The Home Depot

BU657
Case Presentation
May 6, 2006
The Home Depot
Group Presenters

Anouska Harris
Kevin Melo
Kate Richard
Rafael Torres
Agenda
Home Depot - Overview
Business Strategy
Analysis of Accounting Policies
Evaluating Performance
Is the Strategy Viable?
Closing Remarks
Home Depot Overview (1)
Case Date: 1986
The Home Depot: Founded in 1978
Market: Do it yourself (DIY) market selling a large
selection of building materials and home
improvement products
3 stores opened in Atlanta 1979 and grew rapidly in
the sunbelt geography.
Sales in 1979: $7mm
The Home Depot went public 1981
Initially traded over the counter
Listed on NYSE (HD) in 1984
Home Depot Overview (2)
1985
Sales: $700mm
Assets: $380.2mm
Earnings: $8.2mm
Customers: 23.3mm
Markets served:15
Stores: 50
Employees: 5,400
Business Strategy (1)
What is Home Depots Business Strategy?
Business Strategy (2)
What is Home Depots Business Strategy?
Focused on DIY segment of market
Keep costs low through low overhead,
purchase discounts, and high inventory turns
Attracting customers through aggressive
advertising and competitive pricing
Providing high quality service to customers
Business Strategy (3)
What is Home Depots Business Strategy?
Provide high service to target customers
with well paid ees
well trained ees
well stocked stores
Focus on the relationship (helping customers
choose the right product and provide assistance
throughout the project)
Shopping convenience (7 days, evening hours)


Analysis of Accounting Policies
Revenue Recognition
Cash-and-carry basis
Inventory Valuation
Stated at lower of cost or market
FIFO method
Overall Impression
Nothing unusual for retail sales company
Dupont Ratio Analysis



Net Profit Margin = Measures how many cents of income is
earned on each dollar of sales
Asset Turnover = Measures how efficiently assets are used to
generate sales
Financial Leverage = Measures degree of indebtedness (risk)
Return on Equity = Measures rate of return on Shareholders
investment
Evaluating Performance (1)
SE
NI
SE
Assets
X
Assets
Sales
X
Sales
NI

Evaluating Performance (2)

Net Profit Margin: 8,219,000
= 1.17%
700,729,000
Asset Turnover: 700,729,000
= 1.84
380,193,000
Financial Leverage: 380,193,000
= 4.27
89,092,000
Return on Equity: 8,219,000
= 9.23%
89,092,000
Evaluating Performance (3)
Profitability 1986 1985 1984
Net Profit Margin Home Depot 1.2% 3.3% 4.0%
Hechinger 4.8% 5.2% 5.3%
Return on Equity Home Depot 9.2% 17.6% 15.7%
Hechinger 15.8% 18.9% 19.1%
Asset Management
Total Asset Turnover Home Depot 1.84 1.74 2.43
Hechinger 1.48 1.72 2.02
Debt Management
Financial Leverage Home Depot 4.27 3.11 1.61
Hechinger 2.21 2.12 1.79

Dividend Payout Ratio Home Depot 0 0 0
Hechinger 0.93 0.95 0.95

Sustainable Growth Rate Home Depot 9.2% 17.6% 15.7%
Hechinger 14.7% 18.0% 18.1%
Evaluating Performance (4)
Physical Analysis (from Exhibit 1)






Average Sale per customer is $30
Stores are getting bigger but not selling more
1985 1984 1983 1982 1981
Sales per Store ($M) 14.0 14.0 13.5 11.8 6.4
Sales per Transaction $ 30.07 $ 30.27 $ 30.14 $ 28.00 $ 27.11
Sales Transactions per Store (K) 466.0 461.3 447.4 420.0 237.5
Sales per Square Footage $ 175.18 $ 180.33 $ 183.00 $ 168.00 $ 85.83
Evaluating Performance (5)
Time-Series vs. Cross-sectional approach

Exercise (15 minutes)
Gross Profit Margin
Inventory Turnover
Debt to Asset
Which company would you invest in?
Evaluating Performance (6)
Cash Flow Analysis (pg 5-56)
Negative cash flow from operations for all 3
years
Inventory increases
Store expansions (property and equipment)
Most cash provided through LT Debt
Hechinger had positive cash for all 3 years
Evaluating Performance (7)
Assessment:
Home Depot is expanding fast
Loosing control of costs
Heavy reliance on debt financing
Is The Strategy Viable? (1)
Can they continue to provide low prices
and offer high levels of service?
Is their growth strategy sustainable?

