FINANCIAL REPORTING AND ANALYSIS

CASE SUBMISSION :- THE HOME DEPOT CASE

DATE :- 03/12/2020

GROUP – 3

Aayush Saha PGP/23/001

Aman Kumar PGP/23/004
Chilla Naveen Shankar PGP/23/012
Sashank Sharma PGP/23/039
Syam Sunkavalli PGP/23/117

Table of Contents
Question 1...................................................................................................................................................2
Question 2...................................................................................................................................................3
Question 3...................................................................................................................................................4
Question 4...................................................................................................................................................4

Question 1
Evaluate the Home Depot’s growth strategy.
The home improvement industry was large and growing in the 80s. The DIY segment had grown
at a CAGR of 14% for the last 15 years. Increase in disposable income was fueling the growth
even more. The Home Depot emerged as the pioneer in warehouse retailing with just a handful
of serious competitors in contention for the crown.

The Home Depot’s growth strategy had the following elements:

 Offered low and competitive prices
 Stores doubled up as warehouses – helped keeping the overheads low, passing the
benefit to customers. Kept 25,000 SKUs worth $4,500,000 at retail on the sales
floor
 Focus on higher volume with low margins and high inventory turnover
 Merchandising strategy included offering nationally recognized products as well
as lesser known ones
 Immense focus sales assistance. Customers were more likely to reach out to the
sales executive for any technical query. This made it very important for the
employees to have technical knowledge as well as service orientation
 Used aggressive advertising across mediums such as television, radio and direct
mail catalogues to attract customers. Sponsored in-store demos of DIY techniques
 Stores were open seven days a week including weekday evenings

The image it had created for itself over the course of its growth was captured in the best
possible way by Fortune magazine – ‘Only company to have successfully brought off the
union of low prices and high services’.

However, the growth was not all rosy. Rapid expansions were affecting the stock price which
had fallen significantly since 1985. As a result, equity financing was becoming less attractive
with time.

Question 2
Ho well did the company implement its strategy. Analyze the Home Depot’s financial
performance and cash flow during the fiscal year 1985.

For the Fiscal year 1985,

Service and operations expenses blew up by 71.1% against the sales growth of 68.9% this can be
utilised to observe the drop in Gross margins from 27.33% to 26.42%

Operations Cash Flow: If we consider the working capital table for the same duration we can
observe a significant rise in net-working capital generated due to operations.
By further utilising the data in the table we can determine the
Cash Flow from Operation activities ~12.6 M
Cash Flow from investing activities ~(80 M)
and Financial activities are at ~ 120 M

This large amount of debt incurred due to raising 120 Million of long term debt will severely
effect the loan taking capability of the company and also impact the PBT for the following
financial year.

This can be, as predicted, seen in the drop in the Net earnings value for the year 1986.
A significant portion of the financial activities is sent into investment activity to expand.

Thus, implementing the strategy to expand rapidly by the addition of 20 facilities has added a
huge dent into the earnings, as well as reduced the future borrowing capacity. In addition, the
cost of hiring and inventory has shot up reducing the operational cashflow ability further.

Question 3
How well did the company perform in 1985 relative to the previous years? How does The Home
Depot’s performance compare to that of Hechinger? You may use the analysis in Exhibit 3 in the
case as guide to begin your analysis. Also make sure that you use data on store productivity in
your analysis.

Financial Analysis – The Home Depot

Two major financial tools have been used to conduct an analysis of the financial performance of
The Home Depot in 1985 relative to the previous years –

a. Ratio Analysis

Home Depot
1985 1984 1983
Current Ratio 3.12 2.43 1.92
 Days Sales Outstanding 8.03 3.18 1.98
Debt/Equity Ratio 1.470 0.067 0.013
Gross Profit Ratio 26.42% 27.33% 28.35%
Inventory Turnover 5.15 4.34 6.56
Net Profit Ratio 3.26% 4.01% 4.52%
Return on Assets 5.66% 9.75% 16.10%
Return on Equity 17.61% 15.72% 28.96%
Receivables Turnover 46.21 116.71 187.33
Payables Turnover 9.84 5.74 2.82
Quick Ratio 1.30 0.71 0.63
Interest Coverage Ratio 6.10 160.27 207.1

The profitability ratios of Home Depot Inc. show that it is not very lucrative. The ROE and ROA
have been consistently falling since 1983. This might be because of reduced asset turnover over
the same period, as the financial leverage has increased as evident from the Debt-to-Equity ratio.
This means that the current assets of the firm are inefficient in generating expected revenues or
sales. The firm is in good condition to meet its short-term obligations as evident from the “Quick
Ratio and Current Ratio”. While the long-term solvency ratios (Interest Coverage Ratio and
Debt/Equity Ratio) are unimpressive. From the net profit and gross profit ratios we understand
that the firm is under pricing pressure in its core operations. DSO and Receivables turnover show
that the company has changed its policy recently for its customers and might have reduced the
quota on providing its product for credit.

b. Cash Flow Analysis

Home Depot
1986 1985 1984
Cash from Operations
Net Earnings 8219000 14122000 10261000
Depreciation and amortization of
property and equipment 4376000 2275000 903000
Deferred Income Taxes 3612000 1508000 713000
Amortization of cost in excess of the
fair value of net assets required 637000 93000
Net gain on disposition of property
and equipment -1317000
Other 180000 77000 59000
Working Capital Provided by
Operations 15707000 18075000 11936000
Changes in components of
Working capital -
 Receivables, net 15799000 7170000 1567000
Inventory 68654000 25334000 41137000
Prepaid expenses 587000 1206000 227000
Accounts payable -21525000 -10505000 -17150000
Accrued Salaries and related
expenses -1578000 93000 -2524000
Other accrued expenses -3736000 -2824000 -341000

