Business Strategy Key Success Factors

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Business StrategyKey Success Factors

• Warehouse retailing concept
• - Low overhead
• - High turnover
• - Purchase quantity discounts
• Focus on DIY market
• Excellent sales assistance
• Aggressive advertising program
• Strong housing market
• Several brands (e.g., Expo)
• Offer expanded services
• http//biz.yahoo.com/rc/030207/retail_homedepot_1.
  html

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Business StrategyKey Risks

• Competition (Lowes)
• Growing too quickly and losing control of costs
• Strategy conflict (cost leader with high level of
  service)
• Capital constraints
• Housing Market bubble (interest rates go up)
• Sensitive to seasonality, weather
• Cannibalizing their own stores
• New, controversial CEO (Nardelli)

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HD, LOW, DJIA (2000-2003)
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http//yahoo.marketguide.com/
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THE HOME DEPOT COMMENTS ON OUTLOOK FOR FISCAL
2002

• ATLANTA - Jan 02, 2003 - The Home Depot, the
  world's largest home improvement retailer, today
  announced that it is revising its diluted
  earnings per share guidance for the fiscal year
  ending February 2, 2003 from 1.57 to between
  1.53 and 1.55.
• The change in earnings per share outlook is due
  to slowing sales during the month of December,
  which lowered the company's expectation of a
  decline in comparable store sales in the fourth
  quarter to as much as 10 percent versus
  previously provided guidance of a decline of
  between three and five percent.

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Home Depot Q4 2002 Step 1 Forecasting sales
growth

• A Naïve forecast
• Sales weekly sales (Q3)x13 weeks x stores
• Sales 754,000 X 13 X 1471 14,419 mil
• However, there are other relevant factors
• Sales are seasonal
• HD is growing, so need to factor in new stores
• Separate between (1) same-store or comp sales
  growth, (2) new store sales growth, and (3) total
  sales growth (Same stores are those
  that were in operation for the entire quarter in
  both quarters)
• What else? (cold weather, disruptive renovations)

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Weighted Average New Stores Added During Q4 2002
http//www.homedepot.com/prel80/HDUS/EN_US/compinf
o/financial/pg_sixmonths.jsp?
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Q4 2002 Sales Estimate Option 1
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Q4 2002 Sales Estimate Option 2
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Next, forecasting COGS and SGAAre they also
seasonal?
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Gross Margin Estimate

• Q3 2002, 10K
• The gross profit rate increase was primarily
  attributable to improvements in shrink, benefits
  from the rationalization of our merchandise
  assortment and increased penetration of import
  products.
• Assume increase based on the increase in Q3 to Q4
  of last year (30.81 to 30.18)
• GM31.6 (Q3 2002) x 30.2/30.8 32.2
• or GP of 67.8

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SGA expenses 4th quarter

• First, take out depreciation expense
• May be included in COGS or SGA
• Assuming SGA
• Why?investments in CAPX, what to keep track of
  changes in depreciation
• Notice the fluctuations in the percentages
• Similar information as when examining COGS

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• Per Merrill Lynch (1/21/203), expect a flat SGA
• Historical (multexinvestor.com)
• TTM 19.3 5 yr avg. 19.0
• Quarterly fluctuations (10qs)
• 2002 2001
• 1st - 19.5
• 2nd 17.5
• 3rd -
• 4th - ?
• Industry (Multexinvestor.com)
• TTM 19.6 5 yr avg. 19.4

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Depreciation, Interest, Taxes

• Depreciation and Amortization
• Based on relation with PPE and Intangibles
• NewGoodwill is tough!
• If using SL and replacement at depreciation rate,
  ratio should be constant
• 1/(.5 useful life)
• High growth firms, need to estimate ending PPE
  and depreciation rate

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Home Depot- Forecasting PPE and Depreciation

