30 May 2009

INTC: Look Ahead to June 2009 Quarterly Results

The GCFR Overall Gauge of Intel Corporation (NASDAQ: INTC) sank from 53 to 29 of the 100 possible points in the first quarter of 2009, which ended 28 March 2009.  Our initial and updated analysis reports explained in some detail how the score was attained.

The decline in sales of computer chips, which was painfully evident in late 2008, continued into 2009.  Intel's Revenue in the first quarter was 26 percent less than in the March 2008 period.  The resulting inefficiencies ("factory underutilization") brought the Gross Margin down to 45.3 percent, which was a shade lower than the September 2001 quarter and the worst since 1994.  Net Income dropped 56 percent, and the fall would have been steeper if there had not been significant tax benefits (the income tax rate was zero).  In the last four quarters, Cash Flow from Operations tumbled 31.6 percent, and Free Cash Flow dived from 30 percent of Invested Capital to 11 percent.

We have now modeled Intel's Income Statement for the quarter that will end on 27 June 2009.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company will announce on 17 July.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we present some background information.

Intel Corporation is the foremost manufacturer of integrated circuits for computers, servers, hand-held devices, and communication products. 

The company's most direct competitor in the market for general-purpose microprocessors has long been the scrappy, smaller, and now financially stressed, Advanced Micro Devices (NYSE: AMD).  However, NVIDIA (NASDAQ: NVDA) has also emerged as a competitor as new uses are being found for high-power Graphics Processing Units.  NVIDIA is fostering this view, and has even discussed making its own general-purpose x86 microprocessor.

With Larrabee, expected in 2010, Intel will have its own potent entry in the competition for general-purpose GPUs.

With financially strapped consumers and businesses buying fewer computers, the semiconductor industry has been one of the casualties of the ailing worldwide economy.  Hewlett Packard (NYSE: HPQ) and Dell (NASDAQ: DELL) are Intel's two largest customers.  According to an IDC report quoted in eWeek.com,

"Worldwide PC shipments—including desktop and portable PCs, but excluding x86 servers—were down 7.1 percent" in the first quarter of 2009, relative to the same period of the previous year. 

The Semiconductor Industry Association reported that sales declined year-over-year in 2008 for the first time since 2001.  In the first quarter of 2009, semiconductor sales were 29.9 percent less than in year-earlier period. 

Many of the popular, low-priced netbook PCs are built around an Intel Atom CPU.  Although the Atom is helping to lift Intel's share of the microprocessor market, this device is less profitable for Intel than the more capable microprocessors in its product line.

Intel has faced antitrust charges for many years and in many jurisdictions.  In May of this year, the European Union fined Intel more than 1 billion Euros for anti-competitive actions.

When Intel announced its first quarter results, it provided the following quantitative guidance for the second quarter of 2009:
  • Due to continued economic uncertainty and limited visibility, Intel is not providing a revenue outlook at this time. For internal purposes, the company is currently planning for revenue approximately flat to the first quarter.
  • Gross margin percentage: Expected to be in the mid-40s.
  • Spending (R&D plus MG&A): Approximately flat to the first quarter.
  • Restructuring and asset impairment charges: Approximately $115 million.
  • Net loss from equity investments and interest and other: Approximately $150 million.
  • Depreciation: Approximately $1.2 billion.

Intel had good reasons to be cautious about the Revenue outlook, but we currently believe it is more likely than not (i.e., we guess) Revenue will be somewhat higher in the second quarter than in the first.  For one thing, as mentioned above, worldwide semiconductor sales were extraordinarily weak in the first three months of 2009.  However, sales in March were 3.3 percent more than in February.  While a one-month improvement is hardly a sure sign of recovery, Paul Otellini, Intel President and CEO, stated:

    “We believe PC sales bottomed out during the first quarter and that the industry is returning to normal seasonal patterns."

The latest reports of Dell, HP, and NVIDIA, which have quarters that extend into April, tell a mixed story.

Given this sketchy information, we will set a 5-percent target for Revenue growth over the first quarter's $7.145 billion.  Our $7.5 billion estimate might seem optimistic, but it is 21 percent less than Revenue in the second quarter of 2008.

