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Home depot vs lowes financial analysis
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  • 1. Annual report analysis HomeDepot vs Lowes 1. Reporting to Shareholders The approach to reporting to shareholders for both companies is a truly interesting comparison. The main points of each letter for both companies are: o o o o Capital Allocation Customer Service Product Authority and Differentiation Internet/On-line capability The main difference as far as context is concerned is the international growth portion delivered by Home Depot. The delivery approach however cannot be further apart, in short their words are very similar about the above main point while the delivery of those words is night and day. Home Depot is straight forward and to the point while Lowe’s has more of a marketing campaign flow and feel. Lowe’s letter is a total of nine (9) pages long with graphs, charts, financial highlights and historical data as you would see displayed in a brochure. Their approach to shareholders is a "vision strategy" approach describing what the company is striving towards. Statements like "even as we redefine our business" or "naturally, as we transform the business model to better serve customers" describe a company that is painting a picture for the future. They are trying to re-assure their shareholders about the future with very little information about the past. A quick review of past shareholder letters shows that there is a lack of consistency and succinct format over the past few years. Home Depot takes a very straight forward; clean, to the point approach to their shareholders with a simple two page (2) letter. Their approach to shareholders is also a "vision strategy" approach but with specific details describing what they have accomplished in 2012 and what they will do in 2013 and beyond. Descriptive terminology and creative writing is not involved in the Home Depot letter just like you see when you walk into a store. A review of their past shareholder letters shows a consistent and straightforward approach has been used for quite some time. When you review their individual letters they are a solid representation of the actual stores. You can visit both of the stores today and visually see their shareholder letters come to life. Lowe’s has larger aisles, well put together end-caps with colorful displays throughout the store. They highlight the fact that over 80% of their product line has been reviewed and they have reset over 30% of all of their business thus far. The shareholder letter has colorful charts and displays and a well thought out strategic vision similar to a typical Lowe’s store. Home Depot letter is all there laid out in front of you, like their stores. It does not consist of charts and graphs just simple words that your average day person can
  • 2. understand without having to read a story about the future. Their aisles are not as neat and orderly, customer service is there but much more businesslike and to the point and many signs are simply made up with a black magic marker and Home Depot sign. One thing is for sure that both CEO's have pushed their vision published in the shareholders letter down the food chain throughout the respective companies attempting to make their visions a reality. 2. Ratio Analysis 2.1 Home Depot 2.1.1 Liquidity Ratios Formula Current Ratio Quick Ration Current Assets/Current Liabilities Cash Market Securities+AR 15372/11462 2492+1395/1146 2 2012 ratio 1.34 14520/9376 2011 ratio 1.55 0.34 1987+1245/9376 0.34 13479/10122 545+1085/937 6 2010 ratio 1.33 0.17 Current Ratio and Quick Ratio: Current ratio of Home depot has been consistent around 1.3 for most of the years except 2009 and 2011. In 2009, it went down to 1.2 due to economic downturn. In 2009, Home Depot significantly increased liabilities and this brought down the ratio. As far as the 2011 anomaly is concerned, it was a result of consistent repayment of long term debt. In the 2011 report, current portion of long term debt and capital lease went down to 32m, but their debt went up to $10B. This may have occurred due to consistent payoff of long term debt or refinancing. This is collaborated with the fact that total cash in 2011 went down to approximately $500m from $1.4b in 2010. This was the primary reason for the quick ratio of 2010 to be different from those of 2011 and 2012 respectively. This reasoning is consistent with the Home Depot’s objective of efficient capital structure. Home Depot has performed better than the industry average of 1.5. This also speaks for the operational efficiency of Home Depot. A quick glance of the last five years of their ratio provides more evidence of their operational efficiency. Even though the Housing industry was at the center of the financial meltdown, and Home Depot and its likes would have been the primary casualty of this melt down Home Depot defied the conventional logic.
