Home Depot Financial Analysis

BUS 5440 Financial Management Group A

The Home Depot
Financial Management Project
Company Financial Analysis

For: Professor Ana Machuca

Submitted by Team A:
Betcher, Rhonda
Cammack, Cheryl
Desai, Shekhar
Barnes, John
Babatunde, Lasisi
Adamson, Christopher

Submission Date: February 26, 2012

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TABLE OF CONTENTS

EXECUTIVE SUMMARY: ...................................................................................... 3.

COMPANY INTRODUCTION: ............................................................................... 5.

FINANCIAL ANALYSIS: ......................................................................................... 8.

WEIGHTED AVERAGE COST OF CAPTIAL (WACC): ........................................ 11.

FUTURE CASH FLOWS: ...................................................................................... 16.

HISTORICAL STOCK PRICE: .............................................................................. 22.

SECURITY ANALYST’S REPORTS: .................................................................... 25.

DIVIDEND and CAPITAL STRUCTURE: .............................................................. 26.

CORPORATE GOVERNANCE: ............................................................................ 28.

MERGER and INTERNATIONAL STRATEGY: .................................................... 29.

REFERENCES: ..................................................................................................... 30.

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EXECUTIVE SUMMARY:

The attached report analyzes the financial position of The Home Depot. Home Depot (HD) is the largest U. S.
home improvement retailer as well as the fastest growing retailer in U.S. history. The company was founded
in 1978 by four gentlemen who had a vision for a one stop shop for do-it-yourselfers. The company’s
headquarters is in Atlanta, Georgia and has stores in all fifty states as well as Canada, Mexico and China.
The company is publicly traded on the New York Stock Exchange (NYSE).

Home Depot offers many different products for the home improvement enthusiast or the do-it-yourselfer.
Some of the products the company offers are: hardware, plumbing, electrical, building materials, lumber, paint
and flooring to name a few. They also provide services such as flooring, carpeting and countertops
installation, as well as rental tools. Their customer base includes three different groups: Do-It-Yourselfers,
Do-I-For-Me Customers as well as Professional Customers. Home Depot is open seven days a week, 24
hours a day.

Some of Home Depot’s largest competitors include companies such as Lowe’s, Ace Hardware and Sears.
Lowe’s of course is Home Depot’s biggest competition because the two companies offer similar products and
services.

The Home Improvement industry has had some ups and downs during the last few years mainly due to tough
economic conditions. Home Depot found a decrease in the amount of new construction materials that were
purchased but did see increases in the amount of home improvement projects. Customers were not looking to
purchase new homes but rather wanted to update and maintain their existing homes.

This report summarizes Home Depots financial position from 2010 to 2011. Home Depot increased its sales
from last year but was 41.3% lower than industry average. The debt to equity ratio increased by 14.8% from
2010 which is still higher than industry average. Home Depot did increase its net profit margin from last year
but was 1.3 points higher than the home improvement industry. Home Depot continues to outperform the
industry concerning investments with a Return on Equity (ROE) at 17.1% which is nearly double that of the
industry. Return on Assets (ROA) also increased by 7.9% which equates to 29% higher than the industry
average. An analysis of Home Depot’s Weighted Cost of Capital (WACC) shows a rate of 9.10%. This
WACC factor shows that Home Depot is competitive and in alignment with today’s marketplace.

At the end of March, 2011, there were approximately 164,000 shareholders as investors of Home Depot stock.
When looking at a trailing 12 month comparison of Home Depot’s stock prices, Home Depot outperformed the
industry competitors as well as the market indices for this period. Since rebounding from the past financial
crisis during the past few years, Home Depot for the last year has had a 52 week high of $48.07 and a 52
week low of $28.13. Home Depot prices have certainly in the past year stabilized at high levels making it an
attractive investment.

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Analysts estimate that Home Depot’s earnings will raise from a January 2011 EPS of $2.01 to $2.32 in
January 2012 and $2.75 in 2013 which is 70% higher than Lowe’s. Annualized projected EPS growth rate for
Home Depot is to have an EPS growth rate of 14.30% compared to the industry average of 14.00%. When
compared to Lowe’s, Home Depot has twice the market capitalization. Home Depot has a high gross margin
at 34.4% which is comparable to Lowe’s at 34.8%. With all things considered, there is a “bullish” consensus
on Home Depot’s stock.

In summary, it is our recommendation that investing in Home Depot’s stock is a good decision. The company
consistently out performs its competition while earning a good return for its investors. The company has a
lower risk than the industry and the S&P 500 when it comes to their betas. The company has a slightly higher
debt to income ratio which may make it more expensive for the company to borrow. However, its return on
equity shows a good use of equity Home Depot has remained successful due to its mission to always know
what the customer wants and to provide what the customer wants.

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COMPANY INTRODUCTION:

Company History

The Home Depot was founded in 1978 by Bernie Marcus and Arthur Blank who partnered with Ken Langone,
an investment banker, as well as, Pat Farrah, a merchandising guru. All four men had a vision to build stores
with one stop shopping for the do-it-yourselfer. The first Home Depot store was opened in Atlanta, Georgia on
June 22, 1979. The stores started off smaller than they are today at 60,000 square feet per store, stocking
25,000 SKUs. They even placed empty card board boxes to the ceiling to give the impression of having more
merchandise.

Home Depot is the fastest growing retailer in U.S. history. The company in 1981 went public on NASDAQ and
then in 1984 they moved to the New York Stock Exchange. They realized their fastest growth between 1980
and 2000 but are continually finding ways to make their company more favorable with the consumer. They
pride themselves in developing their employees and it shows in their product knowledge.