The guidance from Intel indicates they expect a Gross Margin percentage in "the mid-40s," which is a relative low figure for Intel.  Revenue uncertainty also makes it difficult to project the Gross Margin because diminished sales lead to production inefficiencies.  We assume the Gross Margin will be one point higher than the first-quarter's very weak 45.3 percent.  Given the Revenue estimate above, our target for CGS is (1 - 0.463) * $7.5 billion = $4.0 billion.

R&D and SG&A costs in the first quarter totaled $2.5 billion, and Intel's guidance implies the amount will be similar in the second quarter.  Lacking any better information, we will assume the second-quarter values for these two expense categories will match the first quarter values.

We will also accept without change the company's $115 million estimate for restructuring and asset impairments charges.

With these assumptions, the estimated Operating Income for the quarter is $842 million.  This amount would be down 63 percent from the June 2008 quarter.  However, the estimate is 30 percent greater than Operating Income in the first quarter of 2009.

Intel's guidance for equity investments, interest and other non-operating income is a net loss of $150 million.  To fit this within our presentation, we partition the loss as a $250 million loss on equity investments and a $100 million gain on interest and other income.

The non-operating figures would drop Pre-tax Income to $692 million.  For the income tax rate, we have used Intel's estimate of 24 percent. 

Therefore, we end up with a second-quarter Net Income estimate of $526 million ($0.09 per share).  In the second quarter of 2008, Net Income was $1.6 billion ($0.28 per share).

Please note that the Income Statement presentation format we use for all analyses may differ in material respects from company-used formats and terminology.  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.

Click here for a larger version of the spreadsheet.

Full disclosure: Long INTC at time of writing.

26 May 2009

Summary of First-Quarter 2009 Scores

We have nearly finished reviewing the first-quarter 2009 financial results for the following 18 companies:

When HD and WMT file their 10-Q reports, we will close out the quarter for good.

The following table summarizes the gauges and the changes to the scores during the first quarter:

Overall_Gauge and change (100 = max) Strongest Gauge and score (25=max)
Weakest Gauge and score (25=max) Gauge Rising the Most Gauge Falling the Most
59(-4) Value(17)
Cash Mgt (10)
53(-12) Value(20)
None Growth(-10)
32(-28) Profitability(15) Value(1) Growth(+3)
54(-17) Value(15) Growth(0) None
45(-1.5) Value(12) Profitability(9) Value(+1) Growth(-2.5)
Edison Int'l
Home Depot
23 (-11)Cash Mgt (7)Growth(0)Cash Mgt(+2)Value(-6)
29(-24) Cash Mgt (10) Growth(0) None Value(-9)
King Pharma
69(-2) Value(25)
Growth(3) Cash Mgt(+1)
42(-1) Value(17) Growth(0) Cash Mgt(+1) Profitability(-1)
20(-11)Cash Mgt (7)Growth(0)None
49(-3) Value(16) Growth(0)
Cash Mgt(+2) Profitability(-6)
64(+6) Value(25)
Cash Mgt(+6) None
Cash Mgt(9)
Cash Mgt(+2)Value(-3.5)
Watson Pharma

Before we make a few observations about this table, two cautions (in addition to our normal caveats) need to be emphasized.  This group of companies is not, by a long shot, a representative sample of the market or any segment of the market.  Also, the Value gauge scores were based on share prices at the quarter's end date, which was nearly two months ago in many cases.

Microsoft and Tidewater achieved the highest Overall Gauge scores when the first-quarter results were considered, and both had perfect, rarely seen 25-point Value Gauge scores.  The share prices, by this measure, appear to have fallen disproportionately relative to business fundamentals. 

We see a mixed Value story when looking at the other companies on the list.  The Value gauge had the highest score of the individual gauges for a majority of the firms.  In a few cases, this gauge was the one that gained the most in the first quarter.  However, we also have many cases where the Value gauge fell significantly during the first quarter.  Some share-price rebounds off the late 2008 lows could have been a little too robust.

The Growth Gauge was the laggard for many companies, and zero-point scores were all-too common.  Cash Management improved at firms that took steps to raise cash, refinance debt, reduce inventories, or become more efficient in some other way.

Full disclosure: Long all companies mentioned above, with two exceptions.  No position in NRTLQ and WPI at time of writing.