  • 3. 2.1.2 Profitability Ratios Formula Net Margin Return On Assets Return On Equity Net Income After Tax/ Net Sales Net Income After Tax/Total Assets 4535/74754 2012 ratio 6% 3883/70395 2011 ratio 6% 3338/67997 2010 ratio 5% 4535/41084 11% 3883/40518 10% 3338/40125 8% Net Income After Tax/Shareholder’s Equity 45351/17777 26% 3883/17898 22% 3338/18889 18% All the sales related data for Home Depot has shown consistent improvement in the last three years: Customer transactions went up from 1.3b in 2010 to 1.36b in 2012; sales per square foot went from $288.64 to $318.63; Sales have gone up; Operating expense has gone down from 25.7% in 2010 to 24.2% in 2012. This has led to significant improvement in all numbers. As the economy improves, this will improve further. This is clearly evident from the net margin ratios and return on asset ratio. Home Depot is able to produce better results from assets. Return on Assets: Based on the above calculations the return on assets has increased with the increase in net margin and assets from acquisitions in years 2012 and 2011. When compared to year 2010 ratio, this ratio shows how well the company utilized its assets in generating profits. Home depot has managed to increase long-lived assets year over year from 2010 to 2012 which accounts for 3 billion dollars. The decrease in Depreciation and Amortization as a percent of Net Sales reflects positive expense leverage with comparable store sales environment to the increase in fully depreciated assets. Home depot used straight line on assets like buildings and lease hold improvements from 5 to 45 years and for furniture, fixtures and equipment 2 to 20 years which is standard in the industry. Home depot’s evaluation on long term assets is performed at the lowest level of identifiable cash flows, which is generally at the individual store level. They make critical assumptions and estimates in completing impairment assessments of assets. Return On Equity: Home depot has a good incremental trend on return on equity based on the above calculations with the increasing consecutive Net Income numbers from 2010 to 2012. It has a steady 4% increase on return on equity year-over-year for the last three years. This ratio measures how well Home Depot has managed its shareholders’ investments in generating profits or creating added wealth. From the above calculation it is clear that home depot earning has increased as a result of repurchase of billions of dollars’ worth of shares which reduced the shareholders’ equity for the last 3 years. It also declared dividends of cash every quarter for the last 5 years. Refer to Appendix 6 for Graphical comparisons.
  • 4. 2.1.3 Capital Structure Ratios Formula Debt Ratio Times Interest Earned Long Term Debt/Long Term Debt+Shareholders' Equity Net Income Before Tax+ Interest Expense 9475/ 9475+ 17777 7221+ 632/ 632 2012 ratio 35% 12.43 Times 10758/ 10758+ 17898 6068+ 606/ 606 2011 ratio 38% 11.01 Times 8707/ 8707+ 18889 5273+ 530/ 530 2010 ratio 32% 10.95 Times Debt Ratio: The debt to equity ratio indicates the relative uses of debt and equity as sources of capital to finance the company’s assets. From the above calculations, debt to equity ratio of Home Depot tells about the amounts for debt to equity in the capital structure. For the year 2010 to 2011 the long term debt of Home Depot has raised relative to the shareholders’ equity and also higher proportions to its capital structure as of February 3, 2013. The other important observation is that Home Depot has $2.5 billion in Cash and Cash Equivalents, based on cash position and access to the debt capital markets. With this edge they were able to fund dividend payments and share repurchases. Long-term debt payments were supported through the funds available from the commercial paper programs and the ability to obtain alternative sources of financing. From 2011 to 2012 Home Depot’s current installments of current long term debt was increased from $30M to $1321M. This increase was used to support the financing and operating activities to increase revenues as a result the debt to equity ratio has gone down from 38% to 35% reduction. Return on invested capital was increased from 2010 to 2012 from 21% to 17% based investments made to generate revenue. Home depot’s net cash for Financing Activities for the fiscal year 2012 was $5.0 billion compared to $4.0 billion for fiscal 2011. The change in debt to equity ratios was primarily the result of how home depot funded it share repurchase program. In fiscal 2012, home depot repurchased $4.0 billion of outstanding shares of common stock, using