HD: Financial Analysis through April 2008

We have analyzed Home Depot's preliminary report for fiscal 2008's first quarter, which consisted of the 13 weeks ended 4 May 2008. This period is referred to as the April quarter because retailers typically track sales for intervals that end near 31 January, 30 April, 31 July, and 31 October. Home Depot's initial, pre-10-Q financial statements were, as usual, incomplete. The Balance Sheet was abbreviated, and the Cash Flow Statement was omitted.

We will update our evaluation after the company submits a 10-Q report to the SEC.

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. After Frank Blake replaced Robert Nardelli (now at Chrysler) as Chairman and CEO, the company sold the Home Depot Supply division to a consortium of private equity firms. The sale of the unit serving professional contractors closed on 31 August 2007 at a price of $8.5 billion, which was $1.8 billion less than the originally negotiated figure. The company used the proceeds and other funds to complete a $10.7 billion Dutch Auction tender offer for its own shares. The offer is part of a larger $22.5 billion "recapitalization" plan, although there has been speculation that the further share repurchases will be delayed considerably.

RBS Partners, L.P., a fund associated with Edward Lampert, reported in a Form 13F filing, that it owned more than 22.7 million Home Depot shares on 31 March 2008. The position was worth $636.7 million on that date. Mr. Lampert is Chairman of Sears Holdings.

When we analyzed Home Depot after 2007's final results became available, the Overall score was an encouraging 45 of 100 points. Of the four individual gauges that fed into this composite result, Value was the strongest at 13 of 25 points. Cash Management was weakest at 8 of 25 points.

Because Home Depot's corporate structure changed substantially in 2007, our gauge scores should be treated with an extra dose of skepticism. Comparisons of current financial data with historic results drive the numbers, and the validity of some comparisons is questionable. Caution is also advisable because of the uncertain state of the housing market.

Now, with the available data from the April 2008 quarter, our gauges display the following scores:

• Cash Management: 9 of 25 (up from 8 in January)
  
• Growth: 10 of 25 (unchanged)
• Profitability: 9 of 25 (down from 11)
• Value: 11 of 25 (down from 13)
  

• Overall: 41 of 100 (down from 45)

These scores are subject to change after we evaluate the 10-Q report.

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

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.

($ M)		4 May 2008 (actual)	4 May 2008 (predicted)	29 April 2007 (actual)
Revenue		17907	17700	18545
Operating expenses
	CGS	(11835)	(11682)	(12282)
	Depreciation	(444)	(475)	(405)
	SG&A (1)	(4357)	(4247)	(4186)
	Other	(543)	(547)	(0)
Operating Income		728	748	1672
Other income
	Investments	0	0	0
	Interest, etc.	(164)	(200)	(160)
Pretax income		564	548	1512
Income tax		(208)	(204)	(565)
Net Income from continuing operations		356 $0.21/sh	344 $0.20/sh	947 $0.48/sh
Discontinued operations		0	0	99
Net Income		356 $0.21/sh	344 $0.20/sh	1046 $0.53/sh
Shares outstanding		1683	1680	1969

(1) The $543 million charge related to fewer new stores and closing existing stores was excluded from the 1Q 2008 SG&A amount and listed separately.

Revenue in the April 2008 quarter was 1.2 percent above our target, but 3.4 percent less than in the year-earlier quarter. Using the midpoint of management guidance for 2008, we expected sales would decline by 4.5 percent. On a year-over-year basis, Revenue fell 1.9 percent.

We thought the company could achieve a Gross Margin in the quarter of 34 percent, and they almost made it. The margin was 33.9 percent. In other words, the Cost of Goods Sold (CGS) was 66.1 percent of Revenue.

Depreciation expenses were $31 million below our target, which was based on the company's guidance for the full year. Depreciation was 2.5 percent of Revenue, instead of 2.7 percent.

Sales, General, and Administrative (SG&A) expenses, excluding special charges, were 24.3 percent of Revenue, a little higher than our forecast of 24.0 percent.

On 1 May 2008, Home Depot announced it would recognize a $547 million charge in the first quarter because of its decision to open fewer-than-planned new stores and to close 15 existing stores. The actual charge was $543 million.

Greater Revenue and higher costs nearly balanced. Operating Income was only 2.7 percent below the forecast value.

Non-Operating interest expense was a substantial $36 million less than we expected. And, the Income Tax Rate was also slightly lower than predicted: 36.9 percent vs. 37.2 percent guidance. As a result, Net Income from continuing operations surpassed our prediction by 3.5 percent.


Cash Management. This gauge increased from 8 points in January to 9 points now.

	April 2008	3 months ago	12 months ago
Current Ratio	1.2	1.2	1.4
LTD/Equity	64.0%	64.3%	45.3%
Debt/CFO	3.1 yrs	2.3 yrs	1.8 yrs
Inventory/CGS	97.0 days	87.3 days	97.6 days
Finished Goods/Inventory	N/A	N/A	N/A
Days of Sales Outstanding (DSO)	12.1 days	10.6 days	16.2 days
Working Capital/Market Capitalization	3.6%	3.0%	6.6%
Cash Conversion Cycle Time	43.9 days	50.3 days	47.9 days

Home Depot's capital structure became significantly more leveraged last year, but no more so in the first quarter. The reductions in DSO and CCCT could be signs of efficiency improvements. However, 97 days of inventory, measured by cost, seems to be tying up more working capital than necessary. (Wal-Mart's inventory is about 45 days at cost.)


Growth. This gauge didn't change from 10 points in January.

	April 2008	3 months ago	12 months ago
Revenue growth	-1.9%	-2.1%	-4.5%
Revenue/Assets	168%	175%	139%
CFO growth	N/A	-25.2%	-5.7%
Net Income growth	-24.9%	-20.1%	-19.4%

Growth rates are trailing four quarters compared to four previous quarters.

The growth score is driven entirely by the substantial increase in Revenue as a percentage of Assets. The latter decreased as a result of the share repurchase.


Profitability. This gauge decreased from 11 points in January to 9 points now.

	April 2008	3 months ago	12 months ago
Operating Expenses/Revenue	91.1%	90.6%	89.4%
ROIC	14.5%	15.0%	14.1%
FCF/Equity	N/A	12.2%	11.3%
Accrual Ratio	N/A	-14.2%	4.6%

We await the Cash Flow data to get a better read on Profitability, but the Increase in Operating Expenses is discouraging. On the other hand, for a company in the midst of the housing slump, a 14.5 percent ROIC doesn't seem so bad.


Value. Home Depot's stock price slipped from $30.64 on 31 January to $28.80 on 30 April 2008. The Value gauge, based on the latter price, decreased to 11 points from 13 points three months ago.

	April 2008	3 months ago	12 months ago	5 year median
P/E	13.4	12.2	15.5	15.6
P/E to S&P 500 average P/E	77.0%	73.2%	93.2%	91.4%
Price/Revenue	0.6	0.7	1.0	1.0
Enterprise Value/Cash Flow (EV/CFO)	N/A	11.3	13.1	12.8

The average P/E for the Retail - Specialty industry is 16.6, and the average Price/Sales is 1.1.

Home Depot is selling at a discount to the market.

We need the full set of financial statements that will be in the 10-Q report, but our initial reading of the Overall Gauge is a score of 41 out of 100 possible points.