24 May 2009

PRGN: Financial Analysis through March 2009

Paragon Shipping, Inc., (NASDAQ: PRGN) earned $0.71 per share, up from $0.59, in the first quarter of 2009, which ended on 31 March.  The latest results were announced in this press release.  Typographical errors in the announcement were corrected in this 6-K/A.

This post provides an abbreviated GCFR analysis of the financial statements.  Paragon, which was established in late 2006 and went public in August 2007, is too new to determine meaningful gauge scores.  However, this post does list the financial metrics we would otherwise use to compute the scores.

First, we present some background information.

Paragon Shipping, Inc., owns and charters ships that carry dry bulk cargoes.  The company is officially registered in the Marshall Islands, but Voula, Greece, is where Paragon is headquartered.  It is important to note that Michael Bodouroglou, the Chairman and CEO,  also controls the company, Allseas Marine S.A., that manages Paragon's fleet.

The fleet now comprises 12 ships of three different types.  The twelfth vessel, the Friendly Seas, was purchased in August 2008 for $79.25 million.  Paragon generally charters its ships for extended periods -- one to five year "time charters" that have predictable revenues --  but the company can also enter into "spot charters" contracts for periods as short as a single voyage.

When  Paragon had its IPO, the company sold almost 11 million Class A common shares for $16 per share.  After expenses of $1.04 per share (is that high?), the sale brought in $164.5 million.  These funds, along with $318 million in debt assumed in 2007, have been used to build and expand the company's fleet.

In June 2008, Paragon's share price was over $21.  However, the ensuing collapse of the Baltic Dry Index of shipping rates caused the price of Paragon's share to tumble as low as $2.37 by November of that year.  In 2009, the shares have generally traded in a range between $3 and $6.  Last week, when the first quarter results were announced, the price bounced up to the higher end of the range.

Since Paragon had chartered its vessels under long-term contracts, the company's Revenue did not immediately follow the BDI's plunge.  However, as contracts expire, Paragon's charters will have to adjust to the lower market rates to keep its vessels active. 

While there are now over 700 ships idle off Singapore as consequence of the downturn in global trade, Paragon's strategy of long-term charters has prevented it from suffering this fate.  According to the press release,

" ... Paragon has 98% of its revenue days covered for 2009, 64% for 2010 and 39% for 2011 with some of the world's leading charterers."

It appears, not surprisingly, that lower rates have also reduced the value of the vessels themselves.  Well-capitalized shippers that believe the downturn is temporary could view the current period as an opportunity to expand their fleets.

Before we examine Paragon's financial metrics, we will review the latest quarterly Income Statement.  Unlike our practice with more established companies, we didn't make an earnings projection for the quarter. 

Paragon's financial statements are prepared in accordance with U.S. GAAP.  The currency is U.S. Dollars. 

The spreadsheet below displays Paragon's results in our normalized presentation.  Click here for a larger view of the spreadsheet.  Please note that the tabular format, which we use for all analyses, can and often does 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.

Revenue (after commissions totaling 5.4 percent) in the March 2009 quarter was 1.6 percent greater than in the first quarter of 2008.  Positive revenue growth was achieved despite lower market rates because Paragon had one more ship operating in the latest period.  Revenue was down 7 percent from the immediately preceding December 2008 quarter.

The Cost of Goods Sold -- i.e., Voyage expenses + Vessel operating expenses + Dry-docking expenses -- was 13.7 percent of Revenue in the latest quarter, which translates into a Gross Margin of 86.3 percent.  In the year-earlier quarter, the margin was 89.0 percent. 

Dry-docking expenses fell from $112,500 to $39,700. 

Depreciation expenses were 21.7 percent of Revenue, up from 20.3 percent last year.  Paragon depreciates its vessels on a straight-line basis, assuming each has a useful life of 25 years from delivery.  The oldest ships in Paragon's fleet were built in 1995.
Sales, General, and Administrative (SG&A) expenses, in which we include related-party management fees, were 4.8 percent of Revenue.  These expenses were 5.3 percent of Revenue one year earlier.  Paragon states: 

We paid Allseas an average management fee of $783 per day per vessel during the three months ended March 31, 2009, and an amount of $50,000 that was charged by Allseas to us for legal, accounting and finance services that were provided throughout the period as per signed agreement date February 19, 2008.