Home Depot is the largest home improvement retailer in the United States. They have stores in all fifty (50)
states as well as Canada, Mexico and China. Home Depot’s corporate headquarters is located in Atlanta,
Georgia.

Strategy

Home Depot proposed in 2010, a three-pronged initiative in order to fuel more business. The three areas that
were reviewed are: supply chain transformation, merchandise transformation and customer service.

· The supply chain initiative includes the roll out of the company’s new Rapid Deployment Centers (RDC).
These centers should keep the stores serviced faster and more effectively.
· The merchandise transformation initiative includes the company’s commitment to “great value and re-
establishing product authority.”
· The customer service strategy is summed up as “taking care of their associates” and “taking care of
customers.” Both of these two parts of the initiative help with easier return process, guaranteed price matching
as well as other bonuses.

Main Product and Services

Home Depot stocks and has available to consumers between 30,000 to 40,000 products during a year. As of
January 30, 2011, the product mix was as follows:
· 30.0% Plumbing, electrical and kitchen items
· 29.4% Hardware and seasonal
· 21.7% Building materials, lumber and millwork
· 18.9% Paint and flooring

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Home Depot continually strives to offer the products that the do-it-yourselfer is looking for. They continually
form strategic alliances and exclusive agreements with their suppliers in order to provide a large variety of
recognizable brands for the consumer. Some examples of the brands they carry are Behr Premium Plus®
paint, Hampton Bay® lighting, Vigoro® lawn care products, and Husky hand tools. Martha Stewart Living
products have been well received by Home Depot customers.

Home Depot also offers several different services for the consumer. Some of the services they offer include
installation services for carpet, cabinets, flooring, water heaters and countertops. Home Depot also offers tool
rentals.

Primary Markets and Customers

Home Depot characterizes their customers into three groups:
· The Do-It-Yourself (“D-I-Y”) Customers – This type of customers are homeowners who purchase their
products and go home and do their own projects and installation.
· The Do-It-For-Me (“D-I-F-M”) Customers – This type of customers are homeowners who purchase a product
but would like for Home Depot to assist them with an installation or just completion of a project.
· Professional Customers – This type of customers are general contractors, small business owners,
tradesmen, and repairmen. These customers often take advantage of Home Depot’s delivery and will call
services.

Major Competitors

Lowe’s, Ace Hardware and Sears are some of Home Depot’s major competitors. Lowe’s is Home Depot’s
biggest competition because they offer similar product offerings as Home Depot. Sears is similar to Home
Depot because it sells Craftsman Tools as opposed to Home Depot’s line of tools. Ace Hardware comes
closer to Home Depot’s offerings because of the variety in their stores. Ace Hardware Stores are usually
much smaller in size than Home Depot thus they cannot offer the number of different items that Home Depot
can.

Industry Overview

The Do-It-Yourself or Home Improvement industry is beginning to recover from the housing crisis that has
occurred in recent years. Consumers are beginning to invest in more renovations and remodeling. The
housing crisis was very tough for the do-it-yourself market as consumers were not spending as much money
as they had before. Until 2016, the home improvement industry is expected to grow by at least 1.4% annually.
The U.S. GDP is expected to grow at a rate of 1.8% signifying that the home improvement industry is in a
mature phase of its life cycle because the rate of growth within a ten year period (2006-2016) is less than the
U.S. GDP.

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For Home Depot however, the reverse can be said for their business during the housing crisis. Their sales
turned around during the crisis and they found that more consumers were working on do-it-yourself projects,
home maintenance and small furnishings. However, consumers were not doing any expensive remodeling
during this period. Home Depot was able to stand out from the rest of the industry because of their friendly
and knowledgeable people (known as the “orange-blooded” associates) by offering some of the free
workshops and services that they offered.

Summary

Why has Home Depot been so successful in the past? Home Depot knows what the consumer wants and
provides what they want. Home Depot is open seven (7) days a week, 24 (twenty-four) hours a day in order to
provide everyone the opportunity to get what they want any time that they want. Home Depot prides its
success on the following factors: “know your customers, scale your operation so it can grow rapidly, market
heavily and keep an eye on your financial model.”

References:
http://www.ibisworld.com/industry/Dec 2011
Fletcher, Fran July 11, 2011 http://blog.highbeambusiness.com
http://www.masterplans.com/business-plan-articles-homedepot
http://www.hometextilestoday.com/article/529670-Home_Depot_on_path_to_recovery
http://corporate.homedepot.com/OurCompany/History/Pages/default.aspx

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FINANCIAL ANALYSIS:

