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HOME DEPOT
ANALYSIS OF FINANCIAL STATEMENTS

USMAN RIAZ
December 4, 2013
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Contents
Company Profile..................................................................................................
`

Company Profile
Introduction
Home Depot is an American retailer of home improvement and construction. It is based in
Ge...
`

Home Depot deals in all the home improvement products. It includes Home appliances, tools,
hardware, lumber, building m...
`

distributed amongst big-box retailers such as Walmart and other small chains and businesses.
The small chains and store...
`

and the related industry. Since 2011 the economy is recovering and that can be seen easily on
the ROE of Home Depot.

N...
`

NOPM

2013
6.48%

2012
6.04%

2011
5.44%
(Calculations in Appendix)

Net Operating Asset Turnover (NOAT)
This is a meas...
`

Home Depot is able to payback its debt expenses. This increase is a result of increased
profitability coupled with a dr...
`

improvement has two major drivers. Home Depot had more CAPEX spending and debt before
the recession which dragged the r...
`

Solvency Analysis
Solvency analysis considers a company’s ability to repay the periodic interest payments plus the
prin...
`

A score between 1.80 and 2.99 is Gray area, as the company is exposed to some risk of
bankruptcy. A score less than 1.8...
`

Goodwill and Other Intangible Assets
Goodwill is the excess of purchase price or fair value of net assets acquired. Hom...
`
The stock is trading at 78.40 as of December 4th 2013. This has been a constant upward since 2009. As soon
as the econom...
`

Appendix
ROE
Tax on Operating
Profit
NOPAT
RNOA
Non-operating
Return
NOPM
NOAT

Times Interest
Earned
EBITDA Coverage
R...
`

References
US Securities and Exchange Commission:
(http://www.sec.gov/Archives/edgar/data/354950/000035495013000008/hd-...
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Home Depot - Equity Research Paper

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Prepared an equity research report of Home Depot (NYSE: HD). Analyzed the financial statements and the financial standing of the company related to its peers and the industry as a whole. Computed the critical ratios and their trend during the previous years and predicted how the trends will translate into the future performance. Also came down to a stock recommendation in light of the analysis.

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Home Depot - Equity Research Paper