Operating Income slipped 4.3 percent as higher operating cost and depreciation outweighed the small increase in Revenue and small decrease in SG&A.  Operating Income was, however, 1 percent greater than in the December 2008 quarter.

In the March 2008 quarter, Paragon recorded a $5.2 million loss on an interest rate swap, which is a financial mechanism that limits exposure to interest rate fluctuations.  The latest quarter also included a swap loss, but it was only $300,000.  The much-reduced swap loss helped slash non-operating expenses in half, and this savings enabled Net Income overcome the Operating Income decline and exceed last year's value by an eye-catching 22 percent.

Paragon paid no income taxes in either period.

Now for the metrics associated with our gauges.  As mentioned above, gauge scores are not provided because they would not be meaningful given Paragon's limited existence as a public company.

Cash ManagementMarch 20093 months prior12 months prior
Current Ratio0.91.02.9
LTD/Equity 99%109%105%
Debt/CFO 4.2 years4.6 years6.1 years
Inventory/CGS N/AN/AN/A
Finished Goods/Inventory N/AN/AN/A
Days of Sales Outstanding (DSO)3.2 days2.5 days1.4 days
Working Capital/Invested Capital -1.1%0.5%6.1%
Cash Conversion Cycle TimeN/AN/AN/A

Paragon raised cash in 2006 and 2007 by selling common shares to the public and with debt offerings.  The cash was used to purchase ships for transporting dry-bulk cargoes, and these ships were then chartered to other firms.  Each new ship put into service brings in Cash Flow from Operations that makes the debt level easier to bear.  The danger is that a sustained period of lower charter rates will depress Cash Flows, but the debt payments will still have to be made.

Paragon had $59 million in cash and cash equivalents on 31 March 2009.  This would cover the $53 million of long-term debt that has to be repaid or refinanced in 2009.  The company has $324 million of other long-term debt.

GrowthMarch 20093 months prior12 months prior
Revenue growth63.4%120%N/A
Revenue/Assets 21.7%21.7%14.8%
CFO growth 72.6%95.2%565%
Net Income growth 390%>1000%N/A
Growth rates are trailing four quarters compared to four previous quarters.

These sliding year-on-year growth rates look impressive, but it is important to note that Paragon was still in its start-up phase during the four quarters that ended in March 2008.  The company's capital structure and fleet size have been stable for the last couple of quarters, so it won't be long now before the growth rates provide a more realistic view of the company's performance.

ProfitabilityMarch 20093 months prior12 months prior
Operating Expenses/Revenue 42.1%41.2%67.1%
ROIC 8.7%15.1%5.8%
Free Cash Flow/Invested Capital 1.5%0.5%-56%
Accrual Ratio 14.3%8.6%49%

It's too early to say for sure, but the Operating Expense ratio seems to have a settled in an area that yields substantial Operating Income.

Because size of Paragon's fleet is still relatively small, and ships are expensive, each vessel purchased as an investment in the future represents a significant capital expenditure relative to present Cash Flow.  Each new vessel, therefore, temporarily depresses the Free Cash Flow ratio.  Should a year elapse without a new purchase, the FCF would increase substantially.

ValueMarch 20093 months prior12 months prior
P/E 1.31.927.3
P/E vs. S&P 500 P/E 8.3%9.8%155%
Enterprise Value/Cash Flow (EV/CFO) 4.65.412.9

A Price to Earnings ratio under two, and an earnings growth rate so high the PEG is zero, will get any value investors attention.  However, for all the reasons described above, future earnings are not assured and recent growth rates are unlikely to be repeated.

Paragon's valuation ratios can be compared with other companies in the Shipping industry.

In the March 2009 quarter, Paragon's revenue increased slightly relative to 2008 because the fleet size had expanded.  Higher operating costs were, however, more significant, and Operating Income skidded 4.3 percent.  But, the more interesting difference between the two quarters was the earlier period had a $5.2 million loss on an interest rate swap.  In the recent period, this loss was only $300,000, which made the March 2009 quarter look better by $4.8 million.  Since Net Income was only $3.4 million higher, the effect of this non-operating item is obvious.

