Demand for fixtures will exceed that for fittings, with the former growing over 8.5% yearly to reach almost $6 billion in 2015. Consumer demand for more expensive products such as whirlpool bathtubs, hot tubs, spas and cast-polymer lavatories will generate higher profits. Plumbing fittings demand will increase by almost 5.5% yearly to $5 billion in 2015, fuelled by demand for low-flow fittings as consumers seek to cut utility bills and lower their water use. Fittings demand will show slower growth due to imports, mostly from cheaper Asian alternatives to domestic suppliers.
New homes will represent the highest rate of growth in the US plumbing fixtures and fittings market, with home improvement and repair leading the market in 2015. Demand will be driven by home renovations as consumers renovate kitchens and install more bathrooms.
US roofing demand is expected to expand at over 5.5% yearly to almost 265 million squares in 2015, reaching almost $24.5 billion, according to . Yearly declines of over 6% in the five-year period ending 2010 will be remedied by greater construction spending, with the new homes market growing at over 20% yearly through 2015. Residential reroofing will drive demand through 2015, with laminated asphalt shingles taking the lead at 7% yearly growth. Laminated asphalt shingles is expected to represent 85% of overall roofing demand in 2015.
Market Outlook
Consumer demand for environmentally friendly products, along with government-imposed standards to limit environmental harm is shaping the home building and improvement market. Consumers are opting for greener options such as photovoltaic roofing and vegetative roofs. Homeowners are also motivated to renovate their properties to cut utility costs by replacing windows and opting for energy-efficient thermal insulation.
Major players in the industry and their market positioning
Financial & Operating Performance
The company reported revenues of (U.S. Dollars) USD 70,395.00 million during the fiscal year ended January 2012, an increase of 3.53% over 2011. The operating profit of the company was USD 6,661.00 million during the fiscal year 2012, an increase of 14.08% over 2011. The net profit of the company was USD 3,883.00 million during the fiscal year 2012, an increase of 16.33% over 2011.
Financial Ratios of the company
Analysis
- The earnings per share of the company increased from 2.01 to 2.47 for the period 2011 – 12 an increase of around 22.8%
- The operating margin of the company has increased by 10.1% i.e. company is self sufficient in paying for its fixed cost after paying for its variable cost etc.
- The return on equity for the company for the period specified increased by 22.8% i.e. company has increased its net income with respect to share holder’s equity.
- The company Net income with respect to its total assets has increased by 15.14%.
- Company’s debt to equity ratio has increased by 16.77%. This means that company has increased the percentage of debt as compared to equity.
- The current ratio of the company has increased by 16.54% i.e. the company ability to pay short term obligations has improved over the period more over company contains assets that can readily be converted into required cash.
Financial Performance
SWOT Analysis
Strengths
Diversified Stores, Product and Service Portfolio
Home Depot’s diversified range of products and services and its wide network of stores enable it to improve sales and increase profitability. Its store inventory consists of almost 40,000 different kinds of building materials, home improvement supplies, appliances, and lawn and garden products. The products offered by the company mainly fall into four categories, namely plumbing, electrical and kitchen; hardware and seasonal; building materials, lumber and millwork; and paint and flooring. In addition, the company offers a variety of installation services through pre-screened independent contractors. These installation services are offered for products ranging from windows to water heaters, floors to roofs, and kitchen cabinets to vinyl siding. It also offers professional installation of products such as generators, furnaces and central air systems through its in-home sales programs. Besides, Home Depot provides credit services and assistance with the selection of tools and supplies to its customers. Such diversified stores, product and service portfolio enables the company in meeting the varied needs of its customers.
Wide Customer Groups
Home Depot’s customer centric business has given it a wide customer base, which mitigates its business risk. Each week, Home Depot stores are visited by over 22 million people. These customers are segmented into three categories, namely do-it-yourself customers, do-it-for-me customers and professional customers. The do-it-yourself customers are typically home owners who purchase products and complete their own projects and installations. Do-it-for-me customers are home owners who purchase materials themselves and hire a third party to complete the projects and installations. The professional customers are professional remodelers, general contractors, repairmen, small business owners and tradesmen. These different categories of customers spread out the business risk of the company by reducing its dependence on any one particular customer segment.
