Business Strategies and Financial Performances of Home Depot - Case Study Example

of paper: number: Managerial Finance The report is prepared with the aim of evaluating the business strategies and financial performances of Home Depot over the last two years of its operation i.e. 2013 and 2014. The report is prepared with a suitable introduction given about the company. This is followed by a discussion regarding the background of the company and the financial performance and current financial position of the company. The background information is to discuss the financial position of the company in the last two years. This includes an overview of the general financial performances like revenues generation, financial management and investment and stock prices. This is followed by an in depth analysis including an analysis of the corporate strategies, ratios, accounting policies, and a prospective analysis done by considering the financial statements of the company from 2012-2014. The research report is suitably concluded with a proper decision made regarding the investment proposal after evaluating the financial position and the benefits of investing in Home Depot. Introduction Home Depot Inc. is a home improvement retail business operating in the United States of America. There are more than 50 Home Depot retail stores in different cities of the United States. Home Depot was found in the year 1978 and is headquartered in Georgia, Atlanta. The current Chief Executive Officer of the company is Francis Blake under whose management the company has been performing extremely well in the last few years. Home Depot is the biggest retailer in the home improvement retail segment of the United States. The research is done with the aim of evaluating and assessing the financial position of Home Depot Inc. in order to make a critical investment decision. The financial performances of the company are evaluated over the last 2 years and the projected financial statements are prepared for the next two years. This is done to analyze the investment attractiveness of the company and also to make a key decision regarding the investment of USD 25 million in the selected company. Background The main competitors of Home Depot are Lowes Companies Inc., True Value Company and Menard Inc. Home Depot is the number 137 company in the Forbes Global 2000 list. The company operates in various cities of the United States of America and has a total employee base of 385000 employees from diverse backgrounds. Home Depot Inc. is one of the most valuable brands in the globe. The stock price of Home Depot has been increasing on a steady basis and was recorded as USD 81.02 in the first quarter of 2014. The revenues generated by the company in the year 2013 was USD 74.8 billion which increased by 5% to become USD 78.8 billion in the first quarter of 2014. The company is listed in the New York Stock Exchange which is the largest stock exchange in the world. The stocks of Home Depot are also important components of the Standard and Poor 500 and Dow Jones indices. The shares of Home Depot can be identified to be one of the most preferred investment choices for the individuals as well as institutional investors in the United States. The core business and corporate activities of Home Depot from its inception in 1978 to the present day has created a sustainable and predictable image of the company. Also, other ancillary activities like the philanthropic activities carried out by Home Depot has helped to establish a better brand reputation and ensure strong financial performances of the company over years of its existence. Since, the company functions in the home improvement retail sector, therefore, it was much impacted by financial crisis or downturns in the housing markets. As such, the financial performances of Home Depot were much affected during the Great Financial Crisis of 2008 and during the subprime mortgage crisis and housing bubble bursts. However, the company has revived from the effects of the financial downturns and the current financial performances of the business have established the strength of the company to withstand crisis situations in its external environment. Literature Review The business strategy analysis is done in order to understand the corporate strategies used by a company and the competitive advantages of the company. Home Depot has been using the strategy of being the best cost provider in the home improvement retail market. According to Ruback (2002), the main accounting policies taken up by companies are related to self-insurance, revenue recognition and self-interest (Ruback, 2002). Accounting policies are significant in a company because these policies help to determine and evaluate the key financial and corporate functions of a company. Recognition of revenues is critical for a business because it helps to steer the recognition of incomes and gains in the company in the proper direction. The accounting policies of Home Depot seem to be conservative in nature and are not aggressive policies. This guarantees the stability of the company in terms of accounting activities and financial performances. It can be identified from analyzing the accounting policies of Home Depot that the company reflects the proper economic and financial performances in its financial reporting and that there are no dubious values associated with the financial statements of Home Depot. The financial analysis of a company can be done by the use of ratio analysis. As per the work of Timothy and Andrew (2000), this process should ideally involve the computation and interpretation of key financial ratios like profitability, efficiency, liquidity, leverage and investment ratios (Timothy and Andrew, 2000). Ratio analysis is the most implemented technique used for the analysis of financial statements. The ratio analysis for Home Depot is done with a consideration of the main profitability rations, liquidity ratios, and efficiency and leverage ratios. Also, the investment ratios like price earnings ratios are considered. Ratio analysis can be used to analyze the financial performance of a company on a year on year basis. Also, it involves the comparison of the key ratios with the competitor companies operating in the same industry. The key ratios of a company are also compared with the industry standards. This helps to assess the individual performance improvement of a company as well as a comparison of the company with its peer