Paragon has $53 million of long-term debt that has to be repaid or refinanced in 2009. 

Since the first quarter ended, Paragon has sold through a "Controlled Equity Offering" more than 6.2 million common shares, at an average price of $3.65.  Given the good reception to the first quarter earnings announcement, which wasn't issued until 19 May 2009, it would be interesting to learn who was fortunate enough to buy the shares at a low price.

Note: Yahoo! Finance was the source for daily closing share prices. InvestmentTools.com was the source of the  BDI chart.

Full disclosure: Long PRGN at time of writing.

23 May 2009

CSCO: Financial Analysis through April 2009 (Update)

Cisco Systems, Inc. (NASDAQ: CSCO), the proud plumber of the Internet, has a dominant position in the market for enterprise networking products, such as routers, and related services.  Earlier this year, in an effort to broaden its product line, Cisco announced that it would begin to sell computer servers, equipped with virtualization software, for large data centers.  The company also sells devices intended for home use.

Juniper Systems (NASDAQ: JNPR) is usually considered Cisco's most direct competitor.  However, in the crowded server market, Cisco will face off against with Hewlett-Packard (NYSE: HPQ) and IBM (NYSE: IBM).

We have already posted an analysis of Cisco's financial results, which included earnings of $0.23 per share, for the three months that ended 25 April 2009.  This period was the third quarter of the company's fiscal 2009, which will end in July.

Cisco has now filed a 10-Q quarterly report with a typical set of financial statements and notes.  We reviewed the 10-Q to determine if the analysis needed updating, but filing did not change our results.  The gauge scores are almost exactly as originally calculated:

The 10-Q did not change our evaluation of the April quarter's Income Statement, although we noticed a minor restatement of the year-earlier results that we had previously overlooked. (Click here to see our normalized depiction of Cisco's Income Statements for the last nine quarters.  Please note that our presentation, which we use for all analyses, can and often does differ in material respects from company-used formats.)

The following tidbits of information were gathered from the 10-Q:

Cisco added $4.0 billion of long-term debt in the April quarter.  Half was raised by issuing 10-year notes, and the other half was raised with 30-year securities.  Although $500 million of the $4.0 billion was used to pay the principal on maturing debt, the remaining $3.5 billion went (loosely speaking) into the bank.  Cisco now has over $33 billion in cash and short-term investments.

Given Cisco's history, it is likely that some of Cisco's liquid assets will be used to acquire companies that have technologies coveted by Cisco. The 10-Q makes this plain:

"[W]e will attempt to use the current economic downturn as an opportunity to expand our share of our customers’ information technology spending and to continue moving into product markets similar, related, or adjacent to those in which we currently are active, which we refer to as marketadjacencies."

It would also be reasonable to expect that Cisco will continue to use its cash to repurchase its own shares.  In the April quarter,  Cisco paid $1.2 billion to repurchase 77 million shares at an average price per share of about $15.58.

In the April quarter, Cisco's sales fell by 14 to 22 percent in each of five defined geographic areas.  The decline was steepest in the Emerging Markets and Asia Pacific areas.  Although other U.S.-based multinational companies have stated that a stronger U.S. dollar negatively affected their sales figures, Cisco says that currency fluctuations have not had a material effect because most of the company's sales are denominated in dollars.

Cisco's revenue from the sale of routers fell 32 percent in the April quarter, and switches brought in 20 percent less revenue.  Revenue from products dropped 22 percent, but revenue from services increased 9 percent.

The 10-Q attributed the sales decline to the effect of

"the global macroeconomic downturn across our geographic theaters"

and the consequent

"cautious spending by customers in [all] markets."

We were somewhat surprised that Cisco stated a belief that

"the U.S. economy may be the first major economy to recover."

Full disclosure: Long CSCO at time of writing.

22 May 2009

NVDA: Financial Analysis through April 2009 (Update)

NVIDIA (NASDAQ: NVDA) builds specialized Graphics Processing Units, which perform the intensive computations required to produce realistic images for video games and other applications.

We have already posted an analysis of NVIDIA's financial results, which included a loss of $0.37 per share, for the three months that ended 26 April 2009.  This period was the first quarter of the company's fiscal 2010.