Financial Ratio Analysis for the Home Depot

GROWTH RATES % COMPANY INDUSTRY S&P 500 2010

Sales (Qtr vs. year ago Qtr) 4.4 7.5 11 3.8

Net Income (YTD vs. YTD) NA NA NA 121.9

Net Income (Qtr vs. year ago Qtr) 12 -2.4 11.2 95

Sales (5-Year Annual Avg.) -2.46 -0.77 7.84 -2.46

Net Income (5-Year Annual Avg.) -9.96 -8.45 7.53 -9.96

Dividends (5-Year Annual Avg.) 18.76 21.97 5.13 18.76

PRICE RATIOS COMPANY INDUSTRY S&P 500 2010

Current P/E Ratio 19.5 19.2 61.6 18.8

P/E Ratio 5-Year High NA 8.9 14.7 23.7

P/E Ratio 5-Year Low NA 3.2 3.4 8.2

Price/Sales Ratio 1.01 380.98 2.2 0.89

Price/Book Value 3.94 3.26 3.76 3.25

Price/Cash Flow Ratio 13.3 12.1 9.6 12.2

PROFIT MARGINS % COMPANY INDUSTRY S&P 500 2010

Gross Margin 34.4 33.95 38.79 34.3

Pre-Tax Margin 8.4 6.96 17.76 7.8

Net Profit Margin 5.32 4.29 12.85 4.9

5Yr Gross Margin (5-Year Avg.) 33.8 34.7 39.4 33.8

5Yr Pre Tax Margin (5-Year Avg.) 7.7 7.3 15.9 7.7

5Yr Net Profit Margin (5-Year Avg.) 4.9 4.5 11.4 4.9

FINANCIAL CONDITION COMPANY INDUSTRY S&P 500 2010

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Debt/Equity Ratio 0.61 0.53 0.99 0.52

Current Ratio 1.5 1.4 1.2 1.3

Quick Ratio 0.4 0.4 0.7 0.3

Interest Coverage 12 10.7 24.1 11.2

Leverage Ratio 2.3 2.2 3.4 2.1

Book Value/Share 11.53 12.02 20.86 11.64

INVESTMENT RETURNS % COMPANY INDUSTRY S&P 500 2010

Return On Equity 20.04 10.08 22.16 17.4

Return On Assets 8.9 6.4 6.9 8.2

Return On Capital 12.1 4 9.4 11

Return On Equity (5-Year Avg.) 17.3 9.6 20.5 17.3

Return On Assets (5-Year Avg.) 8 7.1 6.4 8

Return On Capital (5-Year Avg.) 10.9 7.1 8.7 10.9

MANAGEMENT EFFICIENCY COMPANY INDUSTRY S&P 500 2010

Income/Employee 19,515 14,434 73,059 17,625

Revenue/Employee 367,005 346,090 500,724 359,032

Receivable Turnover 51.9 34.5 13.2 66.4

Inventory Turnover 4.2 6.2 8.2 4.3

Asset Turnover 1.7 1.6 0.7 1.7

Dupont Analysis

ROA for 2011 was 8% and 6.2% for 2010 and ROE for 2011 was 18.68% and 14.38% for the year prior. These
two ratios can give a good signal to investors that the company is performing well against 2010.

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Financial ratio analysis

The company has experienced an increase of sales from last year but is 41.3% lower than the industry. Its 5
year annual sales average is 1.69% lower than the industry and 1.51% lower in Net Income compared to the
industry. Dividends remained the same from last year ,however lower than the industry. The current P/E ratio
is higher than the industry average Book value and Cash Flow ratios are higher than the industry average.

Gross Profit Margin is higher than last year and higher than the industry. More importantly Home Depot
increased its Net Profit Margin from last year and is 1.3 points higher than the industry.

The debt to equity ratio had increased 14.8% from last year and is 13.2% higher than the industry. This
increase may raise concern for lenders in the upcoming year. The Current ratio increased by 13.4% from the
year prior and remained 6.7% above the industry. The Leverage ratio for the Home Depot increased by 8.7%
from last year this is 4.3% higher than the industry average. The company had a 1% decrease in its Book
Value/Share ratio which is 4.1% lower than the industry. This may raise concern for some investors as the
book value of the stock has performed lower than the industry.

The company had outperformed the industry considerably for its investments. The company’s Return on
Equity was nearly double of the industry. Its ROA had increased from the year prior by 7.9% which is 29%
higher than the industry. The Return on Capital is nearly 3 times that of the industry. The company’s
Investment performance shows the company’s rate of return on its investments has outperformed the industry
and is and for the company.

The company has a 26.1% higher income/employee average and had experienced a 10.7% increase from last
year. The company’s revenue/employee was 3.2% higher than the year prior and 5.7% higher than the
industry. This is a good sign than the management is maximizing its productivity of the workers. Inventory
Turnover is 33.3% lower than the industry this may be a signal that the inventory is staying in the stores too
long before being sold or the company is buying too much merchandise beyond the demand of its customers.

The company has performed better then the industry on key ratios for 2011 while improving their performance
from 2010. The company’s improved performance can be credited to good management decisions. In 2011
the company had experienced high performance while becoming more profitable.

References:
http://investing.money.msn.com/investments/key-ratios?symbol=HD 2/10/2012
http://phx.corporate-ir.net/phoenix.zhtml?c=63646&p=irol-reportsannual 2/10/2012

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WEIGHTED AVERAGE COST OF CAPITAL (WACC):

An accurate analysis of a firm’s WACC requires a complete data set of “inputs” to ensure proportionate and
precise figures are utilized to establish the baseline costs for Equity, Debt & Preferred Stock. All inputs
required are indicated below utilizing several financial models to calculate the required Inputs. Models such as
the discounted cash flow (DCF) method and the Capital Asset Pricing Model (CAPM) are utilized in lock step
with the analysis of Home Depot’s financial statements to generate an accurate (and benchmarked) WACC
factor.

Calculated Beta
(Using regression analysis of daily data over 2 year fiscal period)

To ensure alignment with current Home Depot Form 10K filings (last published January 2011; with fiscal 2012
filings due in a week or two) and the current year now in year-end closing processes, 2 years of data has been
selected as the data sample for calculating Home Depot’s beta utilizing regression analysis.