1987 Projected Income Statement
1986 Net Sales (5-54) $700,729,000
Assume 1987 Net Sales $1,000,000,000

EBIT = Earnings Before Interest and Taxes

1986 1985 1984
EBIT/Sales 0.0311 0.0702 0.0745

Average Annual Decline = 0.0217
1987 EBIT/Sales = 0.0311 - 0.0217 = 0.0095

Assume 1987 EBIT = $9,500,000
1987 Projected Income Statement
EBIT $9,500,000 (Previous Slide)
Interest (Exp-Inc) (8,725,000) (Same as 1986/5-54)
Profit Before Tax 775,000
Taxes (0.461) (357,275)
Net Income $417,725
1987 Projected Cash From
Operations
Net Income $417,725 (Previous Slide)

Add Back Non-Cash Expenses (5-56)
Depreciation 4,376,000 (Same as 1986)
Deferred Income Tax 3,612,000 (Same as 1986)
Working Capital 8,405,725

Changes in Working Capital (5-57)
Inventory (46,994,000) (Avg. r1985 and 1986)
Receivables (11,484,500) (Avg. r1985 and 1986)
Payables 24,560,000 (Avg. r1985 and 1986)

Net Cash From Operations $(25,512,775)

Cash Required for Expansion
(5-47)
Site Acquisition and Construction $6,600,000

Inventory (Net of Vendor Financing) 1,800,000

8,400,000

x 9 Stores

Cash Required for Expansion $75,600,000


Total Cash Needed
Net Cash From Operations
$(25,512,775)

Cash Required for Expansion
(75,600,000)

Total Cash Needed in 1987
$(101,112,775)



Line of Credit
Line of Credit = $200,000,000
$88,000,000 Outstanding, $112,000,000 Available ???

(5-64) Note 3 Restrictions
1. Minimum tangible net worth of $150,000,000 (1985),
increasing annually to $213,165,000 by Jan 1989

Tangible Net Worth = Total Assets - Goodwill - Current
Liabilities - Long-Term Debt - Other Liabilities

Tangible Net Worth = $71,218,000 (Default)

Line of Credit Restrictions
2. Debt to tangible net worth ratio of no more than 2 to 1

= Total Liabilities/ (Assets Goodwill)
=0.8 a

3. Current ratio of not less than 1.5 to 1

=Current Assets/ Current Liabilities
=2.3 a

Line of Credit Restrictions
4. Ratio of EBIT to Interest Expense, net, of not less
than 2 to 1

1987 EBIT (Previous Slide) $9,500,000
x 50%
Max. Net Interest Expense $4,750,000

Current Interest (Previous Slide) $8,725,000
Default

The Home Depot Update 1987
Dramatic increase in profitability in 1986 and 1987
Sales continue to grow = 1986: $1.001 billion
1987: $1.454 billion

Net Earnings = 1986: $23.8 million
1987: $54.1 million

Return on Sales = 1986: 2.4% increase
1987: 3.7% increase

Number of transactions per store = 38% increase from 1985 to
1987 (466,000 - 641,000)

Positive Cash flow of: 1986: $66.8 million
1987: $56.2 million
The Home Depot Update 1987
Dramatic increase in profitability in 1986 and 1987
Company Stock Price =
2/3/1986: $13.125
2/2/1987: $22.375 (increase of 70%)

Debt to Equity = 1985: 2.7
1987: 0.91

Home depot took steps to reduce operating costs
which led to an increase in profitability without
sacrificing growth.
Markets rewarded these developments, enabling
the company to issue equity and reduce debt.
The Home Depot Update 2006
Revenues: $81.5 billion
Net Earnings: $5.8 billion
Assets: $44.5 billion
Stores: 2042
Stock Price: (4/28/06) $39.93
52 Week
High Low
43.98 34.56
20 Jul 2005 29 Apr 2005
*2005 Annual Report Data
Hechinger Update 2006
Was a Home Improvement Retail Industry giant with
200 stores.
1996 Revenues: $2,199,067 (3 consecutive years
with declining sales and million dollar losses.
Could not handle competitive market pressures
(Home Depot & Lowes).
Files CHAPTER 11 in 1999.
Liquidated assets
Home Dcor sell Hechinger brand through e-tailing
network.
Closing Remarks
What value is there in Ratio Analysis?
Pros / Cons
How do analysts assess a company?