Our earlier evaluation of the April quarter was incomplete because NVIDIA's press release did not include a Cash Flow Statement and the Balance Sheet omitted some details.  Since we didn't yet have all the data required to compute exact GCFR gauge scores, the scores we posted were based on a mix of actual and estimated data.

NVIDIA subsequently filed a 10-Q quarterly report with a complete set of financial statements, and we used the data in the 10-Q to update our evaluation.

This post reports on the update.

NVIDIA lost $201 million in the April 2009 quarter, and a significant contributor to this result was a $140 million charge due to the company's purchase of stock options (options that were significantly underwater) from its employees in March 2009.  Note 3 to the financial statements in the 10-Q explains the purchase and charge in some detail.  Employees that tendered their options received $3.00 cash for each option having an exercise price between $17.50 and $28.00 per share.  Options having an exercise price over $28 were redeemable for $2.00 in cash.

In the month of March, NVIDIA shares traded at prices between $7.47 and $11.85.  While we don't know the expiration periods for the purchased employee stock options, the options must have been worth much less in the cash market.  For comparison, the last quote we found for a $17.50 call option with a January 2011 expiration was $1.30.

NVIDIA spent $78 million in cash for these options, but charges to earnings totaled $140 million.  This charge was considered an operating expense, and it was spread across the Cost of Sales, R&D, and SG&A expenditure categories.

The 10-Q did not change our evaluation of the April quarter's Income Statement, although the 10-Q makes it harder to see the effect of special charges on operating expenses. (Click here to see our normalized depiction of NVIDIA's Income Statements for the last nine quarters.  Please note that our presentation, which we use for all analyses, can and often does differ in material respects from company-used formats.)

The additional data in the 10-Q did not move any of the GCFR gauges from the scores reported in the preliminary analysis.  The following are the latest values:
We adjusted the values for a few of the financial metrics we posted earlier to reflect the actual data in the 10-Q.  For completeness, we repeat the tables below with revised figures highlighted in red text.
Cash ManagementApril 20093 months prior12 months prior
Current Ratio2.92.83.1
LTD/Equity 1.1%1.1%0%
Debt/CFO 0.1 years0.1 years0.0 years
Inventory/CGS 72.6 days79.6 days57.2 days
Finished Goods/Inventory 63.2%70.1%53.9%
Days of Sales Outstanding (DSO)59.4 days52.5 days46.5 days
Working Capital/Invested Capital 131%119%168%
Cash Conversion Cycle Time65 days74 days48 days
Gauge Score (0 to 25)

The reduction in the proportion of Finished Goods in the Inventory is a positive, but the ratio is still too high relative to its five-year median value of 54 percent.

GrowthApril 20093 months prior12 months prior
Revenue growth-33.4%-16.4%36.4%
Revenue/Assets 84.0%96.5%133%
CFO growth -78.0%-80.4%36.9%
Net Income growth N/AN/A72.2%
Gauge Score (0 to 25)0
Growth rates are trailing four quarters compared to four previous quarters.

ProfitabilityApril 20093 months prior12 months prior
Operating Expenses/Revenue 104.8%95.6%79.6%
ROIC -11.9%9.1%70.6%
Free Cash Flow/Invested Capital 2.0%-13.6%67.8%
Accrual Ratio -12.9%-2.1%10.0%
Gauge Score (0 to 25)4517

A falling Accrual Ratio, in general, indicates better earnings quality because there is more Cash Flow behind each dollar of earnings.  In this case, NVIDIA's earnings have been depressed by substantial non-Cash expenditures. 

ValueApril 20093 months prior12 months prior
P/E N/AN/A14.4
P/E vs. S&P 500 P/E N/AN/A80%
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)7

OverallApril 20093 months prior12 months prior
Gauge Score (0 to 100)20

Full disclosure: Long NVDA at time of writing.

21 May 2009

HD: Financial Analysis through April 2009

Home Depot (NYSE: HD) earned $0.30 per share in the three months that ended 3 May 2009, up from $0.21 last year.  The latest results were announced in this press release.

This post provides the GCFR analysis for the period, which was the first quarter of the company's fiscal 2009.