• This is a growing company, so difficult to use
  turnover ratios to estimate PPE
• Estimate 62 more stores this quarter
• Jan 2 press release says 1502 stores plus 31 new
  stores from HD website 1533 stores vs. 1471
  from 3rd qtr 62 new
• Use current cost estimates from prior quarters of
  current year
• 2002Q123 capX 1.94B and 142 stores opened, or
  1.366/store.
• 1.366x62 new stores in Q4 847.0M more capX
• Use detailed information from 10K or 10Q
• Per 3rd qtr 10 Q
• 2.1 B for 1st 9 monthsexpect 3.3 B is FY 2002.
• 1.2 B more

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• Estimate depreciation
• Depr. on SCF /average gross balance in PPE
• 3rd qtr Depreciation on SCF 665
• (Gross PPE Beginning year Current)/2
• (18,12919973)/2 19051
• 665/19051 .0349 for Q123 / 3
• .0116 per quarter (22 year useful life).
• Estimated fixed assets at end of 2002
• (19973 847.0/2)x.0116 236.6M depr. exp. in Q4
• (19973 1200.0/2)x.0116 238.6M depr. exp. in
  Q4
• New net PPE 16604847-236.6 17214.4

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Financing

• What about debt?
• CAPX must come from somewhere
• 847M more this quarter
• Spent lots of cash on dividends and share
  repurchase
• Borrowed?
• Increases debt from 1,316,000 by ?
• What interest rate?
• Avg LTD (1316 1250)/2 1283
• 1st 3 qtrs interest expense 10 7 25 42
• 42 1283 x rate x 3/4
• Rate .043
• Current qtr interest expense .043/4 x 1316250
• 16.8

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Forecasting Capital Expenditures

• Per 10Q Q3 and expect total capital
  expenditures to be approximately
  3.3 billion in fiscal 2002.
• capX for Q4 (3.3 1.954 capX for first 9
  months) 1.346 B
• (hit Ending Net PPE/Sales until get a match)

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Forecasting Inventory

• Illustrating the effect of an acquisition
• 2002 Q123 increase in inventory per B/S is 1,589
  M
• 2002 Q123 increase in inventory per SCF is 1,574
  M
• ? 15 M were purchased from Arvada Hardwood
  etc.
• Option 1 assume avg. end inventory/sales of last
  4 qtrs 73.6
• Options 2

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Other assumptions

• End of year cash balance 2.5B (per webcast)?
  ending cash/sales19
• (Ending receivables/sales) assume avg of last 4
  qtrs.
• (Ending AP/COGS) same as Q3
• (Long-term debt/total assets), same level as a
  year ago.
• Assume dividend paid 352/2,97811.8
• Effective tax rate from 10Q, Q3 02
• For the remainder of fiscal 2002, we expect the
  federal and state effective income tax rate to be
  37.6.

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So my forecast is

• Revenue 13,874,900,000
• Net income 719,251,000
• EPS NI/2,326 30.9 cents per share
• The Home Depot will release its quarterly
  earnings, before the market opening, on 4Q02 -
  2/25/03. The Company will conduct live Webcasts
  of its earnings conference calls at 9 a.m. ET on
  these dates.

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Common Size Income Statements
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HD Earnings Surprise History
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What are the analysts predicting?
http//biz.yahoo.com/z/a/h/hd.html
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Breakdown of analyst forecasts http//www.earning
swhispers.com/stocks.asp?symbolHD
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Which of the following types of businesses do you
expect to show a high degree of seasonality in
quarterly earnings?

• A supermarket
• A pharmaceutical company
• A software company
• An auto manufacturer
• A clothing retailer

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Other Issues in Forecasting

• Balance sheet plug (BVt-1 NIt - DIVt BVt)
• Financial Analysis as a Reality Check
• Check of new margins in the income statement
• Sensitivity Analysis
• Results are sensitive to SGA cost per store
• Seasonality and Interim Forecasts
• Used prior year quarter rather than adjacent
  quarter for forecasts
• Forecast Horizon and terminal period assumptions
• Here we only forecast one period out, but
  competition and market conditions will be very
  important for longer forecasts.