Gracie Quintana Jeff Miller Christine Kyrish Steven Poon
December 6, 2004
Table of Contents
Financial Data Snapshot I. Overview of Valuation II. Business Summary Products and Services Competitors Industry Analysis Competitive Strategy III. Accounting Analysis Accounting Policies Degree of Accounting Flexibility Accounting Strategy Quality of Disclosure Quantitative Analysis Red Flags IV. Ratio Analysis and Forecasts Ratio Analysis Section Financial Statement Forecasting Methodology Conclusion V. Valuation Cost of Capital Method of Comparables
1 1 4 4 6 9 15 16 16 19 20 23 23 24 26 27 29 33 34 35 36
Discounted Dividends Discounted Free Cash Flows Discounted Residual Income Long Run Average Residual Income Abnormal Earnings Growth Altman’s Z-score Results VI. Analyst Recommendation VII. References VIII. Appendix Industry Graphs Ratio Analysis Competitor Annual Financials Quarterly Financials and Forecasts Annual Financials and Forecasts Calculations used in Valuations Method of Comparables Valuation Discounted Free Cash Flow and Sensitivity Analysis Valuation Discounted Dividends and Sensitivity Analysis Valuation Residual Income and Sensitivity Analysis Valuation Abnormal Earnings Growth and Sensitivity Analysis Valuation
37 38 39 39 40 41 41 42 43 44 44 45 47 49 52 55 56 57 58 59 60
Investment recommendation: Home Depot is slightly overvalued therefore we recommend it as a hold. The stock is poised to perform at least as well as the market.
Home Depot is expected to penetrate foreign markets; this growth opportunity will increase market share and the bottom line. Uncertainty in the economy affects Home Depot’s sales, as it operates in a cyclical industry. This uncertainty will not have a detrimental impact on the long term growth of Home Depot and its subsidiaries.
I. Overview of Valuation Company and Industry Overview The Home Depot, Inc. is the world’s largest home improvement retailer and the second largest retailer in the United States, earning $64.8 billion in revenues during the 2003 fiscal year. Operating under the cost leader strategy Home Depot derives its key
success factors based on a tight-cost control system, stability of sourcing channels, and a growth strategy based on core competencies. Home Depot’s growth strategy permits further market penetration by enhancing a value chain of lower priced premium products and the expansion of new store formats to support growing market trends. The successful integration of distribution centers that lower transaction costs, an expansive product selection through exclusive and proprietary agreements, and the initiation of a quality assurance program positioned Home Depot to earn consistent above-average profits within a highly fragmented retail (home improvement) industry. Accounting Analysis The accounting policies adopted by the Home Depot prove to be in line with it’s business strategy. Overall, the Home Depot is very forthcoming with their accounting practices and policies. The specifically identify three major areas of accounting policy in regards to their specific industry to further their business strategy as it relates to merchandise inventories, self insurance and revenue recognition. The firm is proactive in divulging accounting policy regarding each of these areas. They specifically address the firm’s actions in regards to required GAAP changes and liberally discuss their adoption of certain GAAP in their financial reporting such as their policy regarding the upcoming change in policy for the firm in their treatment of operational leases as opposed to capital leases. The firm goes as far as to forecast how the change in policy will affect future financial statements in 2004 the notes to their 2003 financial documents. Ratio Analysis Computation of the ratios relevant to the home improvement retail industry shows no significant problems for Home Depot....