cash flow generated from operations. In fiscal 2011, it repurchased $3.5 billion of its outstanding shares, and funded $1.0 billion of those repurchases with proceeds from long-term borrowings. The company did not issue any long-term borrowings in fiscal 2012. The repurchases of common stock in fiscal 2012 were partially offset by $478 million more in proceeds from sales of common stock due to increased stock option exercises in fiscal 2012 compared to 2011. This shows the liquidity position and the borrowings used to quantify debt to equity ratios. Times Interest Earned: Home depot has a good track record of increased profits consistently over a period of time to cover its required interest payments, lenders look at the profit ratios for the health of the company on short term lending, from year 2010 to 2012 it has produced rising incremental times interest earned trends best in the industry segment, which is more than 10 times. The interest earned expenses ratios to the net sales has consistent ratios of 0.8 in 2010, 0.8 in 2011 and 0.7 in 2012. The slight decrease in 2012 is due to the reduction in
  • 5. operating expenses. In fiscal 2012, home depot recognized $545 million of interest and other, net proceedings compared to $593 million for fiscal 2011. Interest and Other, net, as a percent of Net Sales was 0.7% for fiscal 2012 compared to 0.8% for fiscal 2011. Interest and Other, net, for fiscal 2012 included a $67 million pretax benefit related to the termination of the guarantee of a senior secured loan of HD Supply, Inc. ("HD Supply Guarantee") as additional. 2.1.4 Asset Management Ratios Formula Asset Turnover Average Collection Period Inventory Turnover Net Sales Revenue/Total Assets Account Receivables*365/ Net Sales Revenue Cost Of Goods Sold/Inventory 2012 ratio 1.82 Times 74754/ 41084 1395* 365/ 74754 48912/ 10710 6.81 Days 4.57 Times 70395/ 40518 1245* 365/ 70395 46144/ 10325 2011 ratio 1.74 Times 6.46 Days 4.47 Times 67997/40125 1085* 365/ 67997 44693/ 10625 2010 ratio 1.60 Times 5.82 Days 4.21 Times Asset ratios are also called activity ratios which measure the usage of assets. This helps to gauge how effectively a company is putting its investments to work to generate revenue. From the above calculations, Home Depot has good asset management ratios, across all numbers: like net sales revenue, total assets, accounts receivables, cost of goods sold and inventory. It has dominance over the competitors in industry. Asset turn over ratios from 2010 to 2012 are in growth path, while maintaining good collections periods, Home Depot’s inventory turnover has its pace more than 4 times to cost of goods sold. Few adjustments were made by Home Depot based on acquisitions to earn revenue on new assets for the last 3 years based on street reporting. Home Depot’s sales per average square foot are well over $300 for the last 5 years and considered to be the best in the retail home improvement segment. 2.1.5 Performance Ratios Formula Earnings Per Share Net Income – Preferred Dividends/Number of common shares Price Earnings Dividends Per Share Market Price of Common Stock/Earnings Per Share Common Share Dividends/Number of Common Shares Dividends Per Share/Earnings Per Share Dividend Payout 2012 ratio 2011 ratio 2010 ratio 4535/ 1499 3.03 3883/ 1562 2.49 3338/ 1648 2.03 67.82/ 3.03 1743/ 1499 22.38 45.41/ 2.49 1632/ 1562 18.24 37.98/ 2.03 1569/ 1648 18.71 1.16/ 3.03 38% 1.04/ 2.49 42% 0.95/ 2.03 47% 1.16 1.04 0.95 The two most common performance or evaluation shares that most companies look at are EPS and PE ratios.
  • 6. EPS: For the fiscal year ended February 3, 2013 ("fiscal 2012"), Home depot reported Net Earnings of $4.5 billion and Diluted Earnings per Share of $3.00 compared to Net Earnings of $3.9 billion and Diluted Earnings per Share of $2.47 for the fiscal year ended January 29, 2012 ("fiscal 2011"). The results for fiscal 2012 included a total charge of $145 million, net of tax, related to the closing of their remaining seven big box stores in China ("China store closings") in fiscal 2012, which had a negative impact of $0.10 to Diluted Earnings per Share. Excluding the charges related to the China store closings. For fiscal year ended January 30, 2011 (“fiscal 2010”), Home Depot reported Net Earnings of $3.3 billion and Diluted Earnings per Share of $2.01 compared to Net Earnings of $2.7 billion and Diluted Earnings per Share of $1.57 for fiscal year ended January 31, 2010 (“fiscal 2009”). PE Ratios: The price to earnings is the ratio of the price per share of the common stock to the earnings per share of the common stock. P/E ratio is sometimes used as a proxy for investor valuation of the firm’s ability to generate cash flows in future. Historically for US companies following GAAP tend to fall in the range of 10 – 25, in recent periods PE’s reached much higher. PE ratios for Home Depot on incremental path for the last 5 years except from 2010 to 2011 slightly declined from 18.71 to 18.31. In its current year, Home Depot is 22.38 from above computations. For trends, please refer to the charts on Appendices at the end of the document. 