Case Home Depot

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THE HOME DEPOT
1. 2. Questions Home Depot’s Stock Price Dropped 23% between January 1985 and February 1986. What Were the Reasons for this Decline? Should the Company Change its Strategy?

THE HOME DEPOT
Strategic Analysis The Home Depot Pioneered the Concept of Warehouse Retailing in the Home Centre Industry. The Company’s Strategy Consists of: Focusing on the Do-It-Yourself Segment of the Market; 1. Keeping Costs through Low Overhead, Purchase Discounts, and High Turnover; 2. Attracting Customers through Aggressive Advertising and Competitive Pricing; 3. Providing High Service to the Target Customer Group through Well-Trained Employees 4. and Well-Stocked Stores;

THE HOME DEPOT
Financial Analysis (1) 1. The Home Depot Is Experiencing Declining ROEs (AVG): 45.5% in 1982; 24.5% in 1983; 19.4% in 1984; 9.7% in 1985; This Decline in ROEs Is Explained by Declining ROAs and Obtains in Spite of Increasing Financial Leverage: ROA (AVG) 1983 1984 1985 3. 14.8% 8.0% 2.6% FL (AVG) 1.7 2.4 3.7

2.

The Decline in ROAs Is Explained by Both Declines in ROSs and Declines in ATs: ROS 1983 1984 1985 4.0% 3.3% 1.2% AT (AVG) 3.7 2.4 2.2

THE HOME DEPOT
Financial Analysis (2) 1983 Sales Growth (%) Earnings Growth (%) Assets Growth (AVG %) Asset Growth (%) BY AVG EY F F F F 1983 +218.7 +176.9 +137.0 +117.8 +93.1 +176.9 1984 +137.0 +156.5 +218.7 1984 +68.9 +37.6 +156.5 1985 +61.9 (41.8) +77.5 1985 +52.5 +77.5 +137.0

The Company Has Been Increasing its Asset Base by Adding New Stores; This Expansion Is Financed to a Large Extent through Debt Leading to Increased Leverage; Sales Growth Is However Not Keeping Up with the Rate of Increase in the Asset Base; The Lower Asset Turnover Coupled with the Reduced Profitability of Sales Has Led to a Substantial Decline in the Company’s ROE;

4.

The Decrease in ROSs (Sales Profitability) Results from Higher COGS, SGA, and NIE as a Percent of Sales; 1983 1984 1985

Fiscal Year Return on Sales Return on Sales (%) = Gross Margin (%) - SGA/Sales (%) - NIE/Sales (%) - Tax Expense/Sales (%)

4.0 27.3 20.8 3.4

3.3 26.4 20.6 (0.3) 2.8

1.2 25.9 23.2 1.2 0.5

THE HOME DEPOT
Financial Analysis (3) 5. The Decrease in Asset Turnover Can Be Explained by: An Increase in Inventory: ­ 75 Days in 1983→ 83 Days in 1985; A Decreasing Average Amount of Sales per Square Foot Explained by: ­ A Fairly Steady Number of Transactions per Store; ­ A Fairly Steady Amount of Sales per Transaction; ­ An Increase in the Average Size of Stores; ­ 1983 1984 1985

Fiscal Year Working Capital Ratios Days’ Inventory (365*AVG Inventory/Cost of Sales) Days’ Receivables (365*Accounts Receivables/Sales) Days’ Payable (365*Accounts Receivables/Purchases)

75 3 35

82 8 34

83 4 33

Stores Productivity Sales/Store ($ million) Transactions/Store (000) Sales/Transaction ($) Square Feet/Store (000) Sales/Square Foot 13.5 446 30 74 183 13.9 460 30 77 180 14.0 467 30 80 175

­ ­ F

Summary of Financial Analysis The Home Depot Has Been Able to Increase Sales through an Increase in the Number of Stores; The Productivity of these Stores is However Declining, Resulting in Lower Turnover and Profitability; The Company’s Profits Are Not Keeping Pace with its Sales!

THE HOME DEPOT
Performance Relative to Hechinger Co (1) While Hechinger Appears to Be Experiencing a Decline in Performance, the Decline Is Relatively Small Compared to that of the Home Depot. In General: Hechinger’s Ratios Are Strong Relative to The Home Depot’s; • Hechinger’s ROSs Are Significantly Better than the Home Depot’s Margins; • Hechinger’s Gross Profit Margins Are Higher and Selling Costs Are Lower; • The Home Depot Has a Higher Turnover; •

THE HOME DEPOT
The Home Depot vs Hechinger Home Depot Fiscal Year ROE (%) ROA (%) 83 24.5 14.8 84 19.4 8.0 85 9.7 2.6 Heching er 83 19.1 10.7 84 18.9 8.9 85 15.8 7.1

ROS (%) AT FL •

4.0 3.7 1.7

3.3 2.4 2.4

1.2 2.2 3.7

5.3 2.0 1.8

5.2 1.7 2.1

4.8 1.5 2.2



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