  1. 1. HOME DEPOT ANALYSIS OF FINANCIAL STATEMENTS USMAN RIAZ December 4, 2013
  2. 2. ` Contents Company Profile.................................................................................................................................................... 2 Introduction ...................................................................................................................................................... 2 Customers, Product & Services......................................................................................................................... 2 Competition ...................................................................................................................................................... 3 Financial Statement Analysis ................................................................................................................................ 4 Profitability ....................................................................................................................................................... 4 ROE ............................................................................................................................................................... 4 NOPAT, RNOA & Non-Operating Return ...................................................................................................... 5 Net Operating Profit Margin (NOPM)........................................................................................................... 5 Net Operating Asset Turnover (NOAT) ......................................................................................................... 6 Credit Analysis .................................................................................................................................................. 6 Coverage Ratios ............................................................................................................................................ 6 Liquidity Analysis .............................................................................................................................................. 8 Current Ratio ................................................................................................................................................ 8 Quick Ratio ................................................................................................................................................... 8 Solvency Analysis .............................................................................................................................................. 9 Liabilities to Equity Ratio .............................................................................................................................. 9 Total Debt to Equity...................................................................................................................................... 9 Bankruptcy Risk ................................................................................................................................................ 9 Altman Z-Score ............................................................................................................................................. 9 Notes to Consolidate Financial Statements ........................................................................................................ 10 Revenue Recognition ...................................................................................................................................... 10 Merchandise Inventory................................................................................................................................... 10 Goodwill and Other Intangible Assets ............................................................................................................ 11 Employee Benefit Plans .................................................................................................................................. 11 Future Potential .................................................................................................................................................. 11 Stock Recommendation ...................................................................................................................................... 12 Appendix ............................................................................................................................................................. 13 References .......................................................................................................................................................... 14 1
