1. The Home Depot Inc.
Mark Breen
Greg Callow
Marv Franz
Mary Mumcuoglu
Tracey Weiler

2. Agenda 1) Case Background 2) Industry and Strategy Analysis
3) Accounting Analysis
4) Evaluating Performance
5) Cash Flow Analysis
6) Financing
7) Subsequent Developments
8) Summary

3. Case Background Warehouse concept hardware stores
Increasing competition in the industry
Experiencing rapid growth
Faces common problems like many growth companies, i.e. financing growth
Runs up against debt covenants and dropping stock price

4. Industry Rivalry: Moderate
Industry Analysis
Industry Rivalry: Moderate
High market growth
Low product differentiation – more on service/selling side
Economies of scale in purchasing, advertising
Exit barriers are low

5. Threats of Substitute Product: Low
Industry Analysis
Barriers to Entry: Low
Some difficulties in achieving economies of scale
Channels are easily accessible
Some capital requirements
Threats of Substitute Product: Low
Contractors are more expensive
High growth in industry shows people enjoy doing work themselves

6. Power of suppliers: Low Power of customers: High
Industry Analysis
Power of suppliers: Low
Low switching cost
Power of customers: High
Switching cost are low
Importance of price
Repeat business at Home Depot may be small
Once people learn from Home Depot’s sales people they may then go to the competitor offering the lowest prices

7. Strategy Analysis
Value Proposition: Low cost, high service, full stock
Product Market Focus: Full selection of product for Do-It-Yourself home renovations
Core Activities: Merchandising, purchasing, customer service
Goals: Growth, market share

8. Strategy Analysis
Low cost strategy but differentiates themselves on service
Keep costs low through minimal overhead, volume purchase discounts & inventory turnover
Much higher S&G expenses – advertising & customer service
Often dangerous to position in between low cost and differentiation

9. Major Questions about Strategy
Strategy Analysis
Major Questions about Strategy
Do they have a sustainable competitive advantage?
How much of success is driven by market growth?
Growth by itself can be a problem:
Profitable growing markets attract competitive responses driving margins down
As business dynamics change companies can end up over-leveraged

10. Accounting Analysis Nothing looks unusual Major Accounting Policies
Revenue Recognition: Business is cash and carry, revenue is recognized at time of sale
COGS- Booked at time of sale to match with revenues
Inventory Valuation: Inventory is valued using FIFO

11. Evaluating Performance - Time Series Comparison
Dupont Framework:
NI/SALES X -
Profitability
SALES/ASSETS X -
Asset Management
ASSETS/SE -
Financial Leverage
= ROE
1986
1.17
1.84
4.27
9.19
1985
3.26
1.74
3.11
17.64
1984
4.01
2.43
1.61
15.69

12. Evaluating Performance - Time Series Comparison
Conclusions:
ROE has decreased dramatically because margins and asset turnover are decreasing
This is offset by an increase in leverage.

13. Evaluating Performance - Further Investigation - NI/SALES
Dollars (Millions)
Percent of Sales
Dollars (Millions)
Percent of Sales
Dollars (Millions)
Percent of Sales
SALES
100%
COGS
74.10%
73.60%
72.70%
SELLING
19.20%
74.447
17.20%
43.514
17.00%
PRE-OPENING
7.521
1.07%
1.917
.44%
2.456
.96%
ADMIN
20.555
2.93%
12.817
2.96%
7.376
2.88%
INTEREST EXPENSE
8.725
1.20%
(1.114)
(.26%)
(2.318)
(.90)
MARGIN
1.50%
5.80%
6.46%

14. Evaluating Performance - Further Investigation - NI/SALES
Conclusions:
Overall MARGINS ARE DECREASING
Most costs increased steadily over the three years
COGS increased from 72.7% to 74.1% of sales
Selling costs increased from 17.0% to 19.2% of sales
Pre-opening costs decreased from 0.96% to 0.44% and then increased dramatically to 1.07% of sales
Net interest expense has decreased dramatically from (2.38%) to 1.2% of sales
They had interest revenue during 1984 and 1985 and an interest expense during 1986

15. Evaluating Performance- Further Investigation- SALES/ASSETS
Key Business Drivers:
1986
1985
1984
Inventory Turns
3.4
3.79
3.17
Sales per Store (M)
14.0
13.9
13.5
AVG Size of Store 80
77.4
73.7
Sales per SQR/FT
175.2
180.3
183.0
Transactions per Store
466.5
459.9
446.3
Sales per Transaction
30.04
30.36
30.21

