Home Depot- Economic and Industry Analysis - Example

Home Depot Macroeconomic factors provide a good indication about the country’s of economy. Every economy passes through boom and bust and so the business cycles. Accordingly, Home Depot would also be impacted by the current macroeconomic scenario of the US economy. In this perspective, it will be worthwhile to investigate about some of the current macroeconomic parameters in US economy. Positive economic trends would facilitate smooth and faster company growth and that could perhaps be the right moment for investment in the company chosen. I. Economic Analysis Some of the economic measures such as GDP, unemployment rate, inflation rate would describe about the current state of US economy. GDP Growth As per Bureau of Economic Analysis, real gross domestic product increased by 1.9 percent in the first quarter of 2012 over the last quarter of 2011. It is worth noting that in the last quarter of 2011 GDP was increased by 3.0 percent. In the advanced estimate, the GDP growth was estimated to rise by 2.2 percent. The rise came through personal consumption expenditure, and exports. Imports too increased along with. The positive aspect is that real exports of goods and services in the first quarter increased 7.2%, a substantial jump over previous quarter increase of 2.7% (Bureau of Economic Analysis, 2012). It is not yet on a steady and robust path rise in GDP to establish that US economy is on sure path of recovery after the meltdown in 2008 (Bureau of Economic Analysis, 2012). Unemployment Rate There was not much of a change in Nonfarm payroll employment in the month of May 2012. The unemployment rate remained unchanged at 8.2 percent. The increase in Employment rate was noticed in transportation, health care and wholesale trade but construction registered a decline in employment rate. Employment in Other industries remained unchanged. The long-term unemployed people increased from 5.1 to 5.4 million in the last month. Construction employment continues to decline. Construction industry reached a low in January 2011 and since then there has been little change on this. Though there has been some improvement in unemployment rate but not sufficient enough to warrant that US economy is in the path of robust recovery (Employment Situation Summary, 2012). Inflation Rate The inflation rate in US is hovering around 2.3-2.9 percent, which is a bit lower than what registered in the last three quarters of 2011. Economy is not showing signs of good recovery yet and unemployment rate is fairly high, high inflation rate is certainly reducing the buying capacity of the US citizens. The Federal Reserve is keeping the cost of money low (low interest rates) to accelerate the investment and thus decrease the unemployment rate but the economy is still not ready to relent (United States Inflation Rate, 2012). Low unemployment rate, high GDP growth rate and low inflation rate in the economy are prerequisites for any company to grow and increase its earnings significantly. While making investment in any company, timing of investment is equally crucial as that will put the investment onto the fast track of appreciation. From the macroeconomic perspective, the time is not yet ripe for investment in general and it is better to observe some more quarters before making any firm decision for the investment. About Home Depot The Home Depot Inc., an Atlanta based company, caters to the needs of home improvement market. The company operates several stores to serve as a retailer. It sells building materials, lawn and garden products and provides numerous related services. It has 2252 stores spread throughout US including Canada, Mexico, and China. The company has over 300,000 products to offer online. Recently, the company acquired Redbeacon (money.msn.com, 2012). II. Industry Analysis The following table provides about the comparative growth rates of Home Depot versus industry average. GROWTH RATES % COMPANY INDUSTRY S&P 500 Sales (Qtr vs year ago qtr) 5.9 6.4 8.8 Net Income (YTD vs YTD) NA NA NA Net Income (Qtr vs year ago qtr) 27.5 24.1 24.5 Sales (5-Year Annual Avg.) -2.29 -1.13 8.35 Net Income (5-Year Annual Avg.) -5.91 -6.82 8.23 Dividends (5-Year Annual Avg.) 9.03 13.05 5.34 Source: http://investing.money.msn.com/investments/key-ratios?symbol=us%3aHD Near term outlook seems to be improving and likely to improve further with improvement in macroeconomic factors of the country. Major Competitors There are numerous players operating in the home improvement Stores. The nearest competitor is Lowes Companies Inc. with half the size of Home Depot in terms of market capitalization and employee strength. Wolseley plc, and the Sherwin-Williams Company are two other listed companies with market capitalization of 10.82 billion and 13.29 billion operating in home improvement market. Other privately owned companies are True Value and Menard Inc. Financial Ratio Analysis Financial Risk Ratios Current Ratio (most recent quarter): 1.43 Total Debt/Equity (mrq): 60.22 Current ratio informs about the company’s ability to pay short term obligations and that is certainly quite healthy for Home Depot. Profitability Profit Margin (ttm): 5.75% Operating Margin (ttm): 9.74% Qtrly Earnings Growth (yoy): 27.50% Three-year Comparatives of Home Depot (All numbers in thousands) Period Ending 28-Jan-2012 29-Jan-2011 30-Jan-2010 Total Revenue 70,395,000 67,997,000 66,176,000 Gross Profit 24,262,000 23,304,000 22,412,000 Net Profit 3,883,000 3,338,000 2,661,000 Source: http://in.finance.yahoo.com/q/is?s=HD&annual In the year ended Jan, 2012, even in recessionary and difficult market condition, the company’s revenue has grown by 3.5% and the net profit has registered a decent increase of 16.3% over the previous year, which is certainly laudable. Cash Flow Cash flow generated from the operating activities indicates about the liquidity of the company. In the year ended Jan, 2012. The company generated cash of $6651 million up from the previous year figure of $4585 million. This was largely due to increased margins realized from the operational activities (finance.yahoo.com 2012). Total Current Assets The company has been able to increase the total current assets in the year ended Jan, 2012 by 2,850 millions and in percentage terms that amounts to almost 20% rise over previous year and that implies that companys asset deployment is more on liquid assets and that is a good strategy looking to the current state of national economy (finance.yahoo.com). Earnings per Share and Dividend Distribution Diluted normalized EPS in the year ended 2012 is 2.47, up from the previous year EPS of 2.0 and the dividend declared per share is 1.04 against 0.95 in the year ended 2011. Dividend growth is almost 10%, which is in line with the increased earnings of the company (finance. yahoo.com 2012). III. Company Analysis Beta of Home Depot The Beta of Home Depot is 1.02, which indicates the volatility of the share price in reference to the volatility of the index. The beta value indicates that the Home Depot share price would have 2% more volatility than the volatility in the index value. Based on given beta, the share does not carry very high risk in terms of volatility (finance.yahoo.com 2012). Stock Scouter Report Fundamentals Quarterly earnings estimates for Home Depot have been forecast to go up by one or more analysts. Also, the last year earnings growth has been fairly steady compared to the previous three years and that augurs well for the company. Ownership Pattern Shares are being accumulated by financial institutions and that is surely a positive sign for Home Depot. The company is likely to outperform the market significantly over the next six months and the risk perception is lesser than average. Stock Scouter rating is 10 and that is the best possible rating (money.msn.com, 2012) Analyst Ratings Analysts mean rating recommendation is Moderate Buy (money.msn.com, 2012). Required Rate of Return The required rate or return largely depends upon the risk perception and the risk free return that is available in the market. The required rate of return from the security increases with the increase in underlying risk while making an investment in the stock. It can be given as: Ke = Rf + b (ERP) Ke is the required rate of return Given that Rf (risk free return) rate=5% and ERP= 6.4%. ERP is the risk premium that is applied to take care of unsystematic risk. And, for Home Depot, b=1.02 Thus, required rate of return for Home Depot Ke = 5 + 1.02 * 6.4 = 11.53% Given the risk involved in the stock, this is the minimum return (11.53%) that any investor would like to have on investment in stock of Home Deopt. P/E Ratio This is defined as Market Value per Share/ Earnings per Share (EPS) of the stock. The market price of the stock rises, if EPS of the company increases provided all other conditions remain the same. Rising EPS quarter to quarter would increase the value of the stock and vice versa is also true. Usually, all industries have their own typical P/E ratio. High growth industry will command higher P/E ratio and low growth industry will have lower P/E. As such, P/E ratio cannot tell the whole story about the company but when compared with the peer company in the same group, it is a good relative measure to indicate whether stock is worth investing or not. P/E Comparison Home Depot Low Inc. Industry P/E 19.35 17.76 23.08 Source: http://in.finance.yahoo.com/q/co?s=HD Home Depot stock is available at lower P/E ratio of 19.35 than the industry average of 23.08 in that sense currently, the stock is undervalued; however, when seen in the context of its nearest competitor Low Inc, the stock is expensive to buy. IV. Conclusion From macroeconomic perspective, time is not yet ripe for investing in any stock as underlying weakness in the economy such as high unemployment rate and inflation still prevails. Any downward trend in the economy would lower the industry P/E in general and that will bring down the market value of the stock; however, on fundamental considerations Home Depot is certainly on a stronger footing. It is certainly a company that can be chosen for long term investment as the company is poised for good growth in future. The moment economy of the country stabilizes and all negatives that have shrouded the economy since long vanish, that will be the right time for investment in the stock of Home Depot. References Bureau of Economic Analysis (2012), retrieved June 11, 2012 from http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm Employment Situation Summary (2012), U.S. Bureau of Labor Statistics, retrieved June 11, 2012 from http://www.bls.gov/news.release/empsit.nr0.htm finance. yahoo.com (2012), Yahoo Finance, retrieved June 11, 2012 from http://in.finance.yahoo.com/q/cf?s=HD&annual msn.com (2012), msn money, retrieved June 11, 2012 from http://investing.money.msn.com/investments/stock-ratings/?symbol=us%3aHD United States Inflation Rate (2012), retrieved June 11, 2012 from http://www.tradingeconomics.com/united-states/inflation-cpi Read More