  3. 3. ` Company Profile Introduction Home Depot is an American retailer of home improvement and construction. It is based in Georgia, Atlanta. Founded in 1978, Home Depot is the largest home improvement retailer in the United States with 2248. This includes 2256 stores in US and the rest in Canada, Mexico, China, UK, Argentina and Chile. Home Depot serves three primary customer groups; do-ityourself (D-I-Y), do-it-for-me (D-I-F-M) and professional customers. The company offers over 300,000 different products. Home Depot operates in the home improvement and construction industry. The industry consists of other competitors like Lowe’s in USA which is the main competitor in term of size. The Average size of Home Depot stores is 105000 ft2 and its largest store is located in New Jersey. Customers, Product & Services The D-I-Y customers are the one who buy products to use themselves. These are usually home owners who can complete their projects themselves. The other main target of Home Depot is the D-I-F-M segment that consists of consumers who want to get the services with the products. Home Depot provides customers with services like installation, carpeting, flooring, cabinets, roofing, windows etc. The third segment is the professional customers. These are general contractors, repairmen, tradesmen. These customers usually need special delivery arrangements and Home Depot has a dedicated customer services staff to cater their needs. The median age group of the customers is 45-50. 2
  4. 4. ` Home Depot deals in all the home improvement products. It includes Home appliances, tools, hardware, lumber, building materials, flooring, plumbing, paint, garden supplies and plant. On average a Home Depot store carries 30,000 – 40,000 products. It also offers 600,000 products online. The products are divided into 4 broad groups; Plumbing, electrical and kitchen, Hardware and seasonal, Building materials, lumber and millwork, and Paint and flooring. The percentage sales contribution of these groups for the last 3 years is given below: Plumbing, electrical and kitchen February 3,2013 30.8% January 29,2012 30.5% January 30, 2011 30.0% Hardware and seasonal 29.4 29.5 29.4 Building materials, lumber and millwork Paint and flooring 20.6 21.1 21.7 19.2 18.9 18.9 Total 100% 100% 100% The figures represent that Plumbing, electrical and kitchen group has consistently been the major contributor in sales. Competition The home improvement industry is highly competitive with little product differentiation advantage. The industry is saturated and consists of other competitors like Lowe’s in USA which is the main competitor in term of size. The revenues for the year ending Feb 2013, Home Depot reported revenues of 74,754 Million whereas Lowe’s Revenues were a distant 50,521 Million. Home Depot has a core competency in store locations throughout the country. Home depot and Lowe’s together make up only 18% of the total industry and the rest of the market share is 3
  5. 5. ` distributed amongst big-box retailers such as Walmart and other small chains and businesses. The small chains and stores cannot be ignored because Home Depot is not present in every location so these small stores offer a substitute for people who are not going for a big purchase or who need something immediately. Notice that the Home Depot and Lowe’s combined only make 18% of the total industry that leaves a huge incentive for small competitors to enter. There are some small retailers who beat Home Depot on prices but their limited size and after sales services is something that cannot match Home Depot. In addition Home Depot now faces growing competition from online and multichannel retailers too. Financial Statement Analysis Profitability ROE Profitability can be measured by calculating the ROE. ROE is the return on equity and is the sum of the operating return and the non-operating return. The table below summarizes the ROE ofthe last three years. The return on equity is increasing steadily for the last three years. 2013 2012 2011 25.42% 21.11% 17.44% Years ROE (Calculations in Appendix) The ROE is improving significantly. The economic reason for this is the industry is coming out of a recession. The recession that primarily hit the housing market and hurt the sales of houses 4
  6. 6. ` and the related industry. Since 2011 the economy is recovering and that can be seen easily on the ROE of Home Depot. NOPAT, RNOA & Non-Operating Return Further disaggregation of ROE will give us a better insight. ROE can be broken down intooperating return andnon operation return. The table below shows the component of ROE and their trend in the last three years. 2013 2012 2011 4846.16 4251.78 3696 Operating Return (RNOA) 18.56% 15.68% 13.30% Non-operating Return 6.86% 5.43% 4.14% Net operating profit after tax (NOPAT) (Calculations in Appendix) The figures show that the operating and non-operating returns have increased in the last 3 years. The more significant increase can be seen in the operating return. This is a positive sign as it depicts that each dollar invested in the operating assets and also the non-operating assets are now generating a greater return. Beside this, the net operating assets have been decreasing in the last 3 three years. So in the last 3 years the returns are on a rise. Net Operating Profit Margin (NOPM) This ratio measures the amount of operating margin a firm earns from each sales dollar. The profit per dollar is increasing through the last three years and currently at 6.48 cents per dollar. This could be due to a decrease in the cost, increase in prices or both. 5
