The Home Depot Inc.: Some Basic FactsYear of Inception Founded by : 1978 : Bernard Mercus Arthur Blank No.

of Stores Stock Listing : 50 (end of 1985) Market Market Segment Selling Method Expansion Target : Home Remodeling : Do-It-Yourself (DIY) : Cash-and-Carry : 9 Stores (1986)

: New York Stock Exchange (April, 1984).

QUESTIONS: 1. Evaluate Home Depot¶s business strategy. Do you think it is a viable strategy in the long run? Ans. Business strategy analysis gives the picture of key profit drivers, business risks as well as profit potentials with qualitative judgments. Strategy Analysis is generally comprised of industry, competitive strategy and corporate strategy analysis. Since, The Home Depot Inc. has only one business, the corporate strategy analysis is not relevant for this case analysis. Identifying key success factors and key risk through business strategy analysis helps the firm to find out key accounting policies.

A. Industry Analysis: Though The Home Depot Inc. is the leader in the industry, its market share is negligible (only 0.9% in 1985). However, its sales grew by 62% in 1985 which far above the industry average. In terms of Porter¶s five forces, the company has been facing challenges by the existing firms and the competition is heating up. The Home Depot does not have much challenge from new entrants, but it has possible threats from the suppliers since the rivals are expected to be stronger and stronger. As a result it will also have high threat from the bargaining power of buyers.

Sales grew by-18%(1985) 3High Switching Cost 3 Competition based on cost Threat of New Entrants .Huge Inventory cost . of buyers increasing -Low substitutes 3 High Bargaining Power B. -55 stores (1985) -Sales Share-0. Beneath here.Scale of Operations 3 Low Threats Threats of Substitutes -Homogeneous Product -Low buyer¶s willingness to switch 3Low Threats Industry analysis Home Depot -Sales Share-0. Home Depot competitive strategy has been analyzed comparing with that of Hechinger¶s.Fig-1: Industry Analysis Rivalry among Firms 3Industry Growth-14% CAG 3Rivals-Hechinger Co.Large Warehouse . The Home depot Inc. However. . Competitive Strategy Analysis: There are two types of strategies in competitive positioning: cost leadership and differentiation. their market shares are very low compared to the whole industry.9% (1985) -Sales grew by-62% (1985) Bargaining Power of Suppliers -Quality matters -quality assured by suppliers -Few retailers in the market 3 High Bargaining Power Bargaining Power of Buyers -Cost & quality matters -HD guaranteed quality -No.6% (1985) . is the leader in D-I-Y market and Hechinger¶s is its immediate rival.

5 3 Differentiation Strategy Key Depot. However. Evaluation of Strategy: The Home Depot Inc. quality products. The company creates value chain by sharing cost savings with the customers. But. is pursuing a cost leadership business strategy in the industry it operates (D-I-Y segment of home decoration). AT:1. Since.8%. It seems that The Home Depot¶s business strategy seems successful in the short run. the company will not survive in the long run with its present strategy. As the industry is growing rapidly. are selling brands with guarantee. the company¶s net earnings has been decreased last three years and failed to generate cash from its operating activities. AT:2. The core competencies of Home Depot Inc. Success  Giving guarantee for both popular and less popular brands  Excellent sales assistance by its employees with technical know how  Best quality products and quality of service  Aggressive advertising and in store demonstration Factors of Home Key Risk Factors  Dropping of net earnings (42% in 1985) and stock prices(23. high turnover Hechinger Company y Upscale stores y High margin. y Low & Competitive Price y Low margin. the operation activities could not succeed . low turnover Competitive Strategy -In 1985-ROS:1.  Already attracted some chain stores in the industry that challenges its market dominant position. excellent staffs and assisting buyers.4% in of Home Depot 1985) made the financing difficult for expansion.Table-1: Competitive Strategy Analysis The Home Depot Inc. the company needs more expansion.In 1985-ROS:4.2%.2 y Keeping cost by low overhead y Stocked right products-25000 items 3Cost Leadership Strategy .

