry. Also since HD is not a manufacturer per se,most its efficiencies are operational. Unlike Apple it does not come out with market changing products whichwhen launched would significantly impact FCF to cause product information asymmetry. Table 8.2 INSIDER AND INSTITUTIONAL ACTIVITY Net Share Purchase Activity Page 28 of 33
  • 29. BUS 5440 Financial Management Group A Insider Purchases - Last 6 Months Shares Trans Purchases N/A 0 Sales 62,161 2 Net Shares Purchased (Sold) (62,161) 2 Total Insider Shares Held 1.9M N/A % Net Shares Purchased (Sold) (3.2%) N/A Page 29 of 33
  • 30. BUS 5440 Financial Management Group A Net Institutional Purchases - Prior Qtr to Latest Qtr Shares Net Shares Purchased (Sold) (63,089,600) % Change in Institutional Shares Held (5.97%) Data provided by: Thomson FinancialA new generation of lawn mowers or refrigerators which HD markets will not create the same market shareprice impact as a new model of iPhone or iPad! In the last six months less than 3.5% of total insider heldshares and less than 6.0% of Institutional shares were sold. Interestingly the share prices showed an upwardtrend during this period.References:http//:www.yahoofinance.comhttp// Page 30 of 33
  • 31. BUS 5440 Financial Management Group ACORPORATE GOVERNANCE:Home Depot have the following set of officers in-charge of the corporate running of the affairs of the company,Executive Officers of the company, comprising the Chief Executive Officer in-charge of the day-to-day runningof the affairs assisted by eight other executive directors who are appointed by the Board of Directors of thecompany.The Chief Executive Officer is Francis S. Blake, who is the chairman as well, and has been in that positionsince 2007. The other eight directors, have series of experiences from various backgrounds and had core-competencies in their various disciplines. Their ages range between 46 to 61 years of age.In the year 2010, management achieved their first year of positive sales growth since fiscal year 2006. Thecompanys sales increased by 2.9% with total sales up of 2.8% over the previous year. Earnings per yearshare from continuing operations were up 29.7% from last year, reflecting positive sales-growth, continuingbenefits from their merchandising transformation efforts and effective expense control. Management is doing agood job from all indications and parameters, in 2010, they continued to invest in their business, and theymaintained key focused on customer-service, supply chain and merchandising initiatives, as well as thedevelopment of the interconnected retail strategy.As of March 14, 2011, there were approximately 164,000 shareholders on record and position approximately1,030,000 additional shareholders holding stock under nominee security position listings. Executive stockownership and retention guidelines require executive officers to hold shares of common stock with a valueequal to the specified multiples of salary. For fiscal 2010, 25% of the equity compensation provided to nameexecutive officers was in the form of performance shares. The directors and executive officers as a group of 18people owned 1.04% of the common stock, which is 16,371,537, while institutional investors, by named,Capital World Investors owned, 193,108,800 shares which is 11.94%. Page 31 of 33
  • 32. BUS 5440 Financial Management Group AMERGER and INTERNATIONAL STRATEGY:At the end of fiscal year 2010, Home Depot had 179 stores in the ten Canadian provinces, while in Mexico,they had 85 stores. In China, they had 8 stores in four Chinese cities. Right now Home Depot is not into anymerger and acquisition. The stores acquired in those cities of China, were made by acquisitions in 2006.From Home Depot Support Center, they maintain a global sourcing merchandising program to source high-quality products from manufacturers around the world. Home Depot merchant team identifies and purchasesmarket leading innovative products directly for their stores. This international strategy has really help HomeDepot to become a leading Home Improvements outlet. Sourcing offices are located in Chinese cities ofShanghai, Shenzhen and Dalian and also, offices in Gurgaon, India, and Rome in Italy, Monterrey in Mexicoand Toronto in Canada. The company continues to seek expansion into other countries as expansion andmarket demandsThe global expansion demonstrates how Home Depot combines its vast knowledge of the homeimprovements industry with the needs, shopping trends and customs of each unique geography to the bestserve 2/9/2012 Page 32 of 33
  • 33. BUS 5440 Financial Management Group A References & AppendixReference Sources: 2011Fletcher, Fran July 11, 2011 http://blog.highbeambusiness.com 2/10/2012 2/10/2012 Table 8.1 Page 33 of 33