HD: Financial Analysis through January 2009 (Update)

We previously posted an analysis of Home Depot's (NYSE: HD) earnings announcement for the 13 weeks that ended on 1 February 2009, which was the fourth 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.

Using the 10-K Home Depot has submitted to the SEC on 2 April 2009, we have updated the analysis to incorporate the data that hadn't previously been disclosed.

For example, we now know that Cash Flow from Operations in the fiscal year was only 3.5 percent less than Cash Flow in the previous fiscal year.  This is impressive given the challenging economic conditions and that the earlier year included a 53rd week.  This was much better than our estimate of a 9.5 percent decline in Cash Flow. 


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).  Investing guru Warren Buffett, of course, runs Berkshire.

In January 2009, Home Depot announced it would 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.


The additional data in the 10-K resulted in minor alterations to the gauge scores we computed using the preliminary report.

• Cash Management: 5 of 25 (down from 10 in October)
  
• Growth:  1 of 25 (up from 0)
• Profitability: 8 of 25 (up from 6)
• Value:  12 of 25 (down from 13)

• Overall:  34 of 100 (down from 35)

Note that the earlier results were recomputed (generally downward for Home Depot) because of the recent tweaks to our gauges.

The 10-K didn't change our examination of the January quarter's Income Statement.  See this earlier post for the results.

http://sheet.zoho.com/public/ncarvin/hd-income-statement-2?mode=html

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	2.1 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/Invested Capital	7.7%	9.4%	6.4%
Cash Conversion Cycle Time (CCCT)	50.5 days	44.3 days	50.3 days
Gauge Score (0 to 25)	5	10	4

The drop in the Cash Management gauge score from October is mostly due to the higher Cash Conversion Cycle Time, which is related to efficiency, and the lower ratio of Working Capital to Invested Capital.  These two changes probably reflect a combination of economic challenges and seasonal factors. 

The lower Long Term Debt to Equity Ratio mitigated the drop.  Debt has decreased slowly, but steadily, since 2007's restructuring and massive share repurchase.

Growth	January 2009	3 months prior	12 months prior
Revenue growth	-7.8%	-3.6%	-2.1%
Revenue/Assets	167%	166%	160%
CFO growth	-3.5%	-19.0%	-25.2%
Net Income growth	-45.1%	-31.8%	-20.1%
Gauge Score (0 to 25)	1	0	0

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

The Revenue contraction became more severe in the fourth quarter.  The small increase in Revenue as a percentage of Assets is interesting, but we distrust this metric when Revenue is falling.

The plunge in Net Income was exacerbated by the large special charges in the fourth quarter.  The relative minor drop in Cash Flow from Operations is surprising and encouraging.

Profitability	January 2009	3 months prior	12 months prior
Operating Expenses/Revenue	93.1%	92.1%	90.6%
ROIC	11.0%	13.0%	15.0%
FCF/Invested Capital	12.8%	10.1%	7.1%
Accrual Ratio	-3.7%	-0.4%	-13.7%
Gauge Score (0 to 25)	8	6	9

The increase in Operating Expenses is indicative of the difficult retailing environment and special charges.  Improved Cash Flow, seen in the Free Cash Flow and Accrual Ratios, is the principal reason this gauged edged upward.  For a company in the midst of the housing slump, the profitability 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	96%	89%	70%	89%
PEG	N/A	1.7	1.1	0.5
Price/Revenue	0.5	0.5	0.7	1.0
Enterprise Value/Cash Flow (EV/CFO)	8.5	9.4	11.3	11.5
Gauge Score (0 to 25)	12	13	13	N/A

Home Depot's stock price fell about 30 percent during the fiscal year.  However, it made up some of this ground during the market's recent rebound. Per GCFR standard practice, the January closing price was used to calculate the Value gauge score.

Two numbers above deserve your attention.  Home Depot could have been purchased for only 8.5 times Cash Flow (an 11.8 percent return) and the Price to Revenue is only half its historical level.

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)	34	35	35

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 are encouraged that the drop in the Overall Gauge wasn't more severe for this firm at the intersection of two weak markets: retailing and housing.