The Home Depot has to think of its business strategy for future success. So. We begin by the ratio analysis first.71% in 1985. ROE shows how well managers are using the funds from the firm¶s shareholders.to generate cash for its expansion. Analyze Home Depot¶s financial performance during the fiscal years 1983-1985. in 1985 sales grow by 62%. wherein assets grow by 78%. The decline in ROE is the result of decline in ROA. the Asset Turnover (AT) falls. 2. During the period from 1983 to 1985 sales grows very rapidly. Two major principle tools of financial analysis are employed for analyzing the financial performance of The Home Depot Inc. As a result. As a result. These are Ratio Analysis and Cash Flow Analysis. For instance. it is also happened due to increase in days inventory held. ROA has decreased due to both decline in ROS and Asset Turnover.54% in 1983 to 9. Ans: (I). The increase in assets for expanding business is financed by debt. but the average asset growth is higher than that. thereby increase in the financial leverage.e. Compare Home Depot¶s performance in this period with Hechinger¶s performance. A. Ratio Analysis: The financial performance i. The Home Depot Inc is experiencing a sharp decline in ROEs from 24. . the profitability ratios of The Home Depot Inc are not so lucrative. the company has to have enough cash generating operations as well as net earnings. it is not difficult for the rivals to imitate Home Depot core competencies. Financial Analysis: The Home Depot Inc. May be. And. for the year 1983-1985. the company may face obstacles for financing even through debt. though the financial leverage increased during the period 1983-85. Moreover. the company may pursue a mixed strategy for their long run business prosperity.

1983-1985 Ratios Profitability Ratios Return on Sales (ROS) X Asset Turnover (AT) = Return on Assets (ROA) X Financial Leverage (FL) = Return on Equity (ROE) X (1-Dividend Payout Ratio) =Sustainable Growth Rate Short-Term Liquidity Ratios Current Ratio (CR) Quick Ratio (QR) Cash Ratio Operating Cash Flow Ratio Days Inventories Held Days Receivable Outstanding Days Payable Outstanding Long-Term Liquidity/ Solvency Ratios Interest coverage ratio(Earnings) Interest coverage ratio(Cash) Debt-to-Equity Ratio Liabilities-to-Equity Ratio 183.58 2.37 7.31 75 2.61 2.84% 1.12 1. .65 24.41% 1. It shows that The Home Depot Inc¶s efficiency in creating value chain has also been declined over time.00 9.56 -16.37 3.37 0.1985 (1984) Feb 2.54% Jan 29.XLS´ file The decline in ROS is the result of continuous increase in COGS.20 0.89 0.1984 (1983) Feb 3.52 83 8.17% 2.27 2.71% 1.01 26.11 Ref: Details of calculations are provided in ³The Home Depot Inc.10 -0.44 7.71% 0.00 19.27 0.72 9.04 30.61% 3.71 14.64 -0.68 2.54% 1.71 0.23 2.Table-2: Financial Ratios: The Home Depot Inc. SGA and net interest expense as a percent of sales.26% 2.31 4.43 0.03 3.01% 3.41% 1.06 82 4.00 24.95 31.14 -2.97% 2.30 1. The overall picture is depicted below in the common size income statement of company.78 0.77 3.12 -0.1986 (1985) 3.44 19.

the trend is alarming (though there is some discrepancy in calculation)-it decreased from 11.24% -0.Due to data unavailability averages of some items are not used for the year 1983 and 1984. From the view of alternative decomposition method (Table-4).Table-3: Common size Income Statement.27 15. Though.26% 100.1985 (1984) 9.00% 74.00% 73. the trend of average collection period become worse.18% -1. .25% Both short term liquidity ratios and long term solvency ratios are also not impressive. Detail calculation are performed in Excel File (Ratio sheet) 2.14% 0.1986 (1985) Sales COGS (% of Sales) Gross Margin (% of Sales) SGA (% of Sales) Net Interest Expense(% of Sales) 100.97% in 1985.89% -0.89 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 1983-85.89% in 1983 to 1.82% 0.1984 (1983) Feb 3. Table-4: Alternative Decomposition of ROE Jan 29.1986 (1985) 6. However.1985 (1984) Feb 2.67% 27. we see that The Home Depot has positive spread for all the years: 1983-1985.58% 26.71% Operating ROA(OROA) (-)Effective Interest Rate after Tax =Spread Net Financial Leverage(NFL) ROE=OROA+(Spread X NFL) Note: 1.10% 25.97% 1.61% Feb 2. 1983-85: The Home Depot Inc Jan 29. As a result ratios differ from that of traditional methods.33% 20.82 17.58 9.62% 1. In terms of the cash basis.06% 11.72% Feb 3.90% 100.90% 23. the negative interest coverage ratio (-2.91% 10.1984 (1983) 18.61% 0.00% 72. Home Depot has a better position in collecting funds (receivables) than that of payables.42% 20.95% 7.60% 4.

