08 June 2010

HD: Financial Gauge Analysis for the April 2010 Quarter

Home Depot (NYSE: HD) earned $0.43 per diluted share on a GAAP basis in fiscal 2010's first quarter, which ended on 2 May 2010.  Reported earnings were 41 percent more than the $0.30 Home Depot made in the same quarter last year.

Non-GAAP "adjusted" earnings, which exclude various charges and discontinued operations, increased from $0.35 to $0.45 per share, a rise of 29 percent.

In our earlier review of Home Depot's Income Statement, we compared the actual results to our "look-ahead" estimates.  Reported earnings were $0.04 better than the $0.39 per share we had forecast.

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value for Home Depot.  This post reports on the metrics and the associated financial gauge scores.  The metrics were calculated using data from Home Depot's current and historical financial statements, including the latest 10-Q report.

The Home Depot, Inc. (NYSE: HD) is the largest retailer of do-it-yourself merchandise, which includes building materials, home improvement supplies, and lawn and garden products.  The company operated 2,244 retail stores at last count, of which 1,976 (88 percent) were in U.S. states or territories.  Home Depot competes with Lowe's (NYSE: LOW), cooperatives such as Ace and True Value, and a multitude of smaller hardware stores.  Additional background information about Home Depot and the business environment in which it is currently operating can be found in the look-ahead.

In summary, Home Depot's latest quarterly results produced the following changes to the gauge scores:

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.  Caution is suggested when comparing Home Depot's results before and after the company's restructuring in 2007.

Cash Management02 May 201031 Jan 201003 May 20095-Yr Avg
Current Ratio1.
Debt/CFO (years)
Inventory/CGS (days)90.589.992.488.3
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)
Working Capital/Revenue4.9%4.8%3.8%4.4%
Cash Conversion Cycle Time (days)46.448.245.244.7
Gauge Score (0 to 25)7777

Home Depot has slowly but surely been trimming the amount of debt it has outstanding.  Long- and short-term debt totaled $9.7 billion at the end of the latest quarter, from $11.4 billion one year earlier.  Long-term debt to Equity is now below the five-year average for this ratio, and total debt as a percentage of cash flow is getting close to that threshold.

The company notes in its 10-Q that its "current cash position, access to the debt capital markets and cash flow generated from operations should be sufficient to enable us to complete our capital expenditure programs and fund dividend payments, any share repurchases and any required long-term debt payments through the next several fiscal years. In addition, we have funds available from our commercial paper programs and the ability to obtain alternative sources of financing."

Working Capital was reduced to $2.67 billion from $2.77 billion last year.  The reduction was mostly due to debt maturing this year moving from Long-term to Current liabilities. The 10-Q addresses steps the company has made to hedge interest rates for the debt refinancing.

Inventory measured in terms of days of Cost of Goods Sold is down slightly from last year.  This improvement in efficiency wasn't significant enough to improve the gauge score, but the trend is encouraging. 

The reduction in Days of Sales Outstanding is also a sign of better cash efficiency.  The latter two metrics also helped cut the Cash Conversion Cycle Time.  However, the latter measure is still a day higher than it was one year ago.

Growth02 May 201031 Jan 201003 May 20095-Yr Avg
Revenue growth-3.9%-7.2%-9.3%-4.9%
Operating Profit growth-11.8%-15.7%-19.3%-13.1%
CFO growth5.5%-7.3%-6.4%8.1%
Net Income growth14.6%13.3%-31.7%-11.0%
Gauge Score (0 to 25)8503
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.

Revenue in the last quarter was 4.4 percent more than in the same period of 2009.  This ended a stretch of eight consecutive quarters of Revenue declines relative to the year earlier.

The trailing-year growth rates for both Cash Flow from Operations and Net Income are now positive, which reversed the contractions observed last year.  Special charges last year associated with store closures and exiting businesses made it easy for the current year to look better in comparison.

Profitability02 May 201031 Jan 201003 May 20095-Yr Avg
Operating Expenses/Revenue92.3%92.5%92.6%90.7%
Free Cash Flow/Invested Capital16.6%14.8%12.7%11.2%
Accrual Ratio-4.0%-4.2%-3.1%-0.9%
Gauge Score (0 to 25)121189

The Operating margin, which excludes special charges, has been relative stable for the last couple of years.  Home Depot has had some success cutting its expenses to match a lower Revenue level.

The Return on Invested Capital has been recovering, although it's still less than its five-year average.  The ROIC has held up better than we would have expected in a difficult retailing environment.

Free Cash Flow has improved significantly because Home Depot has slashed capital spending. 

A lower Accrual Ratio, when compared to last year, is sign of improved earnings quality.

Value02 May 201031 Jan 201003 May 20095-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)12.310.910.212.0
Gauge Score (0 to 25)0078
Share Price ($)$35.23$28.01$25.77-

Although earnings growth has resumed, the share price through April increased at a faster pace.  This enlarged the P/E multiple to a figure deemed excessive by the Value gauge's scoring criteria.  The Price/Sales ratio has also expanded.

The share price has now fallen to $31.55.  This decline brings the P/E down to 18.5 and P/S to 0.8.

Overall02 May 201031 Jan 201003 May 20095-Yr Avg
Gauge Score (0 to 100)22212830

The Growth and Profitability gauges improved modestly, but the Value gauge kept the Overall Gauge in check.  The lower share price caused by the recent market skid may be what the gauge needs to move higher later this year.

Full disclosure: Long HD at time of writing.

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