Home Depot announced earnings for the 13 weeks that ended on 1 February 2009. This post provides the initial GCFR analysis for the period, which was the fourth quarter of the company's fiscal 2008. (Note that the fourth quarter of fiscal 2007 included a 14th week.)To update the GCFR gauges, we had to make a few assumptions because the Balance Sheet in Home Depot's press release omitted some details and because a Cash Flow Statement was not provided. We will recompute the gauge scores when complete financial statements and notes become available in the company's 10-K filing.
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 a multitude of smaller hardware and lumber retailers. Investors with large stakes in Home Depot include RBS Partners, L.P., and Berkshire Hathaway (NYSE: BRK.A). RBS is associated with Edward Lampert, Chairman of Sears Holdings (NASDAQ:SHLD). Berkshire, of course, is run by investing guru Warren Buffett.
In January 2009, Home Depot announced it will discontinue its EXPO Design Center business. The EXPO stores "offer products and services primarily related to design and renovation projects." To account for store closure-related asset impairments, severance pay, and other related expenses, Home Depot recognized a pre-tax charge of $387 million in the fourth quarter. Additional charges totaling $142 million are anticipated in future quarters.
The Expo shutdown came on top of a decision in May 2008 to forgo 50 or so planned stores in the U.S. and to close 15 existing stores. Home Depot recorded pretax charges of $586 million in conjunction with these two actions.
HD Supply, a former Home Depot division serving professional contractors, was sold to a consortium of private equity firms in 2007, and Home Depot then repurchased $10.7 billion of its common shares. As part of the sale, Home Depot invested $325 million for a 12.5 percent equity stake in HD Supply. Now, in recognition of the reduced market value of this investment, Home Depot recorded a $163 million pre-tax charge in the fourth quarter. It should be noted that Home Depot has guaranteed $1.0 billion of HD Supply debt.
Three months ago, the GCFR Overall Gauge of Home Depot slipped from 45 to 41 of the 100 possible points. Our initial and updated analysis reports on the the third quarter explained the results in some detail.
The Cash Management and Value gauges were reasonably strong at 14 and 13 points, respectively, of the 25 possible points. Growth, at zero points, was non-existent. Revenue in the quarter was 6.2 percent less than in the year-earlier period. Same-store sales were down a substantial 8.3 percent, but (only?) by 7 percent if a shift in the fiscal calendar is considered. Trailing four-quarter Revenue fell 3.6 percent and Net Income from continuing operations was down 29.4 percent.
Now, with actual and estimated data for the fourth quarter, our gauges display the following scores:
- Cash Management: 12 of 25 (down from 14 in October)
- Growth: 1 of 25 (up from 0)
- Profitability: 10 of 25 (up from 8)
- Value: 12 of 25 (unchanged)
- Overall: 40 of 100 (down from 41)
These scores are subject to change after the 10-K report is filed.
Because Home Depot's corporate structure changed substantially in 2007, our gauge scores should be treated with an extra dose of skepticism. GCFR numbers are determined in part by comparing current financial data with historic results, but the validity of some recent 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 announced baseline, which was modified after the Expo decision.
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.
http://sheet.zoho.com/public/ncarvin/hd-income-statement-2?mode=html
Revenue was 17.3 percent less than in the year-earlier quarter, but it slightly more (0.9 percent) than our target. We expected, based on the company's earlier guidance, Revenue to decline by 18 percent. Same-store sales were down 13 percent, but (only?) by 11.5 percent if a shift in the fiscal calendar is considered. Revenue in fiscal 2008 was 7.8 percent less than in fiscal 2007.
The Cost of Goods Sold (CGS) was 66 percent of Revenue in the quarter, which translates into a Gross Margin of 34 percent. The quarter was, therefore, a little more profitable than expected because our Gross Margin target was 33.2 percent. The Gross Margin was 34.3 percent in the fourth quarter of fiscal 2007.
Depreciation and Amortization expenses were 1.6 percent less than the assumed $450 million per quarter value.
Sales, General, and Administrative expenses (excluding a $387 million charge that we're handling separately) were 26.5 percent of Revenue, compared to our estimate of 25.0 percent.
We put the $387 million "business rationalization" charge, which accounts for store closure-related asset impairments, severance pay, etc., in the Other Operating Expense category. The value estimated previously by company management was $390 million.