companies and the industry average. Current ratio is a financial ratio used to assess the liquidity position of a company. The liquidity of a company indicates its ability to use the short term assets in order to meet the immediate liabilities. The quick ratio is another key financial ratio used to measure the liquidity position of a company. The quick ratio is calculated by deducting the inventory from the current assets and then dividing it by the current liabilities. As per the work of Alastair (2001), in contrast to the current ratio, quick ratio does not consider the inventories as current assets available to the business (Alastair, 2001). A high quick ratio for a company is considered good. Gross profit margin is financial ratio used to represent the profitability position of a company. Gross profit margin is usually expressed as a percentage. The higher the gross profit margin, the better is the profitability position of the company. According to Horngren, Sundem, Elliott and Philbrick (2005), gross profit margin gives an idea of the amount of money that can be retained by the company from its revenues after paying off the cost of goods sold (Horngren, Sundem, Elliott and Philbrick, 2005). The return on investment indicates the profitability of a company with respect to its total assets. Return on investment ratios are used to measure the returns generated by the investments made in the business. A high return on assets means that the company is generating more returns from less investment. The return on shareholders’ equity is used to measure the returns that would be generated for the equity of shareholders invested in a company. The ROCE is a measure of both the profitability and the efficiency of a company. The fixed asset turnover ratio is a financial ratio used to measure the operating performance of a company. The fixed assets are major components of assets in a company. As such, their effective utilization is necessary for the financial and operational performances of a company. The debt equity ratio is a key gearing ratio which is used to represent the leverage position of a company. The debt equity ratio is indicative of the capital structure balance in the company. This also represents the proportion of equity and debt used in the business for financing the operations. Analysis Competitive strategies The company employs the low cost differentiation strategy as defined in Porter’s generic strategies by providing products and services to the customers at low prices. The company focuses on selling products that are of high quality and are priced competitively. Home Depot has grown by ensuring profitable and supportable growth through the expansion of the business. Also, Home Depot focuses on developing a collaborative structure between the employees and the customers. The low cost pricing and development of high quality products and services have created much competitive advantage for Home Depot. Accounting practices The main accounting policies of Home Depot are employed in the significant areas of accounting including inventory, revenue recognition and self-insurance (United State Securities and Exchange Commission, 2013). The revenue recognition and other accounting policies help to evaluate the performance of a company. The revenue recognition of the company is done on a cash and carry basis. Home Depot recognizes its revenues, taxes and profits once the customers get the possession of the products and services. The inventory valuation of the company is done through the use of the costs to market and through the use of First in First out (FIFO) method of inventory. The self-insurance of the company is done by maintaining worker’s compensation, general liability and automotive and medical claims. Financial statement analysis and ratios Ratio Analysis     Home Depot Lowes       2013 2014 2013 2014 Industry average               Current Ratio   1.34 1.42 0.10 0.13 1.4 Quick Ratio   0.41 0.39 0.02 0.04 0.29 Gross Profit margin   35% 35% 34% 35% 33% Return on Investment   0.11 0.13 0.06 0.07 6.4 Operating Profit Margin   10% 12% 7% 8% 11.13% Return on capital employed   0.27 0.31 0.12 0.15 0.39 Return on Shareholders equity   0.26 0.43 0.12 0.16 0.2 Fixed Asset turnover   3.11 3.38 2.30 2.49 2.2 Debt equity Ratio   1.31 2.24 1.03 1.36 1.4 Earnings per share   2.47 3.76 2.24 2.26 4 Price Earnings Ratio   18.05 20.38 21.11 22.02 19.2 Market value per share   44.58 76.64 47.28 49.76   Current Ratio The current ratio of Home Depot is maintained at more than 1 in both 2013 and 2014. This indicates that the company is in a stable liquidity position. It can be accessed from the current ratio values that Home Depot is strongly equipped to meet its near term obligations like immediate payables and debts through the use of its liquid assets like cash, inventory, accounts receivables etc. Also, the current ratios of Home Depot have remained stable in 2013 and 2014 (Yahoo Finance, 2014). This indicates that the company has shown continuous proficiency in being able to convert its assets and inventories into cash. This also indicates that Home Depot is much efficient in maintaining a high performing operating cycle. Also, the current ratios of the company are close to the industry average which is 1.40. Thus, it can be established that Home Depot maintains a liquidity position which is at par with the industry requirements. Quick Ratio The quick ratio of Home Depot is 0.45 in 2012, 0.41in 2013 and 0.39 in 2014, respectively. This indicates that the short term liquidity of the company reduces when the inventories are not included in the current assets. This is acceptable for a retail company because the inventories are high in a retail company than in any other type of business. Thus, it can be said that Home Depot is highly dependent on the inventories available in the business for meeting the short term liabilities. The average industry standard for quick ratio is 0.29. The quick ratios of Home Depot are much higher than the industry average in both the years. Also, the quick ratios of Home Depot are significantly better than Lowes in both the years. This is indicative of the fact that the liquidity position of the company can be established to be strong when all aspects of the ratio analysis are considered. Gross Profit margin The gross profit margin ratio of Home Depot is around 35% from 2012-2014. This indicates that the company is highly proficient in making profits. The industry