Home Depot's initial financial statements were incomplete. The Balance Sheet was abbreviated, and the Cash Flow Statement was omitted. These shortfalls will be resolved when the company submits a 10-Q report to the SEC, and we will then update our evaluation.
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. 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.
RBS Partners, L.P., a fund associated with Edward Lampert, reported in a Form 13F filing that it owned 19.7 million Home Depot shares on 30 June 2008. The partnership appears to have cut its stake by about 3 million shares over the three previous months. Mr. Lampert is Chairman of Sears Holdings (NASDAQ:SHLD).
When we analyzed Home Depot's preliminary results for the first quarter of the 2008 fiscal year, the GCFR Overall gauge of the company's performance and value stood at 41 of 100 points. This score jumped to 49 points when we re-evaluated the company using the full set of financial statements in the formal 10-Q quarterly report. Of the four individual gauges that fed into this composite result, Profitability was the strongest at 14 of 25 points. Cash Management and Growth were weakest at 10 of 25 points.
Now, with the limited data from the July 2008 quarter, our gauges display the following scores:
- Cash Management: 9 of 25 (down from 10 in April)
- Growth: 10 of 25 (unchanged)
- Profitability: 11 of 25 (down from 14)
- Value: 17 of 25 (up from 13)
- Overall: 51 of 100 (up from 49)
These scores are subject to change after we evaluate the 10-Q report.
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 state of the housing market.
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) | | 3 August 2008 (actual) | 3 August 2008 (predicted) | 29 July 2007 (actual) |
| Revenue | | 20,990 | 21,200 | 22,184 |
| Operating expenses | | | | |
| | CGS | (14,026) | (13,992) | (14,843) |
| Depreciation | (452) | (450) | (414) | |
| | SG&A | (4,470) | (5,088) | (4,370) |
| | Other | (0) | (0) | (0) |
| Operating Income | | 2,042 | 1,670 | 2,557 |
| Other income | | | | |
| | Investments | 0 | 0 | 0 |
| | Interest, etc. | 157 | (175) | (145) |
| Pretax income | | 1,885 | 1,495 | 2,412 |
| Income tax | | (683) | (556) | (891) |
| Net Income from continuing operations | | 1,202 $0.71/sh | 939 $0.56/sh | 1,521 $0.77/sh |
| Discontinued operations | | 0 | 0 | 66 |
| Net Income | 1,202 $0.71 | 939 $0.56/sh | 1,587 $0.81/sh | |
| Shares outstanding | | 1,685 | 1,685 | 1,969 |
We thought Home Depot could achieve a Gross Margin in the quarter of 34 percent, and they fell a little short at 33.2 percent of Revenue. In other words, the Cost of Goods Sold (CGS) was 66.8 percent of Revenue.
Depreciation expenses were a scant $2 million more than we expected. Depreciation was 2.2 percent of Revenue, instead of 2.1 percent.
Sales, General, and Administrative expenses were 21.3 percent of Revenue, much less than our 24.0 percent forecast. We were overly conservative because the SG&A ratio was over 24 percent in the previous two quarters.
Despite lower Revenue and a smaller Gross Margin, the much lower-than-anticipated SG&A costs resulted in Operating Income 22.3 percent above the forecast value. Alas, Operating Income in the quarter was still 20.1 percent less than in the comparable year-earlier period
Non-Operating interest expenses were 10.3 percent less than we expected. And, the Income Tax Rate was also lower than predicted: 36.2 percent vs. 37.2 percent. As a result, Net Income from continuing operations surpassed our prediction by 28 percent. However, Net Income was down by 24 percent from the July 2007 quarter.
Cash Management. This gauge decreased from 10 points in April to 9 points now.
| July 2008 | 3 months ago | 12 months ago | |
| Current Ratio | 1.3 | 1.2 | 1.4 |
| LTD/Equity | 60.9% | 64.0% | 42.8% |
| Debt/CFO | 2.3 yrs | 2.2 yrs | 1.7 yrs |
| Inventory/CGS | 88.0 days | 97.0 days | 91.5 days |
| Finished Goods/Inventory | N/A | N/A | N/A |
| Days of Sales Outstanding (DSO) | 7.4 days | 12.1 days | 12.0 days |
| Working Capital/Market Capitalization | 6.2% | 3.7% | 7.9% |
| Cash Conversion Cycle Time (CCCT) | 41.0 days | 43.9 days | 41.5 days |
Home Depot's capital structure is significantly more leveraged than last year, but the amount of leverage eases a little each quarter. We were concerned last quarter about the high level of inventory, but it was cut back nicely in the most recent quarter. The reduction in DSO and, to a lesser extent, CCCT could be signs of efficiency improvements.
Growth. This gauge didn't change from 10 points in April.
| July 2008 | 3 months ago | 12 months ago | |
| Revenue growth | -2.9% | -1.9% | -5.4% |
| Revenue/Assets | 167% | 168% | 137% |
| CFO growth | N/A | -14.4% | -1.0% |
| Net Income growth | -28.9% | -24.9% | -21.5% |
Revenue, Cash Flow, and Net Income are all down and, in some cases, substantially so. 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 14 points in April to 11 points now.
| July 2008 | 3 months ago | 12 months ago | |
| Operating Expenses/Revenue | 91.6% | 91.1% | 89.8% |
| ROIC | 13.9% | 15.0% | 13.1% |
| FCF/Equity | N/A | 12.4% | 12.2% |
| Accrual Ratio | N/A | -17.6% | 6.5% |
The increase in Operating Expenses might be a reflection of commodity price inflation. 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 ROIC and FCF figures don't look too bad.
Value. Home Depot's stock price fell sharply from $28.80 on 30 April to $23.83 on 31 July 2008. The Value gauge, based on the latter price, increased to 17 points from 13 points three months ago.
| July 2008 | 3 months ago | 12 months ago | 5 year median | |
| P/E | 12.2 | 13.4 | 15.8 | 15.5 |
| P/E to S&P 500 average P/E | 69.2% | 74.2% | 99.1% | 90.2% |
| Price/Revenue | 0.5 | 0.6 | 0.9 | 1.0 |
| Enterprise Value/Cash Flow (EV/CFO) | N/A | 10.9 | 11.8 | 12.1 |
By measures we track, Home Depot shares are selling at quite a discount to the market and to historical conditions. However, we have no way to know how long sales and earnings will continue to decline.
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 51 out of 100 possible points. As far as we're concerned, the big news in the second quarter was the substantial reduction in SG&A expenses as a percentage of Revenue.
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