The figures identified above result in Operating Income 79 percent below the amount in the year-earlier quarter. We estimated that Operating Income would be down 72 percent. Higher SG&A expenses was the main reason Operating Income was worse than we expected.
In the Non-Operating area, the charge to reflect the reduced value of Home Depot's investment in HD Supply matched expectations. Net interest and other expenses was $36 million less than expected.
The costs pushed pre-tax income into negative territory. After taking into account tax provisions and losses on discontinued operations, Net Income of minus $54 million nearly matched our forecast of a $46 million loss.
| Cash Management | January 2009 | 3 months prior | 12 months prior |
| Current Ratio | 1.2 | 1.2 | 1.2 |
| LTD/Equity | 54.4% | 56.3% | 64.3% |
| Debt/CFO | 2.2 years (*) | 2.1 years | 2.3 years |
| Inventory/CGS | 86.4 days | 90.6 days | 87.3 days |
| Finished Goods/Inventory | N/A | N/A | N/A |
| Days of Sales Outstanding (DSO) | 5.7 days | 7.6 days | 10.6 days |
| Working Capital/Market Capitalization | 4.6% | 5.3% | 3.0% |
| Cash Conversion Cycle Time (CCCT) | 50.5 days | 44.3 days | 50.3 days |
| Gauge Score (0 to 25) | 12 | 14 | 8 |
The Cash Management metrics are surprisingly stable given the state of the economy, the weak retail sector, and the housing crisis. Debt is decreasing slowly, but steadily, since 2007's restructuring and massive share repurchase. The inventory reduction, compared to last year, suggests that the company is handling the sales slump as well as could be hoped. The reduction in DSO is a signs of improved efficiency.
| Growth | January 2009 | 3 months prior | 12 months prior |
| Revenue growth | -7.8% | -3.6% | -2.1% |
| Revenue/Assets | 167% | 166% | 160% |
| CFO growth | -9.5% (*) | -19.0% | -25.2% |
| Net Income growth | -45.1% | -31.8% | -20.1% |
| Gauge Score (0 to 25) | 1 | 0 | 0 |
(*) Based on estimated Cash Flow from Operations in the most recent quarter.
The contraction is Revenue worsened in the fourth quarter. We only have actual data for Cash Flow from Operations for the first three quarters of the fiscal year. However, the data we have suggest that the rate at which this important parameter was falling might have eased. Net Income, of course, was negative affected by large special charges in the fourth quarter. Until recently, we would have given the company credit for improving Revenue/Assets. However, we no longer believe this ratio is important if Revenue is falling.
| Profitability | January 2009 | 3 months prior | 12 months prior |
| Operating Expenses/Revenue | 93.9% | 92.8% | 90.6% |
| ROIC | 9.8% | 11.8% | 15.0% |
| FCF/Equity | 18.8% (*) | 16.2% | 10.1% |
| Accrual Ratio | -1.9% (*) | -0.4% | -13.7% |
| Gauge Score (0 to 25) | 10 | 8 | 11 |
The increase in Operating Expenses is indicative of difficult retailing environment and special charges. 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 | January 2009 | 3 months prior | 12 months prior | 5-year median |
| P/E | 16.1 | 13.3 | 11.7 | 14.3 |
| P/E to S&P 500 average P/E | 107.7% | 89.2% | 70.1% | 88.5% |
| Price/Revenue | 0.5 | 0.5 | 0.7 | 1.0 |
| Enterprise Value/Cash Flow (EV/CFO) (*) | 9.1 | 9.4 | 11.3 | 12.0 |
| Gauge Score (0 to 25) | 12 | 12 | 13 | N/A |
Home Depot's stock price ended January at $21.53, which is 8.7 percent below the closing price of $23.59 on 31 October. The shares have fallen further in February. Per GCFR standard practice, the January 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 | January 2009 | 3 months prior | 12 months prior |
| Gauge Score (0 to 100) | 40 | 41 | 41 |
Home Depot's sales are off considerably, and the company has taken some painful steps to realign its cost structure to current conditions. While the company registered a Net Loss in the very difficult fourth quarter, Home Depot would have been profitable if not for special charges involving store closures and investments.
We need to see a 10-Q with full financial statements, but we're encouraged that the drop in the Overall Gauge wasn't more severe. Stable -- in some cases improving -- Cash Management metrics are especially welcome at this time for a firm at the intersection of two weak markets: retailing and housing.
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