391 Alternative Decomposition of Cash Flows Net Profit Operating CF before WC Investment Op.(1)&(2). Most of the company¶s financing activities are met by using long-term debt.937 -85. CF before investment in non-current Assets Free CF available to Debt & Equity Free CF available to Equity Net Increase (Decrease) in Cash Balance 10.655 114. Cash Flow Analysis: 1983-1985 (Figures in .894 8.000) Jan 29.326 -43.120 -92.1986 (1985) Cash Flow (CF) from Operating Activities Cash Flow (CF)from Investing Activities Cash Flow(CF) from Financing Activities Net Change in Cash or Equivalents -10.592 29. From alternative decomposition it is evident that Home Depot has positive cash flow before working capital investment. after using working capital the company has huge negative cash flow.261 9.894 -43.746 13.432 -24.821 13.026 92. It may not be so alarming since the company is growing.917 14.212 -22.574 -16. The number of stores has increased by 163% from 1983 to 1985 to sustain and gain the market share. Cash Flow Analysis: Table-5: The Home Depot Inc. cash needed for financing its growth the company is in danger of default in paying interest and principal payment of debts.882 -29.B.300 -116.330 40.056 -81. The reason may be due to large inventory increase. purchase of PP&E.080 29. The rapid negative growth of the free cash flow available to debt and equity is very noticeable.755 -42.122 16. only the exception in 1983.605 29.219 24.1985 (1984) Feb 2.050 -42.961 -3.391 Note: Calculation of Cash Flow Statement in details are in Excel File-Cash Flow St. But. Besides.917 -3. For each of the three years the company has a negative cash flow from operating activities. .618 -12.1984 (1983) Feb 3.

00 58. this increase its probability of default since the company has been suffering in managing cash and rising operating expenses share of sales.50 1984 3.58 4.16% 2.90% 23. This strategy seems not against the company¶s growth strategy since it still has positive spread-wherein debt is cheaper than equity financing.01 26. Hechinger.23 2.50 1985 4.26% 2.48 7.12 18.00 4.95 31. Collection Period Avg. (II).84% 1.69% 1.65 24.41% 1985 1. vs.44 7.00 61.54% Hechinger 1983 5.39 Both Home Depot and Hechinger¶s profitability (ROA & ROE) has been declining from the period of 1983-85. Home Depot will face hardship in future for financing its business expansion. However. Comparison of Financial Performance: Home Depot Inc.03 4.00 4.72 8.33% 20.61% 4.Summary: From the financial analysis it is evident that Home Depot if expanding fast with heavy reliance on debt financing.89% 2. however.04 30.97% 2.88 26.90% 35.13% 32.30% 21.82% 29.85% 30.71 14.02 10.72 9. Table-6: Financial Ratios Home Depot Inc.84% 1.42% 20.00 4.79 19.60% 32. As a consequence.10% 21.00 63.31 4.10% 33.61% 3.21 15.29% 2.10% 22.71% 27.01% 3. Hechinger¶s declining trend is less than that of Home Depot .18% 8. 1983 ROS X AT = ROA X FL ROE Gross Margin SGA&E Avg.82% 2.17% 2.44 19. A/P Period Inventory Turnover 4.40 1984 5.46 25.17% 1.

531 87.343 2.894 -43.642 20.377 23.391 Note: Details of calculation are performed in Excel File .030 17.391 3.923 28.346 25.261 9. On average both of the company has same inventory turnover.111 30. it may cause problem in cash management and future scope of expansion.377 12.056 -81. However.212 -22. Hechinger¶s has been pursuing differentiation business strategy while Home Depot is pursuing Cost leadership strategy.605 29. in case of managing receivables Home Depot is performing well above than Hechinger¶s.441 -85.917 29.122 16.574 -16. While Hechinger has the success in reducing SG&A expenses.326 29.050 13.310 12.847 3.CF before WC Inv. in NCA Free CF to D & E Free CF to Equity Net +/.026 92.917 -3.618 -12.655 114.441 Alternative Decomposition of Cash Flows Net Profit Op.274 81. Hechinger¶s is better than Home Depot in managing operating expenses.515 -7.821 13.882 -29. Home Depot¶s cost increased substantially during the period 1983-85.007 -25. 1984 1985 Operating Activities Investing Activities Financing Activities Net Change in Cash -10. This difference is attributed due to the business strategy they have.243 22.432 -24.120 -92.755 -42.288 3.388 -8.323 -26.714 -23.746 14. Hechinger¶s than Home Depot.CF before inv.961 -3. Hechinger¶s has higher ROS and lower AT compared to Home Depot. Table-7: Cash Flow Analysis (Fig in µ000) Hechinger 1983 1984 1985 This may be a reason of higher average profitability of Cash Flow From 1983 Home Depot Inc.642 19.300 16.219 24.894 -42.160 12.901 81.534 9.143 -11.080 -43.937 8. If average A/R outstanding is increased further in size and amount for Hechinger¶s.(Table-6).in Cash 10. Op.592 -116.037 27.138 -16.190 -36.330 40.831 -13.