Global Presence
Home Depot’s global presence widens its reach. The company is the largest home improvement retailer in the US, Canada and Mexico. At the end of the fourth quarter ended January, 2011, the company operated a total of 2,248 retail stores, which included 1,976 Home Depot stores in the United States (including the Commonwealth of Puerto Rico, the territory of the US Virgin Islands and the territory of Guam), 179 stores in Canada, 85 stores in Mexico and 8 stores in China. At the end of the fiscal 2009, the company had 268 international operations, which represented 12.1 percent of its store base. Home Depot is also the largest home improvement retailer in Mexico. Besides, the company also operates its procurement offices in the US, Canada, China, Mexico and India. A global presence enables the company a broader and varied customer base.
Improving Financial Condition
The company reported revenue of $67,997m for the fiscal year ended January 2011 as against $66176m in 2010, an increase of 2.75%. The company’s operating profit increased by 21.57% over 2010 and reached $5,839m during the fiscal year ended January 2011. In addition, its net profit also registered an increase of 25.44% over 2010 and became $3,338m in 2011. As a result, the company’s operating margin increased from 4.02% in 2010 to 4.91% in 2011. This reflects an increase of 133 basis points over 2010 which shows management's high focus on improving profitability. In addition, the company also witnessed an increase in its profitability ratios. Its profitability ratios, such as return on equity, return on capital employed, return on assets, return on fixed assets and return on working capital employed increased from 13.72%, 15.74%, 6.51%, 17.80% and 135.79% in 2010 to 17.67%, 19.46%, 8.32%, 21.91% and 173.94% respectively in 2011. As a result, the company’s net profit margin increased from 4.02% in 2010 to 4.91% in 2011. Increasing profitability ratios indicate the company’s sturdy performance and its ability to deliver the returns expected by its shareholders.
Weakness
Product Recalls
Of late, Home Depot has been involved in some product recalls, which raise doubts about the quality control processes of the company. In February, 2011, about 1.7 million video baby monitors with electrical cords were recalled from Home Depot. These cords could pose strangulation hazard to infants and toddlers if placed too close to a crib. In the same month, about 58,000 units of summer infant handheld video baby monitors were recalled due to burn hazard. In December, 2010, 59,000 units of Rachael Ray brand two quart teakettle were recalled due to burn hazard. In November 16, 2010, mini tillers with Honda engines recalled from the company’s stores due to fire hazard. In October, 2010, Kohler Co. recalled its bath doors, which are sold exclusively at Lowe’s and Home Depot Stores due to laceration hazard. In the same month, Ryobi recalled its cordless drills due to fire hazard. Such recalls tarnish the company’s brand image and the consumers could lose their confidence in the company’s products.
Declining Market Share in Sector
The company's compound annual growth rate (CAGR) for revenue was -3.69% during 2007-2011. This was below the sector average* of 9.05%. A lower than sector average* revenue CAGR indicates that the company has underperformed the average growth in the sector and lost market share over the last four years. The company's underperformance could be attributed to a weak competitive position or inferior products and services offering or lack of innovative products and services.
Declining Liquidity Position
The company’s current ratio marginally came down from 1.34 in 2010 to 1.33 in 2011. In addition, its quick and cash ratios also came down from 0.36 and 0.14 in 2010 to 0.28 and 0.05 respectively in 2011. The decline in the company’s liquidity position can be attributed to a decrease in its cash and cash equivalents, which came down from $1421m in 2010 to $545m in 2011. In addition, the company’s total current assets declined by 3.03%, from $13900m in 2010 to $13479m in 2011. The decline in its total current liabilities was only 2.33%, from $10363m in 2010 to $10122m in 2011. As a result, the company’s working capital came down from $3537m in 2010 to $3357m in 2011. A decline in the company’s liquidity position could affect its expansion plans.
Opportunities
Online Shopping
The rising internet penetration and growing demand for online sales would give Home Depot an opportunity to increase its sales. New services and additional features on the company’s website for retail sales would attract more customers and increase its retail sales through growth in online retail. Now, more and more customers prefer to shop online to save the time consumed in journey and long queues for billing. Bouncing back smartly from the recession, online retail sales increased 11% in the fourth quarter of 2010 from the previous year, and full-year 2010 sales were up 9.8% over 2009. Fourth quarter e-retail sales totaled a record $43.432 billion, versus $39.045 billion a year earlier. For the full year, online retailers sold $142.491 billion worth of merchandise, up from $129.797 in 2009. The 25 largest online retailers accounted for 68.4% of e-retail purchases in the fourth quarter, up 5.6 percentage points from Q4 2009. These factors have made the company focus more on online retailing. The company currently offers its products online through the website, homedepot.com. In addition, it is planning to broadcast live product demonstrations, automate special order sales and include new catalogs focused on categories such as outdoor living on its website. A sound presence in the internet format will help Home Depot to enhance its sales through brand awareness and user friendly features in its websites. Besides, it will also save on the operating costs, which are much lower in this retail format as compared to physical store formats.