The earnings announcement included an Income Statement, a condensed Balance Sheet, and some limited Cash Flow data, but no Cash Flow Statement.   We need some of the undisclosed details to compute accurate GCFR gauge scores; we estimated the missing data for this analysis.

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

First, we present some background information.

The Home Depot, Inc. is the largest retailer of do-it-yourself merchandise, which includes building materials, home improvement supplies, and lawn and garden products.  The company competes with Lowe's (NYSE: LOW) and a multitude of smaller hardware and lumber retailers

The depressed state of the housing market has negatively affected Home Depot. The company decided in May 2008 to forgo 50 or so planned stores in the U.S. and to close 15 existing stores.  These actions led to pretax charges of $586 million.

Then, in January 2009, Home Depot announced it would discontinue its EXPO Design Center business.  The EXPO stores "offer[ed] products and services primarily related to design and renovation projects."  To account for store closure-related asset impairments, severance pay, and other related expenses, Home Depot recorded a pre-tax charge of $387 million.  Additional charges totaling $142 million are anticipated.

RBS Partners, L.P., associated with Edward Lampert, Chairman of Sears Holdings (NASDAQ: SHLD), owned 17.8 million Home Depot shares on 31 March 2009.  Berkshire Hathaway (NYSE: BRK.A), run by investing guru Warren Buffett, owned 3.7 million shares on this date.

After Frank Blake replaced Robert Nardelli (who will soon exit Chrysler) as Chairman and CEO in early 2007, Home Depot sold HD Supply, which serves professional contractors, to a consortium of private equity firms.   As part of  the sale, Home Depot invested $325 million for a 12.5 percent equity stake in HD Supply.  In fiscal 2008,  Home Depot recorded a $163 million pre-tax charge to reflect the reduced market value of its HD Supply investment.  It should also be noted that Home Depot has guaranteed $1.0 billion of HD Supply debt.

Home Depot repurchased $10.7 billion of its own shares after the sale of HD Supply.

Looking back to the quarter that ended 1 February 2009, we are reminded that Revenue dropped 17.3 percent and Net Income fell from a $671 million gain to a $54 million loss.  Although sales were weak, the loss was more the result of the EXPO charge and the reduced value of the HD Supply investment.

The GCFR Overall Gauge slipped from 35 to 34 of the 100 possible points when the results of 2008's last quarter were considered.  The Value gauge, at only 12 of the 25 possible points, was the strongest of the four individual gauges.

Now, with actual and estimated data for the first quarter of 2009, our gauges display the following scores:

  • Overall:  23 of 100 (down from 34)

These scores are subject to change after the 10-Q report is examined.

Because Home Depot has restructured substantially during the last few years, 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.

Before examining the metrics associated with each gauge, we will compare the latest quarterly Income Statement to our previously announced 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.

Click here for a larger version of the spreadsheet.

Revenue was 9.7 percent less than in the first quarter of 2008.  The decline, though substantial, was less severe than the 17.3 percent drop experienced the preceding quarter.  We were too pessimistic with respect to Revenue in the first quarter because we expected the drop to be 12.3 percent.

The Cost of Goods Sold (CGS) was 66.3 percent of Revenue in the quarter, which translates into a Gross Margin of 33.7 percent.  The Gross Margin was slightly higher, 33.9 percent, in last year's first quarter.  Our Gross Margin target was 34.0 percent. 

Depreciation and Amortization expenses were almost $50 million less than our target.  We had assumed that the $1.9 billion figure cited in management's guidance for fiscal 2009 would be distributed equally across the four quarters.  It's too soon to know whether the value in the first quarter signals that the annual total will be less (about $1.75 billion) or whether a greater share of the expense will be incurred later in the year.

Sales, General, and Administrative expenses were 25.0 percent of Revenue, which is greater than our estimate of 24.0 percent.  The additional expense could be due to "business rationalization" charges.

The results identified above led to a 34.6 percent increase in Operating Income relative to the year-earlier quarter.  However, the prior period was weighed down by a huge $543 million charge.  Excluding the special charge, Operating Income fell by about 23 percent.

Our estimate for Operating Income was too optimistic by 4.9 percent. 

In the Non-Operating area, the net interest expense was approximately $25 million more than we anticipated.  The income tax rate essentially matched the predicted 36 percent level.

