We previously posted an analysis of Home Depot's earnings announcement for the 13 weeks that ended on 2 November 2008, which was the third quarter of the company's fiscal year. Our evaluation was incomplete because the press release did not include a Cash Flow Statement and because the Balance Sheet omitted certain details. We had to estimate values for some items to compute gauge scores.Since Home Depot has now filed a 10-Q with the SEC, we were able to update the analysis to incorporate the data that hadn't previously been disclosed.
For example, we now have the data to determine that Cash Flow from Operations in the recent quarter was 59 percent more than in the comparable year-earlier quarter. However, CFO in the last four quarters was 19 percent less than in the four previous quarters. Capital expenditures in the third quarter were $1.1 billion less than in the same period in fiscal 2007.
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. The company competes fiercely with Lowe's (NYSE: LOW) and numerous smaller hardware and lumber retailers.
Last year, the Home Depot Supply division, which served professional contractors, was sold to a consortium of private equity firms. The price was $8.5 billion, or $1.8 billion less than the figure originally negotiated. In conjunction with this sale, Home Depot invested $325 million for a 12.5 percent equity stake in HD Supply. Home Depot hasn't yet written down the value of this investment, but, given current economic and market conditions, an asset impairment charge might become necessary at some point. (Home Depot also guaranteed a $1.0 billion of HD Supply debt.)
Funds from the sale of the division were used by the company to execute a $10.7 billion Dutch Auction tender offer for Home Depot shares.
In May 2008, Home Depot announced "it will no longer pursue the opening of approximately 50 U.S. stores that ha[d] been in its new store pipeline." A related decision was made to close 15 existing stores. These two actions, which led to charges of $586 million, did not bring new store openings to a total halt. Home Depot opened 14 new stores during the third quarter of fiscal 2008, including two that were relocated.
RBS Partners, L.P., a fund associated with Edward Lampert, Chairman of Sears Holdings (NASDAQ:SHLD), reported that it owned 19.7 million Home Depot shares on 30 September 2008. The stake didn't change from June.
The additional data in the 10-Q altered the gauge scores only slightly from those we computed using the preliminary report.
- Cash Management: 14 of 25 (up from 9 in July)
- Growth: 0 of 25 (unchanged)
- Profitability: 8 of 25 (down from 10)
- Value: 13 of 25 (down from 17)
- Overall: 42 of 100 (down from 46)
The 10-Q didn't change our examination of the October quarter's Income Statement. See this earlier post for the results.
| Cash Management | 2 November 2008 | 3 months earlier | 12 months earlier |
| Current Ratio | 1.2 | 1.3 | 1.1 |
| LTD/Equity | 56.3% | 60.9% | 65.0% |
| Debt/CFO | 2.1 yrs | 2.4 yrs | 1.9 yrs |
| Inventory/CGS | 90.6 days | 88.0 days | 93.5 days |
| Finished Goods/Inventory | N/A | N/A | N/A |
| Days of Sales Outstanding (DSO) | 7.6 days | 7.4 days | 12.3 days |
| Working Capital/Market Capitalization | 5.3% | 6.2% | 2.6% |
| Cash Conversion Cycle Time (CCCT) | 44.3 days | 41.0 days | 46.8 days |
| Gauge Score (0 to 25) | 14 | 9 | 5 |
Home Depot's long-term debt spiked last year, but the amount of leverage has since eased somewhat. Reduced inventory, compared to last year, suggests that the company is cautiously and deftly handling the sales slump. The reduction inDSO and, to a lesser extent, CCCT are also signs of efficiency improvements, although some of the gains were given back in the most recent quarter.
| Growth | 2 November 2008 | 3 months earlier | 12 months earlier |
| Revenue growth | -3.6% | -2.9% | -4.9% |
| Revenue/Assets | 166% | 148% | 157% |
| CFO growth | -19.0% | -28.5% | -1.1% |
| Net Income growth | -31.8% | -28.9% | -23.3% |
| Gauge Score (0 to 25) | 0 | 0 | 0 |
Revenue is down only moderately in the last four quarter, but the decline has been accelerating. The 10-Q states that "comparable store sales declined 8.3% in the third quarter ... driven by a 5.5% decline in comparable store customer transactions, as well as a 2.8% decline in our average ticket to $55.86."
Cash Flow and Net Income have both decreased more substantially. Until recently, we would have given the company credit for improving Revenue/Assets. However, we no longer believe this ratio is significant if Revenue is falling.
| Profitability | 2 November 2008 | 3 months earlier | 12 months earlier |
| Operating Expenses/Revenue | 92.1% | 91.6% | 90.3% |
| ROIC | 11.8% | 12.7% | 16.2% |
| FCF/Equity | 16.2% | 8.7% | 13.6% |
| Accrual Ratio | -0.4% | -20.1% | -14.9% |
| Gauge Score (0 to 25) | 8 | 10 | 14 |
The increase in Operating Expenses suggests slackening demand, and it might be an artifact of the commodity price inflation earlier in the year.
ROIC slipped pretty significantly in the last 12 months. The company, which computes ROIC somewhat differently, attributes the decline to lower operating earnings and to the charges associated with the termination of some planned stores and the closing of some existing stores.
FCF/Equity is the most positive metric in this category.
| Value | 2 November 2008 | 3 months earlier | 12 months earlier | 5 year median |
| P/E | 13.3 | 12.2 | 13.1 | 15.2 |
| P/E to S&P 500 average P/E | 95.2% | 66.9% | 75.3% | 90.2% |
| Price/Revenue | 0.5 | 0.5 | 0.7 | 1.0 |
| Enterprise Value/Cash Flow (EV/CFO) | 9.4 | 10.3 | 10.4 | 12.0 |
| Gauge Score (0 to 25) | 13 | 17 | 12 | N/A |
Home Depot's stock price ended October at $23.59, just a little less than the $23.83 on 31 July. The shares fell below $20 in November and then staged a mild rebound. Per GCFR standard practice, the October closing price was used to calculate the Value gauge score.
Home Depot's valuation ratios can be compared with other companies in the Home Improvement industry.
| Overall | 2 November 2008 | 3 months earlier | 12 months earlier |
| Gauge Score (0 to 100) | 42 | 46 | 41 |
We're encouraged that the drop in the Overall Gauge wasn't more severe. Improving Cash Management efficiency is especially welcome for a firm at the intersection of the weak retailing and housing markets.
When announcing the third-quarter results, Chairman and CEO Frank Blake stated: “The housing and home improvement markets remain challenging." Without identifying the details, Blake noted that the company is making the necessary adjustments. He cut Revenue guidance for the current fiscal year to an 8 percent decline. The previous projection was for a 5 percent drop. Sales will apparently fall significantly in the fourth quarter, perhaps as much as 18 percent.
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