The higher score was primarily a consequence of Cash Flow from Operations rebounding in the first quarter after weak numbers in the final two quarters of fiscal 2007. (The rebound might have been aided a little by a shift in the reporting calendar.) Of our four individual gauges, the one that most benefited from the re-evaluation was the Profitability gauge. It rose from 9 points in our initial calculation to a much more robust 14 points.
The Home Depot, Inc. (HD) is the largest retailer of do-it-yourself merchandise, which includes building materials, home improvement supplies, and lawn and garden products. New management sold the Home Depot Supply division, which served professional contractors, to a consortium of private equity firms on 31 August 2007. The price was $8.5 billion, or $1.8 billion less than the figure originally negotiated. Management then executed a $10.7 billion Dutch Auction tender offer for Home Depot shares.
Home Depot announced on 1 May 2008 "it will no longer pursue the opening of approximately 50 U.S. stores that have been in its new store pipeline, in some cases for more than 10 years." This decision will reduce the company's capital spending by about $1 billion over several years. But, the write-down of previously capitalized development costs led to a $400 million charge to 2008 earnings. Similarly, a related decision to shutter 15 existing stores resulted in additional charges of $186 million. The bulk of these charges were recognized in the first quarter.
Home Depot is scheduled to report its second-quarter results, for the 13 weeks ending 3 August, on 14 August 2008. In anticipation of this report, we've modeled the company's Income Statement for the quarter. The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data. GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.
When reporting fiscal 2007's fourth-quarter and full-year results last February, Home Depot management issued the following guidance for fiscal 2008:
- Total sales decline of 4 to 5 percent
- Negative comps in the mid to high single digit range
- Flat to slightly positive gross margin expansion
- Operating margin decline of 170 to 210 basis points
- Depreciation and amortization expense of approximately $1.9 billion
- Income tax rate of 37.2 percent
- Continuing operations earnings per share decline of 19 to 24 percent
- Capital expenditures of $2.3 billion
- 55 new store openings with 5 store relocations
At the first-quarter conference call with analysts in May, Carol Tomé, Chief Financial Officer and Executive Vice President, added "While it is early in the year, today we are more comfortable with the low end of our EPS from continuing operations guidance of down 24% from fiscal 2007. This guidance does not include the store rationalization charge."
Management's guidance was also re-iterated at an Investor's Conference last month.
Revenues were $22.2 billion in the July 2007 quarter, excluding the sales of the former Home Depot Supply business. If the company's guidance to expect a 4 to 5 percent decline is accurate, sales in the July 2008 quarter will be between $21.1 and $21.3 billion. We will split the difference and set $21.2 billion as our estimate.
Home Depot's Gross Margin as a percentage of Revenue has averaged 33.6 percent over the last four quarters. Given the company's guidance to expect "Flat to slightly positive gross margin expansion," a reasonable margin expectation for the July 2008 quarter might be 34 percent. Given our Revenue estimate, the Cost of Goods Sold (CGS) in the second quarter should be about (1-.34) * $21.2 billion, or $14.0 billion.
Management indicated that Depreciation and amortization expenses will be about $1.9 billion for the year. This translates into a quarterly charge of $475 million. However, the figure in recent quarters has been closer to $450 million, so this is our target for the second quarter.
Sales, General, and Administrative (SG&A) expenses as a percentage of Revenue have averaged 22.5 percent over the last four quarters, but this ratio has been 24.3 and 24.7 percent in the last two quarters. For the second quarter estimate, we will assume 24.0 percent. In other words, we're expecting SG&A expenses to be 0.24 * $21.2 billion, or $5.1 billion.
In the Other Operating Expense category, there might be some residual charges due to the reduction in new and existing stores. However, we will assume that the first quarter took care of these charges.
Our estimates for Revenue and Operating Expenses would result in an Operating Income of $1.67 billion, down 35 percent from the year-earlier quarter.
Net interest and other expenses have been increasing. We will somewhat arbitrarily choose $175 million as our estimate for these expenses in the second quarter. This value would decrease pre-tax income to $1.5 billion.
Management guided analysts to expect an income tax rate of 37.2 percent. This rate would suggest that provisions for income taxes will be $560 million, and Net Income will be $940 million ($0.56 per share, if the number of shares outstanding hasn't changed much from April). This figure is 38 percent below Net Income from continuing operations in the year-earlier quarter. On a per-share basis, earnings would be down 28 percent.
Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($ M) |
|
3 August 2008 (predicted) |
29 July 2007 (actual) |
| Revenue |
|
21200 |
22184 |
| Operating expenses |
|
|
|
| |
CGS | (13992) |
(14843) |
| Depreciation | (450) | (414) | |
| |
SG&A | (5088) | (4370) |
| |
Other |
(0) |
(0) |
| Operating Income | |
1670 |
2557 |
| Other income |
|
|
|
| |
Investments |
0 |
0 |
| |
Interest, etc. |
(175) |
(145) |
| Pretax income |
|
1495 |
2412 |
| Income tax |
|
(556) |
(891) |
| Net Income from continuing operations |
|
939 $0.56/sh |
1521 $0.77/sh |
| Discontinued operations |
|
0 |
66 |
| Net Income | 939 $0.56/sh | 1587 $0.81/sh | |
| Shares outstanding |
|
1685 |
1969 |
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