Table 4.1 Regression Analysis Using slope function to Calculate Beta
(Sample of two (2) previous fiscal years of data, total data file contains 506 lines of daily stock data)

The published beta estimates from the recorded sources (i.e. Yahoo Finance published beta) and the
regression analysis produced beta drawn from the historic stock and market data analysis do yield figures
that do differ, but only slightly by a factor of 0.01 as indicated in the table below.

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Table 4.2 Home Depot Beta

The published beta vs. the beta that can calculate using a scatter diagram and regression analysis will depend
on the Analyst completing the assessment. In our case, we are using 2 full fiscal years of stock closing prices
as our data sample to establish a sample size large enough to be utilized.

The published beta is typically calculated against 10 years and in some cases aged historical data even further
back in time. The resulting industry calculated/supplied beta figure captures a larger variance sampling of
data to establish the beta coefficient factor used in calculating Home Depot’s beta vs. the market.

The data selected for the regression analysis reflects the most recent 2 fiscal years, which is utilizing historic
data since the impact of the global financial crisis, reflecting some of the hardest times since the great
depression (though in 2012, we are still not out of the woods) in the calculation of the 0.88 beta figure.

Weighted Average Cost of Capital Inputs
(Note: Colour highlight linkages for data sources & calculations can be followed through the attached tables)

Table 4.3 Calculating Home Depot Stock Expected Growth Rate

Table 4.4 Summary of Home Depot Current Market Bonds

The above table illustrates the current Home Depot Bond activity and is being referenced to permit an
educated approach in assessing and analysing the firm’s internal cost of debt for today’s market and the
proposed cost of debt rate to be applied in the WACC calculation.
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Table 4.5 Summary of Calculation Model “Inputs”

As indicated in the above inputs table, the cost of equity as calculated using the CAPM model as Table 4.7
indicates is 10.16% for the value of rs. The table reflects a debt rate for internal cost of debt estimated to be
5.5%. The resulting cost of debt after tax factor applied in the WACC formula as 3.67%; as expected the rate
is less than the expected rate of return for cost of equity.

Table 4.6 Corporate Tax Deduction Figure

Yields an approximate 33% corporate tax rate (T).

Table 4.7 Capital Asset Pricing Model - Required Return = rS

The Expected Market Return of shareholders and future investors has been calculated using actual Home
Depot stock data, growth rate forecasts and ROE figures (as indicated in table 4.5 - “Inputs”).

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Table 4.8 Capital Structure Weighting - Debt, Preferred Stock and Equity

Home Depot has not offered nor has any preferred stock in the market; effective FY10 the figures reflect $0.00
cost of rps.
Table 4.9 The Weighted Cost of Capital (WACC) Calculation

Home Depot may actually have a competitive WACC situation; however, opportunities for improvement always
exist in today’s business marketplace. The ratio of debt is a little light if optimal value in Home depot is to be
achieved. The agents could increase the organizations value while decreasing the WACC percentage with a
different capital structure.

Home Depot’s operations could be maximized while reducing their WACC factor by increasing the debt ratio of
the firm’s capital structure by 20% to 25% to lower the WACC factor by 17%. If the HD’s debt ratio was
increased to 40%, therefore maximizing the value of operations, then the firm’s WACC would drop to 7.57%
from the current 9.10%; but this may make the market unsettled with such a dramatic shift. To ensure not too
much risk or uncertainty was “injected in to the business”, simply doubling the current ratio from 16% to 32%
would still have a positive impact on WACC and the firms operations by generating a WACC (all things
remaining unchanged in rs and rd) of 8.09%, a full percentage point lower.

Understanding that increasing debt also increases the potential of bankruptcy, but not likely a situation for
Home Depot to face with their current cash reserves and large ratio of the company’s assets being highly
liquid inventory which can be converted to cash quickly being the company is a retail operation. In addition,

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interest rates are low, very affordable and could be financially leveraged to maximize the cost operations
without significant increasing fixed monthly costs through debt repayment schedule. The cost of debt is
much lower than the cost of equity; and in Home Depot’s situation, investor expectations for investment
returns, the potential cost of equity in a bond strategy to raise investment capital are dramatically greater than
current debt costs; after all, the agent’s responsibility to increase the firm’s value and maximize shareholder
value – initially being achieved with a slightly modified capital structure and ratios.

The two primary components of capital include the cost of equity and cost of debt to provide or fund the
capital. WACC is the rate that a firm is expected to pay to finance its assets and potentially future investments
in their operations. The minimum return benchmark that a company must earn on their existing asset is equal
to or greater than the WACC percentage to meet and ideally satisfy its shareholders, creditors, and business
“partners” like the financial institutions that provide capital.

When evaluating the company’s current WACC and benchmarking our calculations of Home Depot’s WACC
figure, the investment resources available online have suggested that our 9.10% results is fairly accurate
based on the value referenced in the table below.

Benchmarking Home Depot’s WACC and a few other factors against other companies in the same
industry/sector is a fair approach to assessing if Home Depots WACC is appropriate for the company to use
today and in the future. There are several companies listed in the industry segment; however there is really
only one direct competitor – that being Lowes.

Table 4.10 Industry Side-by-Side

Comparatively, Lowes current capital structure is not dramatically different with ratios similar to that of Home
Depot. When judging if the WACC factor is applicable and in alignment with today’s marketplace, then the
above data table results would suggest yes, Home Depot is competitive and in alignment.

