30 August 2009

HD: Financial Gauge Analysis for the July 2009 Quarter

In an earlier post, we examined The Home Depot's (NYSE: HD) Income Statement for the second quarter of 2009 and compared it to our "look-ahead" estimates.  Earnings in this period, which ended 2 August, fell from $0.71 to $0.66 per share.

Home Depot is the largest retailer of do-it-yourself merchandise, which includes building materials, home improvement supplies, and lawn and garden products.

We have since mined Home Depot's financial statements in the earnings announcement to update the metrics we use to assess Cash Management, Growth, Profitability and Value. This post reports on these metrics and the Financial Gauge scores.

The press release included an Income Statement, a condensed Balance Sheet, and some limited Cash Flow data, but no Cash Flow Statement.  Since some undisclosed details are needed to compute the gauge scores, we had to make certain estimates for this analysis.

We will adjust the scores after Home Depot files a complete 10-Q report with the SEC.

In the mean time, Home Depot's preliminary GCFR gauge scores are as follows:

Because Home Depot restructured substantially in 2007, our gauge scores should be treated with an extra dose of skepticism.  The GCFR approach includes comparisons between current financial data with historic results, but the validity of these comparisons degrades when the subject company reorganizes.

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash ManagementAug 2009May 2009Aug 20085-Yr Avg
Current Ratio1.
Debt/CFO (years) (*)
Inventory/CGS (days)
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)
Working Capital/Invested Capital14.6%10.2%10.9%11.2%
Cash Conversion Cycle Time (days)44.842.741.042.2
Gauge Score (0 to 25)6765
(*) Based on estimated Cash Flow from Operations in the most recent quarter.

Long-term Debt has decreased slowly, but steadily, since it jumped in 2007 to finance a massive share repurchase.  Although the Inventory reduction, relative to last quarter, is a positive, Inventory still appears too high. 

The quarter's increase in Working Capital was the result of a reduction in Current Liabilities, especially Accounts Payable and Accrued Expenses.  The lack of improvement in Days of Sales Outstanding and the Cash Conversion Cycle Time, which degraded, kept the gauge score in check. 

The up-tick in Debt/CFO needs to be confirmed with data in the 10-Q.

GrowthAug 2009May 2009Aug 20085-Yr Avg
Revenue growth-10.4%-9.3%-2.9%-2.8%
Operating Profit growth-20.1%-19.3%-8.0%-11.6%
CFO growth (*)-1.9%-6.4%-28.5%19.7%
Net Income growth-27.8%-31.7%-28.9%-15.6%
Gauge Score (0 to 25)3004
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.  The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

(*) Based on estimated Cash Flow from Operations in the most recent quarter.

Revenue, Cash Flow, and Net Income are all down substantially.  The score moved off zero because the rates of decline have tepidly improved.
ProfitabilityAug 2009May 2009Aug 20085-Yr Avg
Operating Expenses/Revenue92.7%92.6%91.6%90.2%
Free Cash Flow/Invested Capital (*)13.4%12.7%6.1%9.5%
Accrual Ratio (*)-3.2%-3.1%-20.1%1.3%
Gauge Score (0 to 25)7889
(*) Based on estimated Cash Flow from Operations in the most recent quarter.

The Operating Expense ratio only rose by 0.1 percent, which seems promising in this difficult retailing environment.  We await an updated Cash Flow statement to get a better read on Profitability, but for a company in the midst of the housing slump, the estimated ROIC and FCF figures don't look too bad.

ValueAug 2009May 2009Aug 20085-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO) (*)10.410.410.312.0
Gauge Score (0 to 25)77158
(*) Based on estimated Cash Flow from Operations in the most recent quarter.
Home Depot's stock price slipped 1.4 percent, from $26.32 to $25.94, from the end of April through the end of July.  PEG doesn't apply when earnings growth is negative.

The P/E ratio was inflated because we didn't exclude some special charges that weighed down in earnings.

OverallAug 2009May 2009Aug 20085-Yr Avg
Gauge Score (0 to 100)28273830

The gauges held their ground in the second fiscal quarter, but the score is too low to stir any interest.  The financial statements in the 10-Q might lead to some scoring adjustments, but we doubt they will be significant.

Full disclosure: Long HD at time of writing.

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