2.1.6 Common size income statement – Home Depot Home  Depot Common  Size  Income  Statement Sales  Revenue  (net) Cost  of  Goods  sold Gross  Profit Fiscal  Year  Ended        February    3,  74,754    January  2  9,  2012  January  3  0,  2011  January    3  1,  2010  February    1,  2009                                             2013                                        70,395                                      67,997                                    66,176                                      71,288   100% 100% 100% 100% 100% 65% 66% 66% 66% 66% 35% 34% 34% 34% 34% Operating  Expenses: Selling,  General  and  Administrative Depreciation  and  Amort.  Expense Total  Operating  Expense 22% 2% 24% 23% 2% 25% 23% 2% 26% Operating  Income Gain  on  Sale  of  Investment Interest  and  Inv.  Income   Interest  Expense   11% -­‐ 0% -­‐1% 9% -­‐ 0% -­‐1% 9% 8% 7% -­‐                                                            (0)                                                            (0)   0% 0% 0% -­‐1% -­‐1% -­‐1% Net  Income  Before  Tax   10% 9% 8% 6% 5% Income  Tax  Expense   4% 3% 3% 2% 2% Net  Income  after  Tax   6% 6% 5% 4% 3% 24% 3% 26% From the percentages shown in the table above, we can see that the cost of goods sold decreased relative to sales revenue in year 2012. The gross profit increased because of 24% 2% 26%
  • 7. lower cost of goods in the year 2012. Total operating expenses have also decreased because of efficiency achieved by Home Depot in handling its operational costs. Operating Income has consistently increased relative to the sales revenue over the last five years. This shows that the company has managed to control costs associated with its daily business operations. Finally, the net income after tax has consistently grown as well over the years. This figure clearly shows that the company is generating more wealth in the last couple of years as compared to the previous years. 2.2 Lowe’s 2.2.1 Liquidity Ratios Formula Current Ratio Quick Ratio Current Assets/Current Liabilities Cash+Market Securities+AR/ Current Liabilities 9784/7708 541+125/ 7708 2012 ratio 1.27 0.09 10072/ 7891 1014+286/ 7891 2011 ratio 1.12 0.16 9967/ 7119 652+471/ 7119 2010 ratio 1.40 0.16 Lowe’s is suffering due to the fall in net sales and they are trying to artificially inflate earnings per share by buying back significant amounts of stock. This has affected both their current and quick ratio. They used most of the cash from operation and from their reserves to buy back stocks. Lowe’s liquidity ratios are well below the industry average of 1.5 in the retail sector, total current assets has decreased from 2011 to 2012 with falling current ratios for the quick ratios. Cash and marketable securities have significantly reduced from 2011 to 2012 year ending Feb 2013, a 53 week period. The housing market has improved significantly, but Lowe’s is still struggling. There is a limit to buyback and if they don’t turn the ship around, their market value will spiral down. 2.2.2 Profitability Ratios Formula Net Margin Return On Assets Return On Equity Net Income After Tax/ Net Sales Net Income After Tax/Total Assets Net Income After Tax/Shareholder’s Equity 1959/ 50521 1959/ 32666 1959/ 13857 2012 ratio 4% 6% 14% 1839/ 50208 1839/ 33559 1839/ 16533 2011 ratio 4% 5% 11% 2010/ 48815 2010/ 33699 2010/ 18112 2010 ratio 4% 6% 11% For the financial year 2012 Lowe’s Net Income has increased and the net margin is flat at only 4%. There is no growth despite a net margin increase. The return on assets is between 5% to 6%, which is clearly less than that of competitors such as Home Depot. Return on equity did very well compared to the industry average for the last 2 years, 2012 and 2011. ROE is the measurement of how well the company has managed its shareholders’ investments in generating profits, this ratio was a stable 11% in 2010 and