Reference:
http://www.nasdaq.com/symbol/hd/historical
http://finance.yahoo.com/q/is?s=HD
http://www.wikiwealth.com/wacc-analysis:hd
http://money.cnn.com/data/markets/sandp/
http://finance.yahoo.com/q/ks?s=HD+Key+Statistics
http://cxa.marketwatch.com/finra/BondCenter/SearchResult.aspx?q=H

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FUTURE CASH FLOWS

The Home Depot is a conservative company that has weathered the storm from the collapse of the housing
market and credit bubble. The future looks good for The Home Depot as inflation is predicted to be modest
over the long run and the Federal Reserve’s target is about 1.9%. (Wall Street Journal) (Economic Projections
of Fed)The company is using interest rate swaps and hedging conservatively to manage risk and keep the
cost of debt down. HD has 29 million dollars of debt maturing in 2012 (Home Depot 10K pg. 44) and is using
hedging tactics to insulate against volatility in the market as it prepares to issue more long term debt. HD has
begun to buy back stock through a repurchase program and will continue the repurchase of 9.9 billion shares
under the program. There is no expiration date and The Home Depot seems to be transferring some of their
debt from equity to long term bonds. (Home Depot 10K, pg. 15) This is an excellent strategy because it will
lower the cost of capital and increase shareholder value.

The home improvement market is competitive and mature. HD realizes that their market share depends on
creating an advantage through customer service and innovation. The company is developing their customer
base by concentrating on their image as well as their service and the greatest asset is the employees of Home
Depot. (10K, pg. 7) The threats that might affect growth range from supply chain woes to failure to innovate.
(10K pg. 6)
Table 5.1 – Financial Ratios “Snapshot”
INPUTS 2012 Values
Operating Ratios
Growth Rate in Sales 3%
Op costs except depr'n/Sales 23%
Depr'n/Net plant & equip. 6%
Cash/Sales 1%
Account Rec/Sales 2%
Inventory/Sales 2%
Net plant& Equip/Sales 16%
Accounts Pay/Sales 7%
Accruals/Sales 2%
Tax Rate 37%
Financing Data
Notes payable/Investor-sup cap 3%
LT bonds/Investor-sup cap 26%
Comm equity/Investore sup cap 55%
Interest rate on notes payable 5.50%
Interest rates on LT bonds 5.50%

The housing and credit bubbles could not continue in an artificial state of growth and are now in the processing
of correcting and normalizing. In the calculations for sales growth, if we were to use the post bubble figures we
would have a negative growth rate of - 1.56% (Table 5.2). Negative growth in sales is not the goal of any

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company so the data range for sales growth must encompass a greater time period. Overall growth tends to
trend at a more stable pace when covering a greater time period.
Table 5.2 – Short term Revenue Movement
Year Revenue (millions) Period Difference
2009 71,288.00
2010 66,176.00 -7%
2011 67,997.00 (forecasted) +3%
2 Year Growth Average: 2% 71,288(1+g)^3 = -1.56%
10 Year Growth Average: 3.78% 53553(1+g)^10= 2.42%

Using a greater time period evens out the growth and gives us a growth rate of 2.42%. This is an excellent
place to begin forecasting the sales growth for the next three years. The home improvement market is a
mature industry and has projected growth of about 1.4%. The GDP has a projected growth rate of about
1.69% and Home depot’s growth in sales exceeded 3% in 2010. (See Table 5.3 - 10 Year Growth Rates)
Taking the average of the past growth base and the most current growth we have a growth rate of 3.11% , if
the home improvement industry does grow by about 1 to 1.4% it would not be unthinkable for The Home
Depot to achieve between 4 and 4.5% in growth over the next year. This is actually a very conservative
estimate if the market and the domestic economy continue their slow recovery.

Table 5.3 - 10 Year Revenue Achievement Table

Yr. 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Rev $ 53553 58247 64816 73094 81511 90837 77349 71288 66176 67997

G% - +8% +10% +13% +12% +11% -8% -9% -8% +3%

Source: Thomson Business ONE

Lowe’s ranks second after Home Depot and in terms of sales HD did 1.5 times the revenue of Lowe’s. While
HD has been the leader in the industry since 2005 there is always the threat that your competitor will overtake
you in market share. Lowe’s had more growth over the last five years for EPS, and gross revenue compared to
HD. The firm has a very aggressive customer relations strategy that includes online, contact centers and even
personal representatives that will visit the customer on site. The store expansion strategy for the company
concentrates on underpenetrated urban markets. As Sun Tzu said, “Go where your enemy isn’t.” (Lowe’s
Investor Relations, 10K) Lowe’s does trail behind HD’s market share but sales and market share are not static.
There is always the threat that the number two competitor could become the market leader.

In 2007 HD realized that its supply chain management was inferior. The company undertook an ambitious
project to bring the firm into the modern age of inventory deployment. Beginning in 2007 and continuing to
2010 HD rolled out 20 Rapid Deployment Centers that seriously streamlined the inventory delivery process. At
the time of inception HDs inventory turnover was 4 and the goal of the project was to get that number up to 5.
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The Senior Vice President of Supply Chain Management, Mark Holifield, estimated that the project could
possibly give the company an extra 1 billion dollars in cash flow improvement. As of today the inventory
turnover ratio is 4.2. This is not disheartening because the system still needs debugging and the economy will
also impact the efficiency of the system if it continues to recover. (Supply Chain Digest)

Developing a comprehensive Statement of Future Cash Flows first requires forecasting future sales. Future
sales are based on past growth and influenced by industry growth, GDP, inflation, competition, the
corporation’s current market share, and future market share growth. The Home Depot has experienced
negative overall growth over the past five years. The collapse of the housing market and the credit debacle
contributed to the decline in sales and the decline in growth from 2007 to 2009.

