HD: Financial Analysis through July 2008 (Update)

We previously posted a financial analysis of Home Depot's (HD) preliminary report on fiscal 2008's second quarter, which consisted of the 13 weeks that ended 3 August 2008.  Our evaluation was limited because the Balance Sheet in the initial report was highly condensed and there was no Cash Flow Statement to examine.

Home Depot has now submitted to the SEC a 10-Q quarterly report for the period.  This report includes a more complete set of financial statements, which we have used to update our analysis.

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.

The company's 12.5 percent equity interest in the new HD Supply is included in Other Assets on the Balance Sheet.

In May 2008, Home Depot announced "it will no longer pursue the opening of approximately 50 U.S. stores that have been in its new store pipeline."  A related decision was made to close 15 existing stores.  These two actions have led to estimated charges against 2008 earnings of $586 million, of which $561 million has now been incurred (most in the first quarter).

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).

The Income Statement for the second quarter did not change from the preliminary report to the 10-Q.  Readers interested in our line-by-line review of the Income Statement, including a comparison between the actual results and our expectations, might wish to read the analysis we made available earlier.

Taking the data in the 10-Q into consideration, our gauges now display the following scores:

• Cash Management: 9 of 25 (down from 10 after the April quarter)
  
• Growth: 10 of 25 (unchanged)
• Profitability: 10 of 25 (down from 11)
• Value: 17 of 25 (up from 13)
  

• Overall: 50 of 100 (up from 46)

Key metrics are reviewed below for each gauge.

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	2.4 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 degree of leverage has eased a little.  We were concerned last quarter about the high level of inventory, but it was trimmed 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	148%	151%	143%
CFO growth	-28.5%	-14.4%	-1.0%
Net Income growth	-28.9%	-24.9%	-21.5%

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

Cash Flow from Operations and Net Income are both down substantially.  The increase in Revenue/Assets from the year-earlier quarter is more the company becoming smaller than an efficiency improvement.


Profitability. This gauge decreased from 11 points in April to 10 points now.

	July 2008	3 months ago	12 months ago
Operating Expenses/Revenue	91.6%	91.1%	89.8%
ROIC	13.9%	15.0%	13.9%
FCF/Equity	8.7%	10.1%	12.2%
Accrual Ratio	-20.1%	-17.6%	6.5%

The increase in Operating Expenses might be a reflection of commodity price inflation.  The falling FCF/Equity is becoming a concern.  It might reverse given that capital spending should drop with fewer new store openings.  For a company in the midst of the housing slump, the ROIC doesn'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)	10.3	10.9	11.8	12.1

Home Depot's valuation ratios can be compared with other companies in the Home Improvement industry.


The depressed housing market has resulted in Home Depot shares selling at quite a discount to the market and to historical norms. 

The Overall Gauge score of 50 out of 100 possible points, is a modestly attractive figure.  It has to viewed with an extra dose of skepticism because of the substantial changes to Home Depot's corporate structure in 2007.  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.