Geographic Expansion in Asian Provinces
Home Depot could expand its business by selective acquisitions and strategic alliances that add new stores and markets to its existing international business, as well as opening new units in its countries of operations. Owing to the low labor cost, large consumer market and fast growth of the furniture industry in China, the company has an opportunity to decrease its operational cost and increase the demand for its products and services in the Chinese market. The Home Depot operated only 8 stores and three sourcing facilities in China; and offices in Gurgaon, India at the end of the fiscal 2010. The Asian market has huge potential for the company to tap through further expansion. China and India have witnessed years of fast economic development ever since they opened doors to the wider international market. According to recent IMF forecasts the Chinese economy is expected to grow at 10.5% in 2010 and 9.6% in 2011, mainly due to the increase in domestic demand. The Indian economy is expected to grow at 9.7% in 2010 and 8.4 % in 2011, supported by positive macro-economic indicators. By 2010, the share of organized retail in India is estimated to cross 12% and size of organized retail sector would be about $51 billion. The growing economy in these countries has generated new employment opportunities for the residents and has boosted their earnings. Rise in disposable income has changed the consumers’ buying behavior. Customers in the emerging countries are becoming more brand conscious and prefer to buy branded goods. With competition at its peak and markets getting saturated, the company can look forward to new growth avenues in these regions.
Threats
Intense Competition
Intense competition in the operating markets of the company and the threat of competition in expanding new markets may adversely affect the sales of the company. The retailing industry is highly competitive and is highly fragmented. Home Depot faces competition from large multi-national corporations and offshore providers in low-cost locations. The company also expects additional competition as it is planning to address new markets and new competitors that may enter its existing markets. It competes with discount stores, local, regional and national hardware stores, mail order firms, warehouse clubs, independent building supply stores and other retailers. It also competes with other home improvement stores, electrical, plumbing and building materials supply houses and lumber yards. The main factors of competition in the industry include customer services, price, store location and assortment of merchandise. Intense competitive pressures from one or more of the company’s competitors could affect prices or demand for its products and services. If the company fails to timely respond to these competitive pressures, including through maintenance of superior customer service and customer loyalty, its market share and financial performance could get adversely affected.
Rising Manpower Costs
Rising manpower costs could increase the company’s operating costs. With the shortage of talented manpower and increasing government mandated minimum wages, the labor costs have been witnessing an increase. A very significant portion of the workforce, falling under the purview of minimum wages, work in the retail sector. In the US, the government increased the minimum wage rate from $7 per hour in 2009 to $8 an hour in January 2011. The government revised the labor rates for the third year in a row. Besides, many states and municipalities as many as 17 in the country like DC, Illinois and Massachusetts have hiked the minimum wage rate even higher than $8 per hour by January 2011 due to higher cost of living. Any such increases in the minimum wages increases the operating costs of retailers and has an adverse affect on their profits.
Counterfeit Goods Market
The market for counterfeit goods has been on the rise across industries and is affecting the sales as well as the image of the branded products. The home product manufacturing industry is no exception to this trend. According to the International Anti-Counterfeiting Coalition, 2009, about 5%-7% of the world trade is in counterfeit goods and counterfeiting costs the US businesses $200 billion to $250 billion annually. Since 1982, the global trade in illegitimate goods has increased from $5.5 billion to about $600 billion annually, with the US impacted the most. Further, the sales of counterfeit goods are expected to increase with a tremendous growth rate which reflects lots of losses for the firms in near future. The imitated goods in this industry are taking away the share of the branded products through their low price offerings. It also creates confusion among the customers as the imitated goods carry the same design as of the branded ones. However, the low quality of these counterfeits affects the consumer confidence and also tarnishes the image of the branded goods. The company is prone to these challenges as the counterfeit products pose a major challenge for the company’s fortunes.