Table 5.4 – Summarized: Current and Projected Income Statement and Balance Sheet
Part1 - IS

Part2 - BS

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The Home Depot has positioned itself for growth in the market through Contact Relationship Management,
Supply Chain Management, and a strategy to leverage debt and hedge conservatively against the risk. The
economy shows a slow but steady growth and the market should see not only a recovery from the collapses
but an increase from possible pent up demand from unfulfilled need. (Bloomberg Business week) If the market
experiences a greater than projected growth and the demand increases while the market stays stable Home
Depot could see sales numbers as high as 10% above last year’s numbers.

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Table 5.5 – Future / Projected Cash Flow Statement
Future / Projected Cash Flow Statement 2012 2013 2014
Operating Activities (Millions)
Net Income before preferred dividends $ 3,469.6 $ 3,677.8 $ 3,953.6
Noncash adjustments
Depreciation and amortization $ 1,687.0 $ 1,788.2 $ 1,922.3
Due to changes in working capital
Increase in accounts receivable -$ 336.1 -$ 356.3 -$ 383.0
Increase in inventories -$ 478.2 -$ 506.8 -$ 544.9
Increase in accounts payable -$ 257.0 -$ 272.4 -$ 292.9
Increase in accruals -$ 58.1 -$ 61.5 -$ 66.1
Net cash provided (used) by operating activities $ 4,027.3 $ 4,268.9 $ 4,589.1

Investing activities
Cash used to acquire fixed assets -$ 801.4 -$ 849.5 -$ 913.2
Sale of short-term investments $ 0.4 $ 0.4 $ 0.4
Net cash provided (used) by investing activities -$ 801.0 -$ 849.1 -$ 912.8

Financing Activities
Increase in notes payable -$ 29.6 -$ 31.4 -$ 33.7
Increase in bonds -$ 580.0 -$ 614.8 -$ 661.0
Payment of common and preferred dividends -$ 1,665.4 -$ 1,765.3 -$ 1,897.7
Net cash provided (used) by financing activities -$ 2,275.0 -$ 2,411.5 -$ 2,592.4

Net change in cash and equivilents $ 951.2 $ 1,008.3 $ 1,083.9
Cash and securities at beginning of the year $ 545.0 $ 1,496.2 $ 2,504.5

Cash and securities at end of the year $ 1,496.2 $ 2,504.5 $ 3,588.4

Home Depot could reap the benefits of an increase in sales far above its projected numbers and this along
with a well leveraged debt to assets and debt to equity ratio would make Home Depot an excellent investment.
After reading the latest report the company looks like it will meet and exceed all of its projected numbers. HD
just announced a quarterly dividend of .29 cents per share, and a forecast of 2012 earnings of 2.79 per share
is totally reasonable along with a 4.4% increase in revenue.

Table 5.6 – Projected Cash Flows at Current Growth Rate
Corporate Valuation
LONG TERM GROWTH RATE WACC = 9.1%
S(1+g)n=Sn 4.4%

Projected Free Cash Flow: FY1x = FCF x (1+g)/WACC(1-g)

Year Projected Cash CFFY PV of CF
(m illion s ) (1,000s ) (1,000s )

FY 12 $ 1,496 $ 17,173 $15,741
FY 13 $ 2,505 $ 28,747 $24,151
FY 14 $ 3,588 $ 39,355 $30,306

Page 20 of 33


In consideration of the current economic conditions and the market projects as highlighted in the sources
referenced below, it can be expected that Home Depot will continue to experience growth over the next couple
of years. No one has a crystal ball, but a conservative, yet confident position is to believe that HD will continue
to experience growth over the next few fiscal periods.

References:

The Wall Street Journal, Atlanta Fed Survey Finds Long-Term Inflation Worry by Michael S Derby, February
23, 2012 retrieved from the world wide web, February 25, 2012 http;//blogs.wsj.com

Economic Projections of Federal Reserve Board Member and Federal Reserve Bank Presidents, January 2012
retrieved from the world wide web February 25, 2012 www.federalreserve.gov/monetarypolicy

The Home Depot Financial Report 10K www.ir.homedepot.com

Lowe’s Investor Relations, 10K Investor Relations, http://phx.corporate-ir

Supply Chain Digest Aggressive Supply chain Transformation at Home Depot by Dan Gilmore, June 11, 2009,
retrieved from the World Wide Web February 25, 2012 www.scdigest.com

Bloomberg Business week, Construction Jobs Rebound Amid U.S. Home Remodeling Pick-Up, by Anna-Louise
and Anthony Feld, February 22, 2012 retrieved from the world wide web on February 25, 2012
www.bloomberg.com/news/2012-02-22

The Washington Post Home Depot 4th-quarter net income rises 32 percent as revenue improves, by
Associated Press, February 21, 2012 retrieved from the world wide web, February 25, 2012
www.washingtonpost.com/business/home-depot
(The Washington Post, Associated Press)

Page 21 of 33


HISTORICAL STOCK PRICE:

A trailing 12 month comparison of HD stock prices as compared with Lowe’ and the market indices show that
HD has outperformed both its industry competitors as well as the market indices over this period. The HD
stock appreciated very well and reached its peak market price during the financial and housing boom of the
early 2005 through 2007. However s the financial crisis hit the building industry, the entire industry had a
downward slope. HD stock hit its lows in March-April of 2009 when it fell below $ 18.00.