16. Evaluating Performance- Further Investigation- SALES/ASSETS
Conclusions:
Inventory turns have decreased
Average size of store has increased
Average sales per store has been steady
Average amount of sales per square foot of store space has declined
Overall, efficiencies are decreasing

17. Evaluating Performance - Cross Sectional Comparison
HOME DEPOT
HECHINGER
1986
1985
1984
ROE =
9.19
17.64
15.69
15.80
18.90
19.10
PROFITABILITY
(Driver 1) *
1.17
3.26
4.01
4.84
5.17
5.292
ASSET MANAGEMENT
(Driver 2) *
1.84
1.74
2.43
1.48
1.72
2.02
DEBT MANAGEMENT
(Driver 3) *
4.27
3.11
1.61
2.21
2.12
1.79
NOTE: Home Depot has lower profit margins, less asset turnover, better debt management

18. Evaluating Performance - Cross Sectional Comparison
Do these findings align with strategy?
Home Depot:
Low Prices
High Volume
Good Customer Service
Hechinger:
Upscale stores
Higher Prices
Low Volume

19. Evaluating Performance - Cross Sectional Comparison
Further Questions:
What markets does each company operate in?
Why does Hechinger has better inventory turns (4.5 vs. 3.4 in 1986)?
Both have declining ROE, does this imply increased competition or expansion?

20. Cash Flow Analysis Cash 1986 1985 1984 By Operations
(43,120)
(3,056)
(10,574)
Before External Financing
(135,146)
(84,711)
(26,904)
From External Financing
92,755
114,605
40,821
Net Change
(42,391)
(29,894)
13,917

21. Cash Flow Analysis – Further Investigation
1986
1985
1984
Increase in Inventories
(68,654)
(25,334)
(41,137)
Addition to Property and Equipment
(99,767)
(50,769)
(16,081)

22. Cash Flow Analysis Conclusions: Problem:
Home Depot is expanding rapidly
Costs are soaring out of control (inventory and equipment)
Heavy reliance on debt financing
Problem:
How will Home Depot finance their planned expansion?

23. Financing Costs for Expansion Inventories 1.8 M
Property, Plant and Equipment
6.6 M
Cost per Store
8.4 M
Cost for 9 Stores
75.6 M

24. Projected Income Statement
Financing
Projected Income Statement
Sales
1000 M
EBIT
27 M
Interest
(8.7) M
EBT
18.3 M
Taxes (.461 avg of )
8.4 M
Net Income
9.9 M

25. Projected Cash From Operations (M)
Financing
Projected Cash From Operations (M)
Net Income
9.9
Depreciation
4.4
Deferred Tax
3.6
Working Capital (Op’s)
17.9
Change in Inventory
(46.9)
Change in Receivables
(11.5)
Change in Payables
24.6
Net Cash From Op’s
(15.9)

26. Financing Financing Required Line of Credit 200 M – 88 M = 112 M
Financing Required
Line of Credit
200 M – 88 M = 112 M
Restrictions
EBIT/Interest < 2:1
Maximum Interest Allowed
27 X 0.5 = 13.5 M
Current Interest
= 8.7
Amount Interest Cost Allowed
13.5 – 8.7 = 4.8
Max Borrowing All’d
4.8 / 0.8 = 60 M

27. Cash Flow Analysis Is It Enough? Question: Needed – 91.5 M
75.6 M for new stores
15.9 M for operations
Able to Borrow – 60 M
Question:
Where will Home Depot get their additional financing?

28. Cash Flow Analysis Can Home Depot generate greater cash flows?
Yes. If capacity utilization is increased then sales growth will occur as fixed costs spread over a larger sales base.

29. Cash Flow Analysis Can Home Depot generate greater cash flows?
Sales / Store = Sales / Transaction x Sales Transactions / Store
1985 = 14 M = x 30.04
1984 = 13.9 M = x 30.36
1983 = 13.5 M = x 30.21
Can increase sales per store by increasing customer traffic but probably not sales per transaction

30. Conclusions Subsequent Developments:
Performance in future years was a dramatic turn around in the company’s profitability
Sales continued to grow at a slightly lower, but still impressive rate
Return on sales, return on equity, pre-tax margins and asset turnover all increased through better inventory control, and better cost control
Most important improvement was in the number of transactions per store
Financial position improved dramatically, operations provided a positive cash flow
Stock price increased
Company’s leverage dropped to a debt-equity ratio of 0.91

31. Conclusions
Summary:
Management of The Home Depot took key steps to improve the productivity of their assets
Led to an increase in profitability without sacrificing growth
Financial markets rewarded the developments
Enabled the company to issue equity and reduce debt
Company left with considerable financial flexibility to implement its growth plans

32. Questions?