  7. 7. ` NOPM 2013 6.48% 2012 6.04% 2011 5.44% (Calculations in Appendix) Net Operating Asset Turnover (NOAT) This is a measure of the productivity of the company’s net operating assets. It reveals the level of sales realized from each dollar invested in the operating assets. NOAT 2013 2.86 2012 2.60 2011 2.45 (Calculations in Appendix) The figures show an improvement in the 2 years. This shows that for each dollar of net operating assets, Home Depot realizes a gain of $2.86. Credit Analysis Coverage Ratios Coverage ratios compare operating profits or cash flows to interest and principal payments. The ratio is used to assess the company’s ability to generate profits as well as to cover the fixed charges from debt interest and principal in the future. This is an important ratio as it is considered by the rating agencies widely. Times Interest Earned Ratio 2013 Times interest earned 12.42 2012 11.01 2011 10.95 (Calculations in Appendix) The times interest earned ratio reflects the operating income available to pay interest expense. It is getting better since 2011. At the end of 2013 this figure looks very healthy and shows that 6
  8. 8. ` Home Depot is able to payback its debt expenses. This increase is a result of increased profitability coupled with a drop in interest expense. EBITDA Coverage ratio EBITDA Coverage Ratio 2013 14.77 2012 13.59 2011 14.07 (Calculations in Appendix) This ratio reflects the cash available to cover fixed debt charges as depreciation and amortization does not require a cash outflow so more cash is available. The ratio has gone down in 2012 but is up again at a comfortable level. Cash from Operations to Total Debt 2013 Cash from Operations 0.65 to Total Debt 2012 0.62 2011 0.47 (Calculations in Appendix) To analyze the company’s ability to repay the principal instead of the interest in short term we calculate this ratio. The ratio is getting better which shows an increasing ability to pay off the debt if a situation arises. Free Operating Cash Flow to Total Debt Free Operating Cash Flow to Total Debt 2013 0.52 2012 0.49 2011 0.36 (Calculations in Appendix) The free operating cash flow to total debt is used to calculate the ability of a company to repay debt from the cash flows remaining after CAPEX. The table shows the ratios improving. This 7
  9. 9. ` improvement has two major drivers. Home Depot had more CAPEX spending and debt before the recession which dragged the ratios down. Liquidity Analysis Liquidity is amount of cash available and what the company can produce in the short term. There are two main liquidity ratios; current ratio and quick ratio. Current Ratio Current Ratio 2013 1.34 2012 1.55 2011 1.33 (Calculations in Appendix) Current ratio is the ratio of current assets that a company expects to convert into cash in the next operating cycle to the liabilities that are due in the next year. A ratio of 1 or greater implies that a company has more cash inflows than outflows. Home Depot is a cash and carry business so its current ratio cannot be very high. Its current ratio has been above 1 which shows that it is reasonably liquid. Quick Ratio Quick Ratio 2013 0.34 2012 0.34 2011 0.16 (Calculations in Appendix) The quick ratio is a more stringent test of liquidity as it measures the assets likely to be converted to cash within a relatively short period of time. Again nothing to be worried about the liquidity here as a quick ratio of less than 1 is very normal. 8
  10. 10. ` Solvency Analysis Solvency analysis considers a company’s ability to repay the periodic interest payments plus the principal amount borrowed. Liabilities to Equity Ratio Liabilities to Equity Ratio 2013 1.31 2012 1.26 2011 1.12 (Calculations in Appendix) Liabilities to Equity ratio measures the amount of debt financing compared to equity. The median ratio is 1.0 for publicly traded companies and 1.5 for retailing companies. In comparison to retailing companies the ratio is reasonable. The ratio has been increasing for the last three years indicating an increase in the use of debt. Total Debt to Equity Total Debt to Equity Ratio 2013 0.61 2012 0.60 2011 0.52 (Calculations in Appendix) Total debt to equity ratio assumes that current operating liabilities will be repaid from current assets. It does notinclude the accounts receivables. The ratio shows increased debt but still not a lot. The ratio is has slightly worsen in the last three years. Bankruptcy Risk Altman Z-Score Altman Z-Score is a model that utilizes five ratios to calculate the bankruptcy risk for any company. A Z-score of 3 or more is healthy and there is low bankruptcy potential in short term. 9
  11. 11. ` A score between 1.80 and 2.99 is Gray area, as the company is exposed to some risk of bankruptcy. A score less than 1.80 show a company in financial distress and there is a high potential of bankruptcy. Home Depot scored 6.20 on the Altman model that is far beyond the safety mark of 3. This shows the healthy financial condition and almost no bankruptcy risk in the near future. (Calculations in Appendix) Notes to Consolidate Financial Statements Revenue Recognition Home Depot recorded revenue of 74,754 Million in FYE 2013. There has been an increase during the last three years in the revenues. Home Depot recognizes revenue, net of estimated returns and sales tax, at the time the customer takes possession of merchandise or receives services. It estimates the liability for sales returns based on the historical return levels. Merchandise Inventory Home Depot uses First-In-First-out (FIFO) or the market cost whichever is lower to value 81% of the retail inventory and the remainder under the cost method. Home Depot mentions in the notes that this method of valuing the merchandise inventory is widely used in the retail industry. This method keeps the cost of inventory low. Merchandise Inventory grew from 10325 Million in 2012 to 10710 Million in 2013. This can be due to Home Depot’s expectation of increase in sales because in 2012 they experienced increase in sales that resulted in a decrease in their merchandise inventory. 10