It competitor Lowe’s fared just as bad with it slows in March-April 2009 being below $ 15.00, since then the
industry has slowly but sure rebounded and for the last one year HD has had a 52 week high of$ 48.07 and a
52 week low of 28.13. Similarly Lowe’s has had a 52 week high of $ 28.06 and a 52 week low of $ 18.07.

Graph 6.1 HD PERFORMANCE COMPARED TO MARKET INDICES

Splits: Sep 22, 1987 [3:2], Jul 3, 1989 [3:2], Jul 6, 1990 [3:2], Jun 26, 1991 [3:2], Jul 2, 1992 [3:2], Apr 14, 1993
[4:3], Jul 7, 1997 [3:2], Jul 6, 1998 [2:1], Dec 31, 1999 [3:2]

Page 22 of 33


Graph 6.2 HD PERFORMANCE COMPARED TO LOWE’S

Comparing its performance against the benchmark indices an investment in HD 1985 would have appreciated
14,500% by February 2012 today, while returns in the S&P 500, NASDAQ and DOW would have respectively
appreciated somewhere between 2000% and 2500%. Using its close industry competitor Lowe’s as
benchmark, the return would have been approx.14,500% for HD and 4300% for Lowe’s.

[4:3], Jul 7, 1997 [3:2], Jul 6, 1998 [2:1], Dec 31, 1999 [3:2]

Page 23 of 33


Graph 6.3 LONG TERM COMPARISON OF HD, LOWE’S AND MARKET INDICES

Review of historical data charts beginning August, 1984 the shares started trading at a price of $ 15.13. Over
the course of last several years it has undergone a total of seven 3:2 splits, one 4:3 split and one 2:1 split.

[4:3], Jul 7, 1997 [3:2], Jul 6, 1998 [2:1], Dec 31, 1999 [3:2]

In summary HD prices have overcome the downs of the financial and housing crisis and now have stabilized at
high levels making it an attractive investment. Although past performance is not a guarantee for future
performance, based on its historic price trends HD has returned more value to the shareholders than its
competitors in the industry.

Reference:
http//:www.yahoofinance.com

Page 24 of 33


SECURITY ANALYST’S REPORTS:

The overall analyst recommendation summary for HD is 2.0 (strong buy=1.0, sell=5.0). The current share price
$ 44.52 with a median target of $ 45.00, a high target of $ 50.00 and a low target of $ 32.00. Analyst’s
estimates of Earnings estimates are raised from Jan 2011 EPS of $ 2.01 to $ 2.32 in Jan 2012 and 2.75 in
2013. This is an estimated EPS growth rate of 17.70% for 2012 and 15.10% for 2013. Annualized the
projected EPS growth rate is 14.30 % for HD as compared to 14.00% for the industry and more important a
-0.95 for HD for the last five years. Reviewing the analysts’ reports from Credit Suisse, Thomson Reuters and
Stand & Poor’s reveals a positive rating and a “buy” recommendation. This is based on its Beta (.0.89), EPS
($2.32) with a retention ratio of 50% and ROE of 17.1%

Compared to its industry competitor Lowe’s, HD has twice the market capitalisation, HD has a gross margin of
34.4% which is comparable to Lowe’s (34.8%). The two companies P/E ratio are also comparable and in the
19.25 t 19.75 range. HD reported 2011 EPS at $ 2.01 and analysts projected 2012 EPS of $ 2.32. This is
almost 70% higher than Lowe’s. All things considered there is a generally “bullish” consensus on HD stock
However the caveat is that the stock is currently near its 52 week high and with the housing market still in a
slump our recommendation would be a hold rather than a buy. Although this stock has handsomely rewarded
the long term investors, past performance is not a guarantee of future.

Table 7.1 RECOMMENDATION TRENDS

Page 25 of 33


Current Month
Last Month
Two Months Ago
Three Months
Ago

Strong Buy
11
10
10
10

Buy
7
7
7
8

Hold
11
11
11
11

Underperform
0
0
0
0

Sell
0
0
0
0

Reference:

Page 26 of 33


DIVIDEND and CAPITAL STRUCTURE:

HD pays currently pays a dividend of 29 cents per quarter which is $ 1.16 per year. At the current market price
of HD shares that is a yield of 2.57%. HD has been paying steady dividends for the last four years. Its current
spending pattern and payout ratio suggest that this policy is sustainable and will be a good strategy in today’s
economic environment where shareholders expect dividends as a form of income.

Table 8.1 Dividend Historical Data - Calculations 2000 to Present
(Sample of dividend payout data beginning 2007)

Capital Structure Overview

The company has a total Value of $ 66, 444 million. This includes Short term debt of $44 million, Long term
debt of $ 10,739 million and has no preferred equity. The market Capitalisation (value of Shareholders equity)
is $ 55,661 million. This gives HD a Wd=16.23% and a Ws= 83.77%. Taking into consideration the Market risk
premium (approx.9.2%) the Risk free return (currently quoted at 1.98%), the company’s Beta quoted at 0.89)
and the business risk premium its cost of Equity is 10.16% while the cost of Debt is 3.67%. WACC (Wd*3.67%
+ Ws*10.16%) is 9.10%.

This is in our opinion is a fair WACC because it does not obligate the company to pay a significant amount of
earnings towards interest obligations. Also the book value of its Net Debt (Total Debt – Cash and near cash
equivalents) on the balance sheet is $ 8549 million ($ 10,739 million + $ 44 million - $ 2234 million). The book
value of its Total Equity is $17, 769 giving it a Net Debt to Equity ratio of 48.12%.

