29 February 2008

HD: Financial Analysis through January 2008

We have analyzed Home Depot's (HD) preliminary report for the January 2008 quarter, and this post reports our tentative results. The financial statements in this report were not complete: the Balance Sheet was abbreviated and the Cash Flow Statement was omitted. We will update our evaluation after the company submits a complete 10-K report to the SEC.

2007 was a momentous year for the largest retailer of "do-it-yourself" merchandise, which includes building materials, home improvement supplies, and lawn and garden products. Robert Nardelli, now at Chrysler, was forced out as Chairman and CEO because of dissatisfaction with the company's operating performance, stagnant stock price, and bountiful executive compensation. His elephantine severance package became a cause célèbre. After Frank Blake took over, the company decided to sell the Home Depot Supply division, which served professional contractors. The purchase by a consortium of private equity firms closed on 31 August 2007 for $8.5 billion, which was $1.8 billion less than the figure originally negotiated. The company used the proceeds and other funds to complete a $10.7 billion Dutch Auction tender offer for its own shares. The offer is part of a larger $22.5 billion "recapitalization" plan, although there has been speculation that the further share repurchases will be delayed considerably.

A fund controlled by Sears Holdings chairman and successful investor Edward Lampert acquired 16.7 million Home Depot shares, valued at $541.3 million, during the third quarter.

We analyzed Home Depot after the October 2007 quarter. The analysis omitted gauge scores because we didn't have sufficient financial data representative of the new corporate structure.

Before we examine the metrics associated with each gauge, let's compare the latest quarterly Income Statement to our previously communicated expectations. Please note that the presentation format below, which we use for all analyses, may differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.

($ M)

Jan 2008
Jan 2008
Jan 2007

Op expenses

CGS (11605)


SG&A (4353)
(3767) (4000)

Operating Income
Other income


Interest, etc.
Pretax income

Income tax

Net Income

Discontinued ops

84 (0.04)
1. 14 weeks
2. 13 weeks and restated

Revenue in the January 2008 quarter was 1.5 percent more than in the year-earlier quarter and 3.1 percent greater than our prediction. However, Revenue increased only because the recent quarter included an extra, 14th, week. If we multiply $17.659 billion by (13/14), the equivalent 13-week revenue figure is $16.398 billion. On this basis, Revenue in the January 2008 quarter was 5.8 percent less than in the year-earlier quarter. Similarly, on a comparable week basis, Revenue was 4.2 percent below our prediction.

As for Operating Expenses, we thought the Cost of Goods Sold (CGS) would be 66.6 percent of Revenue, and the actual value was nicely lower at 65.7 percent. Depreciation expenses were 2.6 percent of Revenue, fractionally above our 2.2 percent estimate. Sales, General, and Administrative (SG&A) expenses were 24.7 percent of Revenue, significantly higher than our forecast of 22.0 percent.

The soaring SG&A costs outweighed the lower CGS. On the whole, Operating Expenses were 2.1 percent of Revenue greater than we expected. This led to Operating Income 20.7 percent below the forecast value.

Non-Operating interest expense was a substantial $52 million greater than we expected. The slightly lower than expected Income Tax Rate, 36.5 percent vs. 37.0 percent forecast, wasn't enough to compensate for the higher expenses. As a result, Net Income fell below our prediction by a dismal 25.8 percent.

Cash Management. We estimate the value of this gauge at 8 points.

The following measures contributed the most to the score:
The following measures contributed the least to the score:
  • Current Ratio =1.2; much weaker than we prefer, but not too much below the five-year median value of 1.3.
  • LTD/Equity = 64.3 percent, up from 46.5 percent last year; the company has, intentionally, become much more leveraged as it borrows money to repurchase shares.
  • Inventory/CGS = 87.3 days, compared to 84.2 days 12 months ago. The five-year median is much less at 77.4 days, which suggests that sales have been slower than expected.
  • Working Capital/Market Capitalization = 3.0 percent, down from 5.4 percent in January 2007.

Growth. We estimate the value of this gauge at 10 points.

The following measure was the only one that contributed meaningfully to the score:
  • Revenue/Assets = 174.5 percent, way up from 151.2 percent in a year; stock repurchases decrease assets, which create the illusion of improved sales efficiency.
The following measures contributed little to the score:
  • Revenue growth = -2.1 percent year-over-year, compared to -3.1 percent previously
  • Net Income growth = -20.1 percent year-over-year, compared to -9.8 percent
  • CFO growth = -17.6 percent year-over-year (estimated), down from +15.7 percent.

Profitability. We estimate the value of this gauge at 6 points.

The following measures contributed the most to the score:
  • FCF/Equity = 15.6 percent (estimated), down from 16.5 percent
  • ROIC = 15.0 percent, down just a tad from 15.2 percent in a year
The following measures contributed little to the score:

Value. Home Depot's stock price edged down from $31.51 on 31 October 2007 to $30.64 on 31 January 2008. Using January's closing price, we estimate the value of this gauge at 14 points.
  • Enterprise Value/Cash Flow = 10.2 (estimated), down from 12.1 in January 2007 and a five-year median of 12.8.
  • P/E = 12.2, down from 15.5 one year earlier. The five-year median P/E is 15.7 (when the company was growing)
  • P/E to S&P 500 average P/E = 29 percent discount, compared to a five-year median of a 9 percent discount
  • Price/Revenue ratio = 0.72, down from 1.0 last year and its five-year median of 1.07.
The average P/E for the Retail (Home Improvement) Industry is currently 12.8. The average Price/Revenue for the Industry is currently 0.72.

We need the full set of financial statements that will be in the 10-K report, but our initial assessment of the Overall Gauge score is 41 out of 100 possible points. The Cash Management, Growth, and Profitability Gauges are all rather weak -- and they might have been even weaker if not for the 14-week quarter -- but the punishment applied to Home Depot (HD) shares is perking up the Value Gauge.

No comments:

Post a Comment