Home Depot

Topics: Cash flow, Cash flow statement, Lowe's Pages: 6 (1438 words) Published: November 1, 2008
Team Project #1

Home Depot, Inc. in the New Millennium
(HBS 9-101-117)

Question 1. Assess Home Depot’s financial performance from 1986 to 1999. What explains the decline in performance in 2000? (See Question #1 Exhibit)

The slowing economy in 2000 combined with Home Depot’s aggressive expansion efforts was the reason for Home Depot’s poor financial performance. Between June 1999 and May 2000, the FED had raised interest rates six times – or a total of 1.75 percentage points – in an effort to slow the economy and economists had been noticing some softening of overall consumer demand.

From Exhibit 4 we see an average increase in sq. footage of 26% per year for period 1986 – 2000 while average sales growth fall from an average over the same time period of 31% to 19% in 2000. In addition Exhibit 4 shows there was a drop in sales per square footage from $423 in 1999 to $415 in 2000 and a drop in weekly sales per store from $876,000 in 1999 to $826,000 in 2000.

An additional calculation derived from Exhibit 4 is the average number of customer transactions per store per year which had been on the steady increase from 1986 to 1996. However, the number of transactions dropped from 906,250 in 1996 to 881,410 in 1997 to 873,850 in 1998 to 856,989 in 1999, and finally down to 826,279 in 2000. Home Depot faced declining performance in 2000 from cannibalization of sales due to over expansion and market saturation. Resulting sales drops were also magnified by the slowing economy.

Question 2. What is your estimate of the intrinsic value of Home Depot’s stock as beginning of 2001, assuming that it will have a constant growth rate of 6% and maintain its same ROE as in 2000? Prepare a sensitivity analysis varying the cost of equity and ROE. (See Question #2 Exhibit)

CAPM = Rf +β(Rm-Rf)
Ke =.058+1.09(.07)
Ke = 13.43%

ROE = .209
G = .06

V= BVE * (ROE-g)/(Ke-g)
12,341*(.209-.06)/(.1343-.06) = 24,748.44

Value ranges from $25.3B to $61.2B depending on the cost of equity used (estimated by CAPM) with risk market premiums varying from 3-7%. However, further analysis of Home Depot’s past returns, when standardized to a normal distribution with cumulative probabilities, the resulting expected return equated to 13.3% (7.5% higher than Rf) supporting the use of at least a 7% market risk premium.

When we vary the ROE from 20.9% (actual 2000 ROE) to 24.9% (average 1986-2000 ROE) we then get a range of values from $25.3 to $32.1B

Valuation is dependent upon our assumption of the market risk premium, and Home Depot’s growth and ROE. Careful analysis on Home Depot’s past performance does however allow for a considerable narrowing of the target valuation range.

Question 3. Compare Home Depot’s performance to that of Lowe’s. (See Question #3Exhibut & Supplemental Exhibits)

Sales: HD sales as a percent to Lowe’s have increased from 217% in 1997 to 243% in 2000. Sales growth for Home Depot is consistently 4% to 5% higher than Lowe’s each year.

Operating Turnover (sales/net assets): HD has outperformed Lowes through the expansion phase with a 5% drop in operating turnover while Lowes dropped 24%

NOPAT: HD’s NOPAT margin is slightly higher than Lowe’s. Operating ROA is over 5% higher at Home Depot than Lowe’s.

In conclusion, we believe the data analyzed, Sales, Operating Turnover, and NOPAT; favor Home Depot. It has had higher increases in sales, better return on assets, and higher margins. Home Depot also has less debt and a stronger brand name than Lowe’s.

Question 4. Analyze Home Depot’s Cash Flow Statements. Is Home Depot funding its investments out of internal cash flow or from external financing? Are dividends financed out of internal cash flow or by external financing? If Home Depot is using external financing, what percentage is debt financing? Common stock financing? (See Question #4 Exhibit & Supplemental Exhibits)

Table (A)
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