Income Taxes payable 626000 657000 -406000

Increase in Working Capital 58827000 21131000 22510000
-43120000 -3056000 -10574000

Cash from Investing Activities

Proceeds from disposition of
property and equipment 9469000 861000 3000
Additions to property and equipment -99767000 -50769000 -16081000
Acquisition of Bowater Home
Center Inc -29193000
Other, net -1728000 -2554000 -252000
-92026000 -81655000 -16330000

Cash from Financing Activities

Current instalments and repayments
of long-term debt -10399000 -6792000 -52000
Proceeds from long-term borrowings 92400000 120350000 4200000
Proceeds from sale of common
stock, net 659000 814000 36663000
Increase (Decrease) in current
portion of long-term debt 10095000 233000 10000
92755000 114605000 40821000

For each of the three years, the company has a negative cash flow from operating activities, it
might be due to large increase in inventories, it might not be so alarming as the company is in a
growth phase. It is evident that in 1985, the cash flow from investing activities has significantly
increased, it is due to selling away of PPE in some locations to support cash flow from
operations to acquire or buy new store locations. The firm has been increasingly choosing to
finance its working capital needs through long-term debt and might risk itself to default of
interest and principal points. The case talks about the firm changing its debt structure to short-
term revolving debt which might be much suited.
Looking at the current trends, the firm is in danger of facing hardship in business expansion if it
plans to choose debt financing methods.

c. Store Productivity

Home Depot
1985 1984 1983
No. of customer transactions 23324000 14256000 8479000
Average amount of sale per
transaction 30.04 30.36 30.21
Weighted average weekly
sales per operating store 342500 365500 360300

Sales/transaction 18.55509347 17.97025814 13.87486732

Number of stores 50 31 19
Sales/Store 8655580 8264000 6191842.105
Number of Employees 5400 4000 2400
Sales/employee 80144.25926 64046 49018.75

Their increased efforts on providing better consumer service might be one of the reasons that the
average sales per employee has drastically increased.

Comparison of Financial Performance : Home Depot V/S Hechinger

a. Ratio Analysis

Home Depot Hechinger

1985 1984 1985 1984
Return on Equity (%) 17.61% 15.72% 18.90% 19.10%

Gross Profit Ratio 26.42% 27.33% 30.10% 32.10%

Inventory Turnover 5.15 4.34 4.5 4.4
Average Collection Period 8.03 3.13 33 35

Average Account Payables Period 37.69 63.62 61 63

SG&A Margin 20.61% 20.82% 21.10% 22.90%
Interest Expense Margin 0.95% 0.04% 1.70% 1.30%
 Hechinger has better Return on Equity than Home depot it might be because the former deals in
the upscale market. The gross profit ratio for Hechinger follows a similar path like that of Home
depot which might be because of increasing SG&A margin. Hechinger might be providing its
customers with a lucrative credit program to facilitate more sales.

b. Cash Flow Analysis

Home Depot Hechinger

1986 1985 1984 1986 1985 1984
Cash from
Operations -43120000 -3056000 -10574000 12190000 19007000 3138000
Cash used for
Investing
activities -92026000 -81655000 -16330000 -36037000 -25531000 -16346000
Cash used to pay
dividends to
Shareholders -1550000 -1091000 -868000
Cash provided
from Financing
activities 92755000 114605000 40821000 28838000 88992000 26718000
Net Change in
Cash -42391000 29894000 13917000 3441000 81377000 12642000

The effect on Net cash is more evident for Home Depot because of its aggressive expansion
strategy.

Question 4
Recommend a plan of action to The Home Depot’s management based on your analysis of the
company’s current performance and future growth plans. Your recommendations should deal
with the company’s operating performance, growth strategy, and external financing needs.

HOME-DEPOT 1983 1984 1985

Long term debt 236000 4384000 117942000
3301400
Total assets 0 105230000 249364000
Net earnings 5315000 10261000 14122000

Asset Turnover Ratio 16.10% 9.75% 5.66%

Debt to total assets ratio 0.71% 4.17% 47.30%

Critique 1:

Asset turnover ratio describes the efficiency of a company's use of its assets in generating sales
revenue or sales income to the company.

Starting from 1983, the home depot company is not making most of its existing assets let alone
the new generated assets. However, it is still pursuing opening up new stores at new different
locations with the capital financed by debt.

The rate of depletion of assets is worrisome to financial health of Home depot

Critique 2:

The total-debt-to-total-assets ratio shows the degree to which a company has used debt to finance
its assets. The company financed its assets ( investment in stores, equipment) in 1985 through
debt financing by almost 50%.

Despite the Home depot’s cost structure squeezing its net earnings to thin, it is still looking to
invest in 9 new stores by acquiring the site and construction work.

Therefore, It is evident that the company's vision (need for capital) and operational performance
( net earnings, RoA) are on divergent paths.

Immediate focus is
1. to reduce the need for capital by cleaning up cost structure
2. Boosting up the Cash flow engine i.e. operating income

Recommendations:

1. For the 1986 launch plan of Home Depot, we suggest the firm to strongly consider
leasing all new retail locations on contingent rental agreements.

This would essentially reduce the need for capital and also asset depletion rate because
the assets are leased for certain periods but not owned.
 Also, the sustainable growth for each store capped at few years down the line ( 10-15
yrs), then Home depot could end the contingent rental agreement and dispose of the
assets.

2. To refill the investment arm, the firm could look into disposition of property and
equipment and gain profit rather than operating at low efficiency.

Retails stores, which have been making declining sales consecutively for a period of 5
years, could be disposed off.