  12. 12. ` Goodwill and Other Intangible Assets Goodwill is the excess of purchase price or fair value of net assets acquired. Home Depotdoes not amortize goodwill but does assess the recoverability of goodwill in the third quarter of each fiscal year, or more often if indicators warrant, by determining whether the fair value of each reporting unit supports its carrying value. The fair value is calculated using the present value of expected cash flows. Home Depot amortizes cost of other intangible assets over the useful lives. The lives can range up to 10 years. Intangible assets with indefinite lives are tested in the third quarter each year for impairment. The goodwill of the company is was 1120 Million in 2012 which increased to 1170 Million in 2012. This included the impairment costs to the intangible assets too. So there was an overall increase in the last year. Employee Benefit Plans Home Depot has a contribution retirement plan. All employees who fulfill certain criteria are eligible for the Benefit Plan. The company makes cash contributions each payroll period up to the specified percentages of associates’ contributions as approved. The company also has a restoration plan for employees who would have received a higher wage but could not due to the limits under the law. The company funds the restoration plan through contributions made to the grantor trust which are then used to purchase shares of the company. The Company’s contributions to the Benefit Plans and the restoration plan were $171 million, $171 million and $161 million for fiscal 2011, 2010 and 2009, respectively. At January 29, 2012, the Benefit Plans and the restoration plan held a total of 14 million shares of the Company’s common stock in trust for plan participants. Future Potential Home Depot is a huge company and the future potential for the stock is great. The financial statement analysis and the ratios all point towards the situation getting better for the company. The economy as a whole is out of the recession and most importantly the housing sector, that got the biggest hit in the recession of 2008, is out of the recession and is recovering fast. 11
  13. 13. ` The stock is trading at 78.40 as of December 4th 2013. This has been a constant upward since 2009. As soon as the economy started coming out of the recession, Home Depot’s stock started rising. This is a great sign for the future potential of a company that was hit badly by the recession. In August 2011, the stock was trading at around $30 and since then it has been going up. The stock chart shows the strength of the stock. The financial statement and the ratios point towards improvement in the coming years. The revenues have grown in the last three years. The company’s gross profits have impressed the analysts by increasing from 24262 Million to 25842 Million in the last three years. It has outperformed its competitors and Home Depot apparently has no big threat from any of the rivals. Looking further down the income statement, EBIT is increasing along with the net income. So the financial statements surely are getting better. As discussed earlier, the profitability ratios along with solvency and credit ratio all show marked improvements. The figures have shown steady progress and they seem to be improving further in the coming years. Stock Recommendation I will recommend a BUY. The recommendation is fair after reviewing the company’s strategies, doing a competitive analysis, analyzing the financial statements and footnotes and then computing the key ratios. I think that the stock is undervalued and still has the potential to grow keeping in mind the growing economy. 12
  14. 14. ` Appendix ROE Tax on Operating Profit NOPAT RNOA Non-operating Return NOPM NOAT Times Interest Earned EBITDA Coverage Ratio Cash from Operations to Total Debt Free Operating Cash Flow to Total Debt Current Ratio Quick Ratio Liability to Equity Total Debt to Equity Ratio 2013 4535/((17777+17898)/2)= 25.42% 2686+(632*0.37)= 2919.84 2012 3883/((17898+18889)/2)= 21.11% 2185+(606*0.37)= 2409.22 2011 3338/((18889+19393)/2)= 17.44% 1935+(530*0.37)= 2131.10 7766-2919.84= 4846.16 4846.16/26104= 18.56% 25.42%-18.56%= 6.86% 6661-2409.22= 4251.78 4251.78/27111.5= 15.68% 21.11%-15.68%= 5.43% 5839-2131.1= 3696 3696/27787.5= 13.3% 17.44%-13.30%= 4.14% 4846.16/74754= 6.48% 74754/26104= 2.86 4251.78/70395= 6.04% 70395/27111.5= 2.60 3696/67997= 5.44% 67997/27787.5= 2.45 2013 7853/632=12.42 2012 6674/606=11.01 2011 5803/503=10.95 (7221+545+1568)/632= 14.77 6975/(1321+9475)= 0.65 (6068+593+1573)/606= 13.59 6651/(30+10758)= 0.62 (5273+566+1616)/530= 14.07 4585/(1042+8707)= 0.47 (6975-1312)/(1321+9475) = 0.52 (6651-1221)/(30+10758) = 0.49 (4585-1096)/(1042+8707) = 0.36 15372/11462= 1.34 (2994+1395)/11462= 0.34 23307/17777= 1.31 (1321+9475)/17777= 0.61 14520/9376= 1.55 (1984+1245)/9376= 0.34 22620/17898= 1.26 (30+10758)/17898= 0.60 13499/10122= 1.33 (545+1085)/10122= 0.16 21236/18889= 1.12 (1042+8707)/18889= 0.52 13
  15. 15. ` References US Securities and Exchange Commission: (http://www.sec.gov/Archives/edgar/data/354950/000035495013000008/hd-232013x10xk.htm) Financial Statement Analysis and Valuation (3rd Edition) by Easton & McAnally Bloomberg (www.bloomberg.com) Morningstar (www.morningstar.com) 14

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