Strategy of the Company
- The company came with a new concept of introducing warehouse related goods via a retail chain which made it easier for the people to excess the goods and with new concept they can actually compare different products and can choose which one suite them.
- The retail stores of the company have a wide variety of building material and home improvement products and to ensure that they don’t get run of the stock they maintain a huge inventory of stock.
- In order to woo the customers company offers low and competitive prices but at the same time maintains the quality of the products they are offering.
- Company saves upon the cost by not investing much on the store looks and rather shifting this saving on to the customer.
- Moreover the company further reduces cost by purchasing the goods in higher volumes.
- The company’s “Do it Yourself” strategy focuses only on individual home owners and small contractors. Moreover since the customer base consists of individual home owners which do not have any prior experience related to home development company provides its employees with training and knowledge to further assist the customer and improve upon the sales.
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Company is also engaged in an aggressive advertising program to enhance the sales.
Questions
Evaluate Home Depot’s Business Strategy. Do you think it is viable strategy in the long run?
- The company came with a new concept of introducing warehouse related goods via a retail chain which made it easier for the people to excess the goods and with new concept they can actually compare different products and can choose which one suite them.
- The retail stores of the company have a wide variety of building material and home improvement products and to ensure that they don’t get run of the stock they maintain a huge inventory of stock.
- In order to woo the customers company offers low and competitive prices but at the same time maintains the quality of the products they are offering.
- Company saves upon the cost by not investing much on the store looks and rather shifting this saving on to the customer.
- Moreover the company further reduces cost by purchasing the goods in higher volumes.
- The company’s “Do it Yourself” strategy focuses only on individual home owners and small contractors. Moreover since the customer base consists of individual home owners which do not have any prior experience related to home development company provides its employees with training and knowledge to further assist the customer and improve upon the sales.
- Company is also engaged in an aggressive advertising program to enhance the sales.
It seems that The Home Depots business strategy seems successful in the short run. But, the company will not survive in the long run with its present strategy. As the industry is growing rapidly, the company needs more expansion. Since, the operation activities could not succeed to generate cash for its expansion; the company may face obstacles for financing even through debt. So, the company has to have enough cash generating operations as well as net earnings. Moreover, it is not difficult for the rivals to imitate Home Depot core competencies. As a result, The Home Depot has to think of its business strategy for future success. May be, the company may pursue a mixed strategy for their long run business prosperity.
Analyze Home Depots financial performance during the fiscal years 1983-1985.Compare Home Depots performance in this period with Hechingers performance.
We will analyze the performance on the basis of Ratio Analysis & Cash Flow Analysis.
Ratio Analysis:
The financial performance i.e. the profitability ratios of The Home Depot Inc are not so lucrative. The Home Depot Inc is experiencing a sharp decline in ROEs from 24.54% in 1983to 9.71% in 1985. ROE shows how well managers are using the funds from the firm’s shareholders. The decline in ROE is the result of decline in ROA, though the financial leverage increased during the period 1983-85. And, ROA has decreased due to both decline in ROS and Asset Turnover. During the period from 1983 to 1985 sales grows very rapidly, but the average asset growth is higher than that. For instance, in 1985 sales grow by 62%,where in assets grow by 78%. As a result, the Asset Turnover (AT) falls; it is also happened due to increase in days inventory held. The increase in assets for expanding business is financed by debt; thereby increase in the financial leverage.
The decline in ROS is the result of continuous increase in COGS, SGA and net interest expense as a percent of sales. It shows that The Home Depot Inc’s efficiency in creating value chain has also been declined over time. The overall picture is depicted below in the common size income statement of company.
Both short term liquidity ratios and long term solvency ratios are also not impressive. Though, Home Depot has a better position in collecting funds (receivables) than that of payables; the trend of average collection period become worse. In terms of the cash basis, the negative interest coverage ratio (-2.89 in 1985) depicts that Home Depot actually also borrows money to pay the interest. The other ratios also (see table-2) reflect Home Depot’s bad financial performance during the period 1983-85.
Cash Flow Analysis:
For each of the three years the company has a negative cash flow from operating activities. The reason may be due to large inventory increase; purchase of PP&E. It may not be so alarming since the company is growing. The number of stores has increased by 163% from1983 to 1985 to sustain and gain the market share.
