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Financial Analysis: Home Depot

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Introduction

Company Report: Home Depot Inc. I. Investment Policy A) Qualitative Analysis: The Home Depot currently has 2,193 retail stores in all 50 states, the District of Columbia, Puerto Rico, U.S. Virgin Islands, 10 Canadian provinces and Mexico. The Home Depot Inc also owns and operates Expo Design Center stores, THD Design Center stores and Yardbird stores (HD.com). The Home Depot made a very important acquisition in 2006 when they signed a definitive agreement to acquire The Home Way, China's first home improvement retailer. The terms of the deal were not disclosed, but it was estimated that buying control of the retailer would cost $100 million. (IHT Online) The Home Way provides Home Depot with an immediate retail presence in China with 12 stores in six cities, including Beijing. The Chinese home improvement market was valued at nearly $50 billion and had been growing at a compounded annual rate of 20% when the deal was made. Approximately 70%of home improvement spending in China is for the completion of interior space in new homes. This is a solid growth opportunity given Home Depot's strength in merchandise and services geared to finishing out a home. Big-box stores make up only about 4% of the home-improvement business in China. The rest consists of smaller independent vendors who specialize. Expansion in China is an important area of growth and helps establish a foothold in the global market for Home Depot. (Home Depot Online) Home Depot has proven in the past that they can flourish outside the United States and the opportunity in China is something that the world's largest home improvement specialty retailer should be able to capitalize on. Ultimately, we believe that this project is value enhancing because China represents a $1 trillion market opportunity and expanded 10.2% in 2005 creating higher wages and increased purchasing power for consumers. (IHT Online) In recent years, Home Depot has seen its customer service levels fall and with them the price of the average transaction. ...read more.

Middle

and Home Depot will be able to focus more on their expansion abroad. If these factors occur then Home Depot will be considered a potential value stock. II. Financial Policy As a result of the deterioration of the housing, residential construction, and home improvement markets in the last few years, the management of Home Depot decided to rehabilitate its capital structure to finance its investments. Looking at the transition from FY2006 to FY2008, long term debt jumped from $2,291 million to $10,983 million. This led to its total debt/equity ratio increasing from .152 in FY2006 to .758 in FY2008. In 2004, Home Depot's capital structure was comprised of 96.3% equity and only 3.7% debt. Today, these numbers have changed drastically, with equity making up only 60.9% and debt at 39.1% of the capital structure (EXHIBIT). This highly leveraged capital structure has been effective since Home Depot has not had any trouble covering interest payments for its debt holders. In fact the interest coverage ratio for the firm is 11.64%, which means that Home Depot is holding enough cash to handle this increase in interest payments and leave options open in regards to other potential uses of cash. Cash reserves have been steadily declining at Home Depot over the past two years, from $793 million in FY2006 to $445 million in FY 2008. This decline is a result of management's aggressive payout policy in terms of increased dividends and share repurchases as well as the increase in interest payments. In order to thoroughly analyze Home Depot's current capital structure one must compare it to its closest competitor, Lowes Companies Inc. Home Depot and Lowes comprise about 86% of the Home Improvement Retail Industry, with market capitalizations of $50,257.23 million and $38,036.40 million respectively (EXHIBIT). Lowes maintains a less levered capital structure than the one currently in place at Home Depot. Lowes total debt/equity ratio is .415 and equity makes up 74.3% of its capital structure. ...read more.

Conclusion

(HD 10K) As shown in the executive compensation summary table of the 2008 Proxy, Frank Blake's reported annual salary is just over $1M with bonus based on achievement of financial goals and performance measures and no provision for severance pay. These changes are important in ensuring a similar disagreement doesn't occur and for keeping the shareholders' interests aligned with management in the future. (Morningstar) Overall, Home Depot's corporate governance is in good shape but only since the changes instigated after Nardelli's resignation. The company has made an effort to better align shareholder and management interests. These changes have been made in the form of incentive and performance based compensation for both directors and executive officers, changes to the Board to use majority voting in director elections, a requirement for two-thirds of the Board to consist of independent directors and a provision to allow shareholders to ask questions and receive answers from the CEO and other executive officers, among others. Shareholders will likely be on the lookout for any wavering from these policies on executive compensation, especially during the poor performance years when share price is projected to be low and sales continue to fall. If Home Depot can continue to monitor corporate governance and keep the shareholders informed there will be no reason to doubt the company's practices. Appendix Exhibit 1 - WACC Calculation rf 3.48% Beta1 1.00 rm-rf2 6.00% Tax Rate 35% re3 9.48% rd4 5.88% Total Debt 13,170 We5 0.79 Total Equity 49,280 Wd6 0.21 WACC Calculation 8.284% 1 Beta recorded by Value Line 2 From a UBS research report on the market risk premium over the past 12 years 3 Cost of Equity = CAPM Calculation: Ce=rf+Beta*(rm-rf) 4 Cost of debt = YTM of latest debt offering by Home Depot 5 Weight of Equity: Total Equity / (Total Debt + Total Equity) 6 Weight of Debt: Total Debt / (Total Debt + Total Equity) Exhibit 2 - Historical Sales Growth (numbers in millions) Year Sales Growth Years Total Growth Annualized Growth 2007 77,349 2 Year Sales Growth 0.428% 0.214% 2006 79,022 9 Year Sales Growth 155.961% 17. ...read more.

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