  • 8. 2011, and the same increased to 14% in year 2012. Analyzing further and connecting the dots, one can see that Lowe’s has inflated ROE by share buybacks though net margins and ROA both are pretty much flat. 2.2.3 Capital Structure Ratios Formula Debt to Equity Ratio Times Interest Earned Long Term Debt/Long Term Debt+Shareholders' Equity Net Income Before Tax+ Interest Expense 9077/ 9077+ 13857 3137+ 423/423 2012 ratio 40% 8.42 Times 7627/ 7627+ 16533 2906+ 371/ 371 2011 ratio 32% 8.83 Times 6573/ 6573+ 18112 3228+ 332/ 332 2010 ratio 27% 10.72 Times Debt to Equity Ratio: Based on above calculations, Debt to Equity ratio for Lowe’s is on incremental path from 2010 to 2012. Lowe’s has been raising long term debt. They have raised ~$1.5b in 2012, and before that they raised ~$500M. These numbers are alarming especially with quick ratio going down drastically. This combined with almost no long term growth strategy creates a risk for Lowe’s. Times Interest Earned: Lowe’s sales are pretty flat and before that they had negative profits. In addition to that, they have been raising debt. This is reflected in their times interest earned. This is one of the critical ratios that lenders use to analyze the debt/interest paying capabilities. 2.2.4 Asset Management Ratios Formula Asset Turnover Average Collection Period Inventory Turnover Net Sales Revenue/Total Assets Account Receivables*365/ Net Sales Revenue 50521/ 32666 0*365/ 50521 Cost Of Goods Sold/Inventory 33194/ 8600 2012 ratio 1.55 Times 0 Days 3.86 Times 50208/ 33559 0*365/ 50208 2011 ratio 1.50 Times 0 Days 48815/ 33699 0*365/ 48815 2010 ratio 1.45 Times 0 Days 32858/ 8355 3.93 Times 31663/ 8321 3.81 Times NOTE: Accounts Receivables for Lowe’s is sold to GE credit services page 40 of 2011 of form 10 K or AR enclosures From the above calculations Lowe’s has consistent asset management ratios, across all numbers for Net sales revenue, total assets, accounts receivables, cost of goods sold and inventory. Looking at the asset turn over ratios from 2010 to 2012 has stable path, while maintaining good collections periods, inventory turnover went up and down in the last 3 years with a slight increase in cost of goods sold when compared to reduced inventory levels. The Inventory turnover ratio tells how well inventories were managed to generate revenue. Lowe’s has sales per average square foot of well over $250 for the last 3 years
  • 9. with a minimal growth, which is one of the significant numbers that markets look for in specialty retailers, like Lowe’s. 2.2.5 Performance Ratios Formula Earnings Per Share Price Earnings Dividends Per Share Dividend Payout Net Income – Preferred Dividends/Number of common shares Market Price of Common Stock/Earnings Per Share Common Share Dividends/Number of Common Shares Dividends Per Share/Earnings Per Share 1945/ 1150 2012 ratio $1.69 39.26/ 1.69 704/ 1150 23.23 0.61/ 1.69 36% 0.61 1824/ 1271 2011 ratio $1.44 27.57/ 1.44 647/ 1271 19.15 0.51/ 1.44 35% 0.51 1993/ 1401 2010 ratio $1.42 26.29/ 1.42 571/ 1401 18.51 0.41/ 1.42 29% 0.41 The two most common performance or evaluation shares that most companies look at are EPS and PE ratios. EPS: Lowe’s delivered good results (thanks to share buybacks) in 2012, the Net earnings for 2012 increased 6.5% to $2.0 billion and diluted earnings per share increased 18.2% to $1.69. Net sales for 2012 increased 0.6% to $50.5 billion. Fiscal 2011 contained an extra week which contributed $766 M to 2011 net sales or $0.05 to diluted earnings per share. Comparable sales were 1.4%, driven by a 0.9% increase and a 0.5% increase in comparable transactions. For 2012, cash flows from operating activities were approximately $3.8 billion, with $1.2 billion spent on capital expenditures. Lowe’s positive cash flows provided returns to shareholders through both dividends and share repurchases. During fiscal 2012, Lowe’s paid $704 million in dividends and repurchased 146 million shares of common stock for a total of $4.35 billion under their share repurchase program. PE Ratio: The price to earnings is the ratio of the price per share of the common stock to the earnings per share of the common stock. P/E ratio is sometimes used as a proxy for investor valuation of the firm’s ability to generate cash flows in future. Historically for US companies following GAAP tend to fall in the range of 10 – 25, in recent periods PE’s reached much higher. PE ratios for home Lowe’s in on incremental path for the last 3 years as shown above from 2010 it is 1.51, 2011 is 19,15 and current 2012 is 23.23. Though the market has reacted positively to Lowes’ EPS growth, other ratios are not showing any upwards swing. If these numbers don’t improve in one year, Lowe’s could run into problems and may see the stock nose dive. For trends, please refer to the appendices at the end.