average for gross profit margin in the home improvement retail industry is 33%. Thus, the gross profit margin for Home Depot has been maintained at more than the industry standards and is equivalent to that of Lowes. This is indicative of the fact that the company has been performing beyond the industry requirements. The stability of the gross profit margin in the respective years is a proof of the fact that Home Depot can easily maintain reserves and pay the cost of goods sold incurred in the business. Return on Investment The Return on investment ratio for Home Depot is 10% in 2012, 11% in 2013 and 13% in 2014. This is much higher than the industry average which is 6.4% and also more than that of Lowes. This means that Home Depot is performing efficiently in terms of converting the investments into profits. This would give an idea to the investors about the high profitability of Home Depot and its efficiency in terms of converting the invested money into income. Return on Shareholders’ Equity A high return indicates more efficiency of the company. This ratio is for Home Depot is more than the industry average and the competitor Lowes in both years. This means that the company gives high growth in earnings to its investors. Operating profit Margin The operating profit margin is also high as the gross profit margin which means that Home Depot can retain enough earnings after meeting the operating expenses (Ross, Westerfield and Jaffe, 2009). The operating profit margin of Home Depot is at par with the industry standards and is more than Lowes. This means the Home Depot has a healthy profitability position. Return on Capital employed The ROCE for Home Depot is higher than the industry average and the competing companies like Lowes. This means that Home Depot is highly efficient in capital employment and is creating high value for its shareholders. This means that Home Depot is performing better than the competing companies of similar scale of operations. Fixed Asset Turnover ratio The fixed asset turnover ratio for Home Depot is 2.88 in 2012, 3.11 in 2013 and 3.38 in 2014. The high values of this ratio indicate that the management of Home Depot has worked efficiently towards managing the assets available in the business (Brealey, Myers and Marcus, 2005). The year on year increase in this efficiency ratio indicates that Home Depot maintains a sound financial health and generates more sales as compared to the availability of assets in the business. Debt Equity Ratio A low debt equity ratio means that the company is not aggressive in using external finance sources for funding the business operations. A high debt equity ratio can have negative implications because it represents the overuse of external liabilities. The debt equity ratio of Home Depot increased from being 1.31 in 2013 to 2.24 in 2014. This means that the company has taken external debts in 2014. Also, the debt equity ratio is maintained at a value of more than 1 which means that Home Depot is more dependent on using debts than equities in the business. Price Earnings Ratio The PE ratio is used to evaluate the investment position of a business. The PE ratio of Home Depot is high and stable which means that the company is much lucrative for investments (Edwards, 2007). The PE ratio also indicates that the prices of the shares of Home Depot are likely to increase in future. The investors can expect high returns and high growth in earnings from their investments in Home Depot. The PE ratio of Home Depot is more than the industry average in 2014. But, the PE ratio of Lowes is marginally higher than that of Home Depot in both years. Future prospects analysis The prospective analysis is done by preparing the projected financial statements of the company by using the proportionate increase method. The prospective analysis is used to forecast the future earnings and payoffs for the company (Daves, Ehrhardt and Shrieves, 2004). The prospective analysis of Home Depot shows that the company will generate high revenues and retain sufficient profits in the future as well. Conclusion / Recommendations The financial performance of Home Depot, the high return on the shares and the affordable share prices make the company a popular investment option for long term as well as short term investors in the country. It can be concluded from the financial analysis of Home Depot that the company is a high potential investment option for any type of investment. An investment of USD 25 million can be done in this company because the company is financially stable, high performing and less risky as compared to its competitors like Lowes. Also, the key performance indicators of the company are better than the industry requirements. The investments done in Home Depot are likely to generate high returns and the associated risks of investment are much less for this company. Home Depot has always been a credible and return oriented investment option. The current financial performances of the company indicate that it would be in the best interest of the investors to invest in this business. The investment option is especially lucrative if a long position is taken up in the investment i.e. if long term investments are made in the company. References Alastair, L. (2001). Mastering Financial Modeling: A Practitioner’s Guide to Applied Corporate Finance. London: Prentice Hall. Brealey, R. A., Myers, S. C. & Marcus, A. J. (2005). Fundamentals of Corporate Finance. New Jersey: McGraw-Hill. Daves, P. R., Ehrhardt, M. & Shrieves, R. E. (2004). Corporate Valuation: A Guide for Managers and Investors. London: Thomson. Edwards, R. (2007). Technical Analysis of Stock Trends, Ninth Edition. Florida: CRC Press. Horngren, C. T., Sundem, G. L., Elliott, A. & Philbrick, D. (2005). Introduction to Financial Accounting (9th Edition). New York: Prentice-Hall. Ross, S. A., Westerfield, R. & Jaffe, J. (2009). Corporate Finance. New York: Irwin-McGraw-Hill. Ruback, R. S. (2002). Capital cash flows: a simple approach to valuing cash flows. Financial Management. Vol. 85(1). Timothy, G. J. &Andrew, J. (2000). Financial Management 2nd ed. Stamford: Cengage. United State Securities and Exchange Commission. (2013). The Home Depot Inc.-Form 10-K. Retrieved from http://www.sec.gov/Archives/edgar/data/354950/000035495013000008/hd-232013x10xk.htm. Yahoo Finance. (2014). The Home Depot Inc. Retrieved from http://finance.yahoo.com/q/bc?t=1y&s=HD&l=on&z=l&q=l&c=&ql=1&c=%5EGSPC&c=%5EDJI. Read More