3. which will help the firm for long-time existence. However. of Stores. This may not be so concerned because the newly opened at least need some time to be well known to the customers.3 million on average).As of Table-7. Hechinger relies heavily on equity financing rather than debt. in contrast with Home Depot¶s negative cash generation from operation Hechinger has success in generating positive cash. it does not have to borrow money for paying interest. Table-8 shows a handful of productivity measures of the stores of Home Depot Inc. How productive were Home Depot¶s stores in the fiscal years 1983-1985? Productivity is a measure of efficiency how proficiently a company can generate output by using inputs. earnings. Hechinger is continuously giving dividend to the shareholder. the incremental sales for the newly opened stores decline by 32% from $25 million in 1983 to $17 million in 1985. Finally. In Home Depot case No. Another notable difference is that unlike Home Depot. transactions etc are outputs. while Home Depot¶s cash flow reveals faster expansion. These are discussed below: (a) Sales per Store: Net Sales/ Average Number of Stores. . (b) Transaction Per Store: No. for the time span 1983-85.000(in 1983) to 575. Hechinger's cash flow statement reveals a strategy of slow and steady growth. This is also attributed by the slower growth of inventory and A/R of Hechinger. The sales per store remain almost stable for Home Depot for all of the years ($17. of Customer Transaction/Average Number of Store The transaction per store declines from 586.000(in 1985). It is clear from the investing activities that Hechinger¶s is not following rapid expansion strategy like Home Depot. Employees. It is a ratio of output by input. Since the Hechinger¶s has positive cash from operation. Square Footage are inputs and sales. Moreover.

Hence. Net Earnings per employee.Detail calculation are conducted in Excel Files (Store Productivity) 2. From Table-8. Assume that Home Depot did not open all new stores and employ new employees during a period continuous basis.10% Note: 1.14% 564 -20. (d) Net Sales per square Feet: Net Sales/ Avg.085 73. averages are used in some measures. Square Feet It is evident from Table-8 that efficiency of using store space also decreases by 10% over the period 1983 to 1985.000 to $202.48% 5.40% 202 -64.000 from FY 1983 to FY 1985.250 3. Sales growth/new stores (%) Transaction per store(in thousands) Net Sales/Transactions($) Net Sales/Square Feet($) Net Sales/Employee($) Incremental Sales growth/ new Employee (%) Net Earnings per Employee($) Incremental Earnings growth/Employee (%) Net Earnings/Store(in thousands) Earnings Growth/new Store (%) 586 30 244 146.406 -25.31 -33.62% 17.76% 575 30 219 149.(c) Net Earnings per Store: Net Earnings/Average Number of Stores Net Earnings per store drastically decline from $710. And. Net earnings per employee drastically fall from $ 5. Net Sales/ Stores(in millions) Avg.30 2.745 -60. Moreover. we see that sales per employee actually increase by negligibly by 0. in 1984 and 1985 the newly opened stores contributed negatively (-64% in 1985) in net earnings of Home Depot.886 in .67 1984 17.37% 1.60% 1985 17.26% 572 30 228 135.886 -0.18% to $149085 in 1985 from 1983.53% 4. Table-8: The Home Inc: Store Productivity: 1983-1985 1983 Avg.400 -35. It reveals that the new stores take more than 1 year to be in the break-even. (e) Employee Productivity Employee productivity is measured by Net sales per employee.05% 710 20.

000 $75.600.800.000 Second-use Stores Leasing Inventories Total per store Total for 9 new stores Capital needed $1.000 $3. .700. Home Depot¶s stock price was dropped by 23% between January 1985 and February 1986. how? Ans. EBIT to Intt.1983 to $ 1.000(1+12.165. Conclusion: It can be concluded that Home Depot Inc. Covenants on existing debt restrict the magnitude of the company¶s future borrowing.000.000=150.745 in 1985.000 $1. Expense d.600. stores are remain as same as productive during the time span of 1983 to 1985.800. 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.000(1+r)3 So.000. r=12.600.000 $31. Given these constraints.The negative earnings growth per employee shows that Home Depot expenses more to its employees than the actual net worth addition by them.000 b.4%) =168. The Home Depot¶s financing needed for Expansion Construct Stores Acquire sites & construction Inventories Total per store Total for 9 new stores Capital needed $6. Tangible Net Worth : $168.600.4% And. 150.5 to 1. 4.500.000 Covenants of the credit facilities a.000(1986) 213.400.000 $8.000 $1. Current Ration : Not less than 2 to 1 : Not Less than 1. though it is expanding very fast. making it difficult for the company to rely on equity capital to finance its growth.500. Debt to Tangible Net Worth : Not more than 2 to 1 c.

000 Proceeds from sale and lease back (10 stores) =$50.000-$88.000=$112.000.000.000 .Funds available from credit line=$200.000.000.

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