From alternative decomposition it is evident that Home Depot has positive cash flow before working capital investment. But, after using working capital the company has huge negative cash flow. The rapid negative growth of the free cash flow available to debt and equity is very noticeable. Besides, cash needed for financing its growth the company is in danger of default in paying interest and principal payment of debts. Most of the company’s financing activities are met by using long-term debt; only the exception in 1983.
Summary: From the financial analysis it is evident that Home Depot if expanding fast with heavy reliance on debt financing. This strategy seems not against the company’s growth strategy since it still has positive spread-wherein debt is cheaper than equity financing. However, this increase its probability of default since the company has been suffering in managing cash and rising operating expenses share of sales. As a consequence, Home Depot will face hardship in future for financing its business expansion.
Comparison of Financial Performance: Home Depot Inc. vs. Hechinger
Both Home Depot and Hechinger’s profitability (ROA & ROE) has been declining from the period of 1983-85; however, Hechinger’s declining trend is less than that of Home Depot.
(Table-6). Hechinger’s has higher ROS and lower AT compared to Home Depot. This difference is attributed due to the business strategy they have. Hechinger’s has been pursuing differentiation business strategy while Home Depot is pursuing Cost leadership strategy. Hechinger’s is better than Home Depot in managing operating expenses. While Hechinger has the success in reducing SG&A expenses; Home Depot’s cost increased substantially during the period 1983-85. This may be a reason of higher average profitability of Hechinger’s than Home Depot. On average both of the company has same inventory turnover. However, in case of managing receivables Home Depot is performing well above than Hechinger’s. If average A/R outstanding is increased further in size and amount for Hechinger’s, it may cause problem in cash management and future scope of expansion.
How productive were Home Depot’s stores in the fiscal years 1983 – 1985?
Productivity is measured in terms of number of units of input used per unit of output. It is a measure of how efficiently the resources are utilized. In Home Depot case No. of Stores, Employees ,Square Footage are inputs and sales, earnings, transactions etc are outputs. Some of them are discussed below:
Net Sales/ Average Number of Stores
The sales per store remain almost stable for Home Depot for all of the years ($17.3 million on average). However, the incremental sales for the newly opened stores decline by 32% from $25 million in 1983 to $17 million in 1985.
No. of Customer Transaction/Average Number of Store
The transaction per store declines from 586,000(in 1983) to 575,000(in 1985). This may not be so concerned because the newly opened at least need some time to be well known to the customers.
Net Earnings/Average Number of Stores
Net Earnings per store drastically decline from $710,000 to $202,000 from FY 1983 to FY1985. Moreover, in 1984 and 1985 the newly opened stores contributed negatively (-64% in1985) in net earnings of Home Depot. It reveals that the new stores take more than 1 year to be in the break-even.
- Net Sales per square Feet
Net Sales/Avg. Square Feet
It is evident from the following Table that efficiency of using store space also decreases by 10% over the period 1983 to 1985.
Employee productivity is measured by Net sales per employee, Net Earnings per employee. From Table-8, we see that sales per employee actually increase by negligibly by 0.18% to $149085 in 1985 from 1983. And, Net earnings per employee drastically fall from $ 5,886 in 1983 to $ 1,745 in 1985.The negative earnings growth per employee shows that Home Depot expenses more to its employees than the actual net worth addition by them.
Conclusion: It can be concluded that Home Depot Inc. stores are remain as same as productive during the time span of 1983 to 1985, though it is expanding very fast.
Home Depot’s stock price was dropped by 23% between January 1985 and February 1986, making it difficult for the company to rely on equity capital to finance its growth. Covenants on existing debt restrict the magnitude of the company’s future borrowing. Given these constraints, what specific actions should Home Depot take with respect to its current operations and growth strategy? How can the company improve its operating performance? Should the company change its strategy? If so how?
The following are some of the suggestions:
- Given the level of current performance, the previous analysis shows that it is difficult to rely exclusively on debt financing to fund its planned expansion.
- Another option worth considering is to sell and leaseback some of the Home Depot’s fixed assets
- Management states in its letter to shareholders that it is considering this option to raise $50million.
- A third option is to issue equity, but it will severely dilute the ownership interests of current shareholders.
- The another option for the company is to improve the company’s cash flow from operations by controlling on its operating expenses.
- If company is successful in improving operational cash flow than it can come out of this bad situation.
- So company should try to cut down the operating cost instead of think to change the strategy.
by
agupta087 (student)