  • 10. 2.2.6 Common size income statement – Lowe’s Lowe's Common  Size  Income  Statement Sales  Revenue  (net) Cost  of  Goods  sold Gross  Profit Operating  Expenses: Selling,  General  and  Administrative Depreciation  and  Amort.  Expense Total  Operating  Expense Fiscal  Year  Ended February  3,  2013 January  29,  2012 January  30,  2011 100% 100% 100% 66% 65% 65% 34% 35% 35% January  31,  2010 100% 65% 35% February  1,  2009 100% 66% 34% 24% 3% 27% 24% 3% 27% 24% 3% 28% 25% 3% 28% 23% 3% 26% 7% 7% 7% 7% 8% 0% -­‐1% 0% -­‐1% 0% -­‐1% 0% -­‐1% 0% -­‐1% Net  Income  Before  Tax 6% 6% 7% 6% 7% Income  Tax  Expense   2% 2% 2% 2% 3% Net  Income  after  Tax 4% 4% 4% 4% 5% Operating  Income Gain  on  Sale  of  Investment Interest  and  Inv.  Income   Interest  Expense   From the percentages shown in the table above, we can see that the cost of goods sold increased relative to sales revenue in year 2012. The gross profit decreased because of higher cost of goods in the year 2012. Total operating expenses have decreased because of efficiency achieved by Lowe’s in handling its operational costs. Operating Income relative to the sales revenue has been consistent over the last four years. This shows that the company has managed to keep the costs associated with its daily business operations consistent. Finally, the net income after tax has been consistently stable over the last 4 years. This figure clearly shows that the company is consistently generating the same wealth in the last four years. 2.3 Similarities and Differences between ratios of Home Depot and Lowe’s Similarities: Lowe’s and Home Depot both have bought back significant shares in the last few years, which has clearly led to a higher growth in EPS versus Net margin ratio. Both Home Depot and Lowe’s used cash reserves to repurchase shares. Differences: Lowe’s performance seen through all of its ratios is really bad as compared to that of Home Depot’s. Lowe’s sales revenue is not going up; they don’t seem to have a clear strategy to increase their sales per square feet from $250 to $300 in the next two years. They have not opened many new stores. On the contrary, Lowe’s has raised almost $1.5b from market, while using its cash from reserves and operating activities to buy back shares.
  • 11. Note: Most of the above similarities and differences can be very well shown in graphical representation in appendix. 3. Analysis of Cash Flow statement 3.1 Home Depot 3.1.1 Level I Cash Flow Analysis – Home Depot, Inc. Table 2 Amounts shown in millions Home  Depot,  I nc.  Cash  Flow  Story Operating Financing Investing Cash  Change $    5,528 $      (3,680) $  (1,729) 2009 $    5,125 $      (3,503) $        (755)                  867 2010 $    4,585 $      (4,451) $  (1,012)                (878) 2011 $    6,651 $      (4,048) $  (1,129)            1,474 2012 $    6,975 $      (5,034) $  (1,432)                  509 2008                  119
  • 12. 3.1.2 Level II Cash Flow Analysis – Home Depot, Inc. Cash generated from daily business activities has consistently been positive. Except for years 2009 and 2010, cash from operations has grown consistently year over year. This happened due to increased number of in-store sales, which is mainly attributed to improvements in the US housing market as well as other company initiatives. In year 2008, Home Depot paid off significant amount in its short-term debt. It also paid significant amounts as dividends to shareholders. From 2009 to 2010, Home Depot mainly focused on paying off its long-term debt. This brought the debt to equity ratio down to 44.7% from 54.4% at the end of fiscal year 2008. During the 5 year period, Home Depot has been consistently paying dividends in increasing amounts. From 2010 to 2012, a significant portion of its financing activity involved repurchasing stock. In Fiscal year 2012, Home Depot repurchased 74 million shares for $4.0 Billion dollars. Cash from investing has been increasing from 2010 to 2012. During this time Home Depot has been acquiring other companies to increase its growth. During 2008, Home Depot made a huge capital investment which included opening 62 new stores. In 2012, it invested in two major acquisitions: MeasureComp L.L.C. and U.S. Home Systems, Inc. Investment slowed down in 2009 and so did the net sales. This was due to the slowdown in the global business and the weakness in US residential construction, housing and home
  • 13. improvement market. In 2011, Home depot increased its cash significantly which was to be used later in 2012 for acquisitions and opening new stores. 3.2 Lowe’s 3.2.1 Level I Cash Flow Analysis – Lowe’s Table 3 Amounts shown in millions Lowe's  Companies,  I nc.  Cash  Flow  Story Operating Financing Investing Cash  Change 2008 $    4,122 $            (939) $  (3,226)                    (43) 2009 $    4,054 $      (1,801) $  (1,886)                  367 2010 $    3,852 $      (1,651) $  (2,184)                      17 2011 $    4,349 $      (2,549) $  (1,437)                  363 2012 $    3,762 $      (3,333) $        (903)                (474)