It has operating leases with total liability of $ 8181 million and Capital leases (long and short term) with liability
of $ 452 million. The reason most companies have operating leases is because these listed off balance sheet
and we do not see anything unusual with this practice.

Page 27 of 33


Using Insider activity (buys and sells by management) as well institutional activity as reported to the SEC as a
benchmark HD scores a neutral on the S&P analysts report suggesting that there is not much informational
asymmetry. A very high degree of insider buying (apart from exercising stock options) or a high degree of
insider selling would be a reflection of information asymmetry. Also since HD is not a manufacturer per se,
most its efficiencies are operational. Unlike Apple it does not come out with market changing products which
when launched would significantly impact FCF to cause product information asymmetry.

Table 8.2 INSIDER AND INSTITUTIONAL ACTIVITY

Net Share Purchase Activity

Page 28 of 33


Insider Purchases - Last 6 Months

Shares
Trans

Purchases
N/A
0

Sales
62,161
2

Net Shares Purchased (Sold)
(62,161)
2

Total Insider Shares Held
1.9M
N/A

% Net Shares Purchased (Sold)
(3.2%)
N/A

Page 29 of 33


Net Institutional Purchases - Prior Qtr to Latest Qtr

Shares

Net Shares Purchased (Sold)
(63,089,600)

% Change in Institutional Shares Held
(5.97%)

Data provided by: Thomson Financial

A new generation of lawn mowers or refrigerators which HD markets will not create the same market share
price impact as a new model of iPhone or iPad! In the last six months less than 3.5% of total insider held
shares and less than 6.0% of Institutional shares were sold. Interestingly the share prices showed an upward
trend during this period.

References:
http//:www.homedepot.com
http//:www.thompsonfinancial.com

Page 30 of 33


CORPORATE GOVERNANCE:

Home Depot have the following set of officers in-charge of the corporate running of the affairs of the company,

Executive Officers of the company, comprising the Chief Executive Officer in-charge of the day-to-day running

of the affairs assisted by eight other executive directors who are appointed by the Board of Directors of the

company.

The Chief Executive Officer is Francis S. Blake, who is the chairman as well, and has been in that position

since 2007. The other eight directors, have series of experiences from various backgrounds and had core-

competencies in their various disciplines. Their ages range between 46 to 61 years of age.

In the year 2010, management achieved their first year of positive sales growth since fiscal year 2006. The

company's sales increased by 2.9% with total sales up of 2.8% over the previous year. Earnings per year

share from continuing operations were up 29.7% from last year, reflecting positive sales-growth, continuing

benefits from their merchandising transformation efforts and effective expense control. Management is doing a

good job from all indications and parameters, in 2010, they continued to invest in their business, and they

maintained key focused on customer-service, supply chain and merchandising initiatives, as well as the

development of the interconnected retail strategy.

As of March 14, 2011, there were approximately 164,000 shareholders on record and position approximately

1,030,000 additional shareholders holding stock under nominee security position listings. Executive stock

ownership and retention guidelines require executive officers to hold shares of common stock with a value

equal to the specified multiples of salary. For fiscal 2010, 25% of the equity compensation provided to name

executive officers was in the form of performance shares. The directors and executive officers as a group of 18

people owned 1.04% of the common stock, which is 16,371,537, while institutional investors, by named,

Capital World Investors owned, 193,108,800 shares which is 11.94%.

Page 31 of 33


MERGER and INTERNATIONAL STRATEGY:

At the end of fiscal year 2010, Home Depot had 179 stores in the ten Canadian provinces, while in Mexico,

they had 85 stores. In China, they had 8 stores in four Chinese cities. Right now Home Depot is not into any

merger and acquisition. The stores acquired in those cities of China, were made by acquisitions in 2006.

From Home Depot Support Center, they maintain a global sourcing merchandising program to source high-

quality products from manufacturers around the world. Home Depot merchant team identifies and purchases

market leading innovative products directly for their stores. This international strategy has really help Home

Depot to become a leading Home Improvements outlet. Sourcing offices are located in Chinese cities of

Shanghai, Shenzhen and Dalian and also, offices in Gurgaon, India, and Rome in Italy, Monterrey in Mexico

and Toronto in Canada. The company continues to seek expansion into other countries as expansion and

market demands

The global expansion demonstrates how Home Depot combines its vast knowledge of the home

improvements industry with the needs, shopping trends and customs of each unique geography to the best

serve customers.

Reference:
www.yahoofinance.com 2/9/2012

Page 32 of 33


References & Appendix

Reference Sources:

http://www.ibisworld.com/industry/Dec 2011
Fletcher, Fran July 11, 2011 http://blog.highbeambusiness.com
http://www.masterplans.com/business-plan-articles-homedepot
http://www.hometextilestoday.com/article/529670-Home_Depot_on_path_to_recovery
http://corporate.homedepot.com/OurCompany/History/Pages/default.aspx
http://investing.money.msn.com/investments/key-ratios?symbol=HD 2/10/2012
http://phx.corporate-ir.net/phoenix.zhtml?c=63646&p=irol-reportsannual 2/10/2012
http://www.nasdaq.com/symbol/hd/historical
http://finance.yahoo.com/q/is?s=HD
http://www.wikiwealth.com/wacc-analysis:hd
http://money.cnn.com/data/markets/sandp/
http://finance.yahoo.com/q/ks?s=HD+Key+Statistics
http://cxa.marketwatch.com/finra/BondCenter/SearchResult.aspx?q=H

Dividend Table 8.1

Page 33 of 33

Home Depot Financial Analysis

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