Overall, Net Income was up 44 percent (remember last year's special charge).  Our estimate was too high by 9.3 percent.

Now for the gauges:
Cash ManagementApril 20093 months prior12 months prior
Current Ratio1.21.21.2
LTD/Equity 53.7%54.4%64.0%
Debt/CFO (*)2.5 years2.1 years2.2 years
Inventory/CGS 95.1 days86.4 days97.0 days
Finished Goods/Inventory N/AN/AN/A
Days of Sales Outstanding (DSO)7.5 days5.7 days12.1 days
Working Capital/Invested Capital 10.2%7.7%7.6%
Cash Conversion Cycle Time42.7 days50.5 days43.9 days
Gauge Score (0 to 25)
(*) Based on estimated Cash Flow from Operations in the most recent quarter.

The Cash Management metrics are surprisingly stable given the state of the economy, the weak retail sector, and the housing crisis.  Debt has decreased slowly, but steadily, since 2007's restructuring and massive share repurchase.   The inventory reduction, compared to last year, suggests that the company is handling the sales slump as well as could be hoped. 

The small rise in the score was due mostly to the increased Working Capital ratio and the lower CCCT.  The up-tick in Debt/CFO was a drag on the score, but this ratio was estimated, and it needs to be confirmed by the 10-Q.

GrowthApril 20093 months prior12 months prior
Revenue growth-9.3%-7.8%-1.9%
Revenue/Assets 156%167%151%
CFO growth (*)-17.2%-3.5%-14.4%
Net Income growth -31.7%-45.1%-24.9%
Gauge Score (0 to 25)01
Growth rates are trailing four quarters compared to four previous quarters.
(*) Based on estimated Cash Flow from Operations in the most recent quarter.

Revenue, Cash Flow, and Net Income are all down substantially.  Until recently, we would have given the company credit for improved Revenue/Assets.  However, we no longer believe this ratio is germane if Revenue is falling.

ProfitabilityApril 20093 months prior12 months prior
Operating Expenses/Revenue 92.8%92.6%91.1%
ROIC 11.8%11.9%15.0%
Free Cash Flow/Invested Capital (*)11.0%12.8%7.5%
Accrual Ratio (*)0.0%-3.7%-17.4%
Gauge Score (0 to 25)7810
(*) Based on estimated Cash Flow from Operations in the most recent quarter.

The increase in Operating Expenses is indicative of the difficult retailing environment and some restructuring charges as Home Depot adapts.  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.  The rising Accrual Ratio signals weaker earnings quality.

ValueApril 20093 months prior12 months prior
P/E 18.416.113.1
P/E vs. S&P 500 P/E 107%93%71%
Enterprise Value/Cash Flow (EV/CFO) (*)11.88.510.9
Gauge Score (0 to 25)6
(*) Based on estimated Cash Flow from Operations in the most recent quarter.

Home Depot's stock price actually (and surprisingly) increased from the end of January through the end of April by 22 percent, from $21.53 to $26.32.  A surging share price, combined with weak operating performance, tends to wreak havoc on the Value Gauge!

Although the share price is back under $24, the April closing price was used to calculate the Value gauge score, per GCFR standard practice.

Home Depot's valuation ratios can be compared with other companies in the Home Improvement industry.

OverallApril 20093 months prior12 months prior
Gauge Score (0 to 100) 23

In this first quarter of fiscal 2009, Home Depot's Revenue fell 9.7 percent.  Although a Revenue decline can easily lead to a lower Gross Margin (cutting prices to boost sales is a common tactic), the Gross Margin for Home Depot in this quarter only slipped from 33.9 to 33.7 percent of Revenue. Unless there were special factors at play that invalidate the comparison, we would infer from this that Home Depot did a good job holding the line on costs.

Net Income was up 44 percent in the quarter, but the results of the earlier period were depressed by store closing and related charges.  If adjustments are made to exclude non-recurring charges, Net Income fell 16 percent.

The Cash Management gauge inched up, and the Growth and Profitability gauges slipped a point each.  These changes weren't especially significant.  However,  the Value Gauge score plunged from 12 to 6 points because the weak business performance was combined with a soaring share price.  Since the Value gauge is double-weighted, the Overall score also dived.

Full disclosure: Long HD at time of writing.