Value Line Publishing, October 2002 In Case Number 12, “Value Line Publishing, October 2002,” Carrie Galeotafiore presents a five-year financial forecast that shows Home Depot in an positive light. It also prepares to do the same with an analysis of Lowe’s. She supports the changes proposed by the new Home Depot CEO and that would play a role in improving Home Depot’s financial health in the home center and building industry. Galeotafiore supports her by mentioning a number of sources that would help the growth of the two companies.
She mentions the recent consolidation throughout the building industry with both Lowe’s and Home Depot acquiring several smaller companies. Lowe’s and Home Depot have done well by going beyond the traditional home center and offering alternatives such as sales online and one stop design shopping. Both Home Depot and Lowe’s have entered the same metropolitan markets and have created competition that some worry may cause price wars. Home Depot has expanded to international markets, but Lowe’s has not.
Home Depot’s CEO has planned to turn Home Depot around and make it competitive. In the process he will increase stock prices. His goal is to make store operations efficient and cut costs. Additionally, he will have systems to increase movement of stock so less kept sitting around. He will put focus on improving customer service, which has been weak, to hopefully increase sales. An analysis of the financial ratios for Home Depot and Lowe’s shows information that both supports and disproves Galeotafiore’s forecasts. First is the Working Capital Ratio.
After examination of both financial statements, it displays that both have a healthy amount of working capital and both with working capital growing yearly. Working capital for both have doubled in over five years and indicates growth in the industry. The Net Working Capital to Total Assets Ratio shows almost a 20% working capital ratio of total assets for Lowe’s and over 20% a year for Home Depot. Positive ratios show that both are healthy and close to a fifth of total assets is working capital. This bodes well for the companies and demonstrates that both are able to liquidate quickly if necessary.
Current Ratio for both are neither negative nor perfect. With 2. 0 representing the ratio of a healthy company able to pay back debt, Home Depot’s average current ratio of 1. 73 and better than Lowe’s’ average current ratio of 1. 51 over the past five years. While not 100% healthy, they are in position to improve their financial healthy with some careful adjustments in their operations and expenditures. Quick Ratio test is more demonstrative as both Home Depot and Lowe’s have Quick Ratios of . 33, less than the 1. 0 minimum a company should have so they can quickly convert assets to cash.
If a company displays an inability to convert cash when needed, this becomes a liability they need to access large amounts of cash quickly. Return on capital for Home Depot varies from 15% to 17%, a favorable ratio, whereas Lowe’s’ return on capital varies from 10% to 11%. Lowe’s’ returns on capital are not that bad, but not great either. Home Depot’s financial forecast shows that it should be continuing to enjoy high returns on capital in the future. Return On Equity is between 16% and 19% for Home Depot, while it is between 13% and 16%.
Returns on equity are within acceptable average ranges of returns on shareholder investment; this indicates a profitable investment. The average Return on Equity is in the 15% range but higher percentages are better. Operating Margin for both companies are low. Home Depot’s operating margin is in the 8% to 9% range and Lowe’s is in the 6% to 8% range. Considering the operating margin is calculated before taxes, it is a slim margin of revenue from production, as the companies are earning approximately 6 to 8 centers on the dollar, and after taxes and interest, it’s amazing they managed to turn a profit.
Galeotafiore’s forecast for Home Depot in Exhibit 8 shows a favorable increase overall in the forecast, resulting in some more favorable results from the ratio analysis. The forecast results from an aggressive increase yearly in working capital, fixed assets, while depending on taxes remaining stable during the period of the forecast. Obviously, sales growth is going to show a favorable return over the period of the forecast. However the last few years Home Depot has not enjoyed this sort of favorable increase at such an aggressive rate, hich begs the question whether Galeotafiore may have been too aggressive in her predictions. An analysis shows that the gross, the cash operating expenses, receivable turnover, inventory turnover, and P turnover all remain the same as previous years There is concern that Galeotafiore’s analysis is overly positive, despite some concerns with Home Depot’s operating structure, since it is aggressively opening stores, at a rate that in a mere decade Home Depot will have nearly quadrupled the number of stores it operates.
While it certainly can increase sales, the amount of capital and leverage necessary to build these stores will continue to grow as well, creating a potential liability should the economy suddenly turn for the worst.