  • 14. 3.2.2 Level II Cash Flow Analysis – Lowe’s In year 2008, Lowe’s generated solid cash from running it daily business activities. Although sales fell significantly by 7.2% due to a challenging sales environment attributed to declining home prices, rising unemployment, and tightening credit markets. This resulted in a decline in consumer confidence which in turn affected their spending. Lowe’s main focus during 2008 was on investing activities, which primarily included Capital expenditures on opening 115 new stores. This heavy capital expenditure shows that the company did not anticipate the decline in sales that was coming in later quarters of the fiscal year. This demanded a change in strategy and therefore Lowe’s focused on effectively deploying capital, controlling costs, and capturing profitable market share. It only opened 60-70 new stores in 2009 which included 5 stores in Canada and 2 stores in Mexico. This is the reason that the figure under investing in Table 3 above dropped by half of its value in 2008. The stores that did not open were mostly in the US, where the challenging economic environment in markets pushed the sales down and the future looked very uncertain. Lowe’s also adjusted its stores format by lowering the square footage to 103,000 sq. ft. down from 117,000 sq. ft. This move resulted in lower utility and maintenance cost. Lowe’s also planned to continue this new 103k sq. ft. store model. Lowe’s controlled payroll expenses by reducing its store hours in those markets with the lowest sales so that they would not have to sacrifice customer service and lowering customer facing hours. Lowe’s expanded the area covered by each store Manager so that they handle more than one store. It also put a freeze on hiring 400 open positions and cut significantly on marketing spending by relying more on targeted advertising. The amount in financing for the year 2008 in Table 3 is low because the company did not buy back shares as it has done in later years. This could be due to low sales figures. In 2009, the company spent significantly in buying back shares. The company spent huge sums of money repurchasing common stock, nearly $3 billion and increased its financing activity significantly. In 2011, asset write-down and restructuring costs were high. Also changes in other net operating assets were high which contributed high cash flow from operations. The company spent significant amounts of cash in capital expenditure, which is reflected in investing number for 2011 in Table 3 above. This investment included opening new stores as well as owning them on leased land. In 2011, the company increased its cash which it used towards huge spending in 2012 for repurchasing common stock.
  • 15. 4. Three most significant accounting policies adopted by each company Significant Accounting Policies Retail is a tough business that is highly competitive where companies compete, differentiate price and strive for outstanding customer service. Almost any store in any neighborhood can offer a set of screwdrivers or cleaning supplies at close to identical prices. Looking at a company’s significant accounting policies such as inventory, revenue recognition and self-insurance can give insight into company’s management, financial health and their future course. Although many of the policies between Home Depot and Lowe’s are the same, one can find subtle differences. Merchandise Inventory: It is painfully obvious why this would be listed as our number one significant accounting policy because of the affects that is has on both companies line of business. If there was not the right item for sale, at the right time, for the right price on a shelf then these two companies like many others would not exist today. Their management structures and attention to detail understanding that a store in the north east will require different items than store in the Midwest takes a great deal of research. Inventory control is a key aspect to any retail business but even more so when that business is considered the blood line for so many other businesses. For example if a small contracting company requires specific joist hangers because of the possibility of earthquakes in an area than that store had better carry that item and have enough inventory to support that demand. If not that small contracting company business would have to find another way to get their supplies and that could affect if they survive or not as a business. The ability for Home Depot and Lowe’s to manage their inventory effectively is not the only key to their success but the success of the businesses and communities they serve as well. Lowe’s uses lower of cost or market using first-in-first-out (FIFO) method. Home Depot uses FIFO retail inventory accounting method for most of the inventory (76%) in US and Cost method for inventory in Canada and Mexico (24%). Both Lowe’s and Home Depot conduct physical count regularly adjust for shrinkage and swelling at all stores and distribution centers. Historical patterns and data points are used to estimate that shrinkage before the physical counts are conducted. In both cases, FIFO method includes warehouse cost, preparation of inventory for resale etc. Unlike Home Depot, Lowe’s maintains inventory reserve for anticipated loss of selling inventory below cost. Lowe’s builds and maintains additional reserves based on consumption patterns and their need for additional inventory helps explain their lower turnover ratio listed below. As mentioned previously, Turnover ratios for Home Depot and Lowe’s are 4.47% and 3.86%. With Industry averaging at 4 % Home Depot appears to be far more efficient in managing their inventory. It is also able estimate the net value of their clearance
  • 16. inventory and carry-over that inventory at the lower of cost or market. Over the past three years Lowe’s has remained fairly flat, but Home Depot has improved significantly with the effective inventory turnover management. There is also a drastic difference in sales per square foot as seen below: Sales per Square Foot Company Lowe’s Home Depot Difference 2012 $ 255 $ 319 HD + $ 64 2011 $ 250 $ 299 HD + $ 49 2010 $ 249 $ 289 HD + $ 40 Home Depot and Lowe’s net merchandise inventory percentage is right around 26% of their total assets for each company. These simple statistics as well as those listed above show how the management is able to control their inventory, understand what item gets the front shelf or end cap based on solid research and sales per square foot. Both companies have increased their sales per square foot over the past few years but you can see how the gap continues to grow for Home Depot. Revenue Recognition: Our second most significant accounting policy is revenue recognition. Revenue recognition in most businesses is a key performance indicator of how a company is performing. We can learn quite a bit about a company and their style of accounting via their revenue recognition policies. In our class we learned that "78% of Chief Financial Officers said they had been asked to bend accounting rules to show results in a better light" and "during tough times premature revenue recognition is a common problem". It is also right alongside with inventory control with the amount of risk a company takes on and the failure to implement internal controls over this are can be detrimental to the overall success. Both Home Depot and Lowe’s recognize revenues, net sales and tax when customer takes procession of the merchandise. Historical data along with management input is used to estimate sales returns and its impact on cost of sales. Both companies account for gift cards as deferred revenue until that gift cards are redeemed. They also provide different types of home services via their installation and maintenance programs. Revenues from these programs are recognized at the time of service and listed as deferred revenues till customer receives the service. Unlike Home Depot, Lowe’s also recognize revenue from the sale of extended protection plan on a straight line basis over the term of the contract. Home Depot and Lowe’s both take a conservative approach to revenue recognition deferred revenue for Home Depot makes up 3.1% of total assets and for Lowe’s its 2.5%. Both companies recognize income from unused store cards when redemption chances are remote. Home Depot recognized $33 Million last year which was
  • 17. included on their statements as a reduction in SG&A. It was unclear exactly how much Lowe’s recognized but it is known that they have a similar process. Self-insurance: Although Self-insurance does not initially appear to be every ones first choice of significant accounting policies it needs to be in the top three and we list this as our third. Self-insurance is for those cost that most consumers do not think about. How much does it cost to insure that employee, what is our deductible for incidents, how do we increase our safety procedures in order to decrease incidents. A major reason for this choice is that both companies list this policy as one of their critical accounting policies and it is also a major cost that sometimes can be out of your control depending on the amount of claims in a given year. The United States has passed a new health care bill which on average will force the cost of insurance up for individual companies by over 10%. That cost will have to be passed on somewhere and our guess is to the consumer. Self-insurance appears to be a significant accounting policy at the face value that is easy to calculate or review. Home Depot and Lows use self-insurance by cover general liability (including products), workman's compensation, medical and automotive claims. Unlike Home Depot, Lowe’s self-insures their properties for damages. The ability to control and estimate the cost by management is not easy and in the future it will become more difficult as well. Home Depots deduction involving general liability, workers' compensation and automobile liability is limited to $25 million, $1 million and $1 million, respectively. Lows is very different with their liability being limited to $3 Million for automobile, general and product liability, $ 2 Million for workmen's compensation. Neither company has a stop loss limit for self-insured employee group medical claims. Lowe’s in 2012 reduced the rate that it applied to self-insurance which resulted in an unfavorable impact of $20 Million. Home Depot established that their estimated numbers and audits completed regularly reflected that the estimates were very close and not adjustment was necessary. Home Depot lists $459M as accrued self-insurance liabilities for its 2,256 stores which is just over $200,000.00 per store. Lowe’s in comparison is bit higher at almost $215,000.00 per store; this also includes the property insurance. Due to changes in healthcare act in USA and its potential to force higher deductible, it will be interesting to watch future changes in articulating this policy At this point both appear to manage this well using past history as estimates for the future. Other Policies Accounts Receivable for Lowe’s: The majority of Lowe’s account receivables come from commercial business customers and Lowe’s has agreement with GE to sell
  • 18. these Account receivables on face value. Due to this accounting practice Lowe’s doesn’t declare any account receivable on its balance sheet. Unlike Lowe’s, Home Depot declares account receivable on its balance sheet but uses 3rd party to offer credit services to its customers. This accounting practice inflates the current asset account. Capitalized software cost: Though both Lowe’s and Home Depot have made strived towards using IT for both ecommerce and supply chain automation, Lowe’s doesn’t define any separate policy towards capitalizing software or technology cost. In fact Lowe’s makes a huge point of their advancements in technology as part of their shareholders letter as well as list this issue as one of their significant risk but this significant accounting policy is not listed. Home Depot and Lowe’s chose almost identical significant accounting policies for their business and implement them in very similar manners. Below are a few that are similar with minor differences of how much is actually disclosed on the Annual Report. • • • • • Cost of Sale and SG&A Advertising Income Taxes Property and depreciations Impairment of long lived assets and Exits As far as account style goes both would be considered slightly more conservative than aggressive, but not by much they appear to be right in the middle.
  • 19. Appendix 1
  • 20. Appendix 2:
  • 21. Appendix 3:
  • 22. Appendix 4:
  • 23. Appendix 5:
  • 24. Appendix 6: