The Home Depot and Lowes Companies Inc - Assignment Example

RUNNING HEAD: Financial ment Financial ment Analysis– The Home Depot and Lowes Companies Inc. of of Professor Date 1. Introduction This paper seeks to compare the financial data from the 2010 10K financial statements of The Home Depot (or “HD”) and Lowes Companies Inc. (or “LOW”) for purposes of evaluating financial performance, financial condition, earning quality, credit worthiness and other information of the two companies for the years 2009 and 2010 as a basis of choosing which is better between the two. Fiscal year of Lowe’s ends on Jan 30,2011 while that of Home Depots ends on January 28, 2011 financial statements. For the purpose of this paper, 52-week period ending January 2011 would be referred as year 2010 and the same period ending January 2010 would be considered year 2009. 2.1 Balance Sheet 2.1.1 Which three (3) assets are most significant to the company? Using the notes to the financial statements, discuss the accounting methods used to value assets. What method(s) do the companies use to value inventory? What depreciation method(s) do the companies use to value property, plant and equipment? How are accounts receivable valued? The most significant assets of Home in 2010 included merchandise inventory, Property and equipment and other current assets constituting about 26%, 62% and 3% of the total assets respectively. Compared to 2009, the most significant were merchandise inventory, Property and equipment and other current assets constituting about 25%, 63% and 3% of the total assets respectively. The companies appear to have inventories and property as top two most significant assets for both years and this should describe the nature of the industry that they are in. The three most significant assets of Lowe for 2010 would include merchandise inventory, Property and long-term investment constituting about 24.7%, 65.5 and 3% of the total assets respectively. Compared to 2009, the most significant were merchandise inventory, Property and cash and cash equivalents constituting about 25%, 68.2 and 1.9% of the total assets respectively. For Home depot on the other hand, Bother company value their inventory using lower of cost or market under first in first out (FIFO) basis. Both companies used the straight-line depreciation method Receivables are valued by both companies using fair value. 2.1.2. Which three (3) liabilities are the most significant to the companies? Have there been significant changes to the liabilities from 2009 to 2010? The three of the most significant liabilities to HD include the following: Accounts Payable, Accrued Expenses and Long-term Debt. For HD There have been no significant change to liabilities from 2009 to 2010 except on deferred tax which decreased by 15%. The three of the most significant liabilities to LOW include the following: Current Portion of Long Term Debt, Total Current Liabilities and Long-term Debt. For HD, there have been significant changes to liabilities from 2009 to 2010 particularly on Current Portion of Long Term Debt which change by 93% (The Home Depot, 2011). 2.1.3. Have there been significant changes to the equity structures of the companies from 2009-2010? For HD, there has been significant change in the equity structures from 2009 to 2010 particularly on Retained Earnings, Treasury Stock - Common and Other Equity accounts. Changes of each ranged from 13% to more than 400%. For LOW, there has been no significant change in the equity structures from 2009 to 2010 2.1.4. Describe the commitments and contingencies that the companies might have. These appear in the notes to the financial statements. The commitments and contingencies faced by HD had to with its responsibility to the environment including targeted reduction in carbon emission. The company has therefore implemented standards as part of its energy efficient practices. The company is also contingently liable for an amount of more than $600 million under open accounts and letter or credit issued for certain business transactions (The Home Depot, 2011). LOW has also no cancellable commitments for amounts reaching above $600 million in relation to certain marketing and information technology. Said commitments are not part of the liabilities and should be considered for credit purposes to have the effect of increasing reported liabilities (Lowes Companies Inc, 2011). 2.2 The Income Statement 2.2.1 Prepare common size income statements for both companies for years 2009 and 2010. The common size statements of HD and LOW are found in Appendices A and B. 2.2.2 For each company, calculate the percentages of sales growth, operating expense growth, and net income/loss growth from 2009 to 2010. The percentage of sales growth, operating expenses, and income/loss growth from 2009 to 2009 are as follows: 2.3 The Statement of Cash Flows 2.3.1 For each company, identify the three (3) most significant changes in cash flows, during 2010, in each of the three sections (operating, investing, financing) of the statement of cash flows. The three (3) most significant changes in cash flows for HD, during 2010, in each of the three sections (operating, investing, financing) of the statements of cash flows are follows: For HD operating cash flows, the most significant changes happened in Net Income, Depreciation/Depletion and Increase in Merchandise Inventory; Under investing, the most significant changes happened in Capital Expenditures Proceeds from sale of property and equipment with no third item; and, Under financing, , the most significant changes happened in Repayments of Long-Term Debt, Repurchases of Common Stock, and Cash Dividends Paid to Stockholders (The Home Depot, 2011). On the other hand, for LOW operating cash flows, significant changes occurred in net income, Change in Non-Cash Items and Changes in Working Capital. Under investing for LOW, the most significant changes happened in purchase of investments; While under financing, the most significant changes happened in Net proceeds from issuance of long-term debt and repurchase of common stock (Lowes Companies Inc, 2011). 2.3.2. For each company, determine what the percentage of cash growth/shrinkage was between the ends of year 2009-2010. The cash growths/shrinkages between 2009-2010 for HD and LOW are as shown below. 2.4 Ratio Analysis 2.4.1 Prepare a financial statement analysis of each company for the year 2009. The set of ratios for the two companies are shown below: Table A – Calculated ratios; Sources: (The Home Depot, 2011, Lowes Companies Inc, 2011) 2.4.2. For each company identify specific strength and weaknesses observed from the calculation of the ratios. The strength/weakness of each company may be viewed in terms of liquidity, solvency and profitability and efficiency (Johnson, et al, 2003). HD may be considered liquid, solvent profitable and efficient. LOW may be described to have the same strengths of being liquid, solvent profitable and efficient. 2.4.3. Find the industry averages and compare them with the calculations that you have made. Sources that provide comparative statistical ratios are to help determine a company’s relative position within its industry. The industry average as compared with the calculated ratios would appear as follows: Table B – Comparative Ratios vs. Industry Average: Sources: (The Home Depot, 2011, Lowes Companies Inc, 2011; Reuters, 2011a) 2.4.4. Based upon the information gathered in step (3) discuss the relative strength or weakness of your companies within their industry. A company’s liquidity should indicate its ability to meet a companys currently maturing obligations as measured using the current ratio and the quick asset ratio. HD is more liquid than LOW with the current ratio of the former at 1.34 as against the latter at 1.32 and even against industry average of 1.15. This is also true in terms of the comparative quick ratios of two companies where HD reflected 0.23 as against that of LOW at 0.14. However, this time both companies are less liquid than industry average of 0.42. Quick ratio is a more strict measure of liquidity since inventory, prepaid expenses and other current assets are removed from current assets. See Table B Both ratios for the two companies are however considered liquid because both their current ratios and quick asset ratios exceeded 1.0. This would mean that their current liabilities are still matched by their current assets. The better liquidity of a company, however, may be explained by increased investments made by owners or by better profitability and management efficiency Apart from having good liquidity is the need to have good solvency or financial leverage. Such position should indicate a company’s long-term capacity to keep up it steadiness over the long term. Since solvency can measured by the debt to equity ratio, by relating or dividing the total debt of the company to its total equity or total shareholder funds, said gearing if good will promise investors that the companies are not just to endure the short term. Can the companies live a long life to withstand a financial storm like a crisis that was experience in the United States in 2007 and the following years? Solvency should provide the answer. As applied now to companies, HD had debt to equity ratio of 1.11 as against that of LOW at 0.73. Compared to industry average of 0.57, both companies are more highly leverage or less superior solvency position. See Table B In terms of profitability, HD was found to be more profitable than LOW in terms of return on equity (ROE) since the former had 14% as against that of the latter at 9%. If proved further in terms of net profit margin (NPM) both the same at 4%. However their return on assets (ROA) indicated that HD was more efficient at 7% as against LOW at 5% and even against industry average of 4%. Viewed from the point of investor, HD, higher ROE should be considered more favorable. This would mean that the higher management efficiency in terms of ROA necessary resulted to higher profitability and better liquidity of HD over that of LOW as explained earlier. 2.4.5. Briefly describe the quality of earning for each of your companies. The quality of earnings for each of the companies may be measured in terms of price earnings ratios compared with the industry. These type of ratios combined historical information of present market information unlike the first three ratios which dwell essential from historical data. The same ratios can articulate valuation each company’s share under the theory of the efficient market (Brigham and Houston, 2002) as management attempts or aims to maximize value or stockholders’ wealth. Investors willingness to take risk as they invest with company given the latter’s level of earnings can be determined using the information below. The P/E ratio of HD for the past trailing months was 18.45 compared with LOW at 18.57. (Reuters, 2011a, 2011b) Comparing their ratios as against industry average of 15.31, it may mean a valuation for the latest performances of the company with high profitability than industry speaks on the good quality of their earnings. (Reuters, 2011a) 2.4.6. Give your opinion as to the credit worthiness of the companies that you have selected. To evaluate credit worthiness companies, it is normal to include looking into the capacity, condition, capital and collateral and character or the Five C’s of credit. Capacity would refer to the ability to pay in terms of liquidity which was determined earlier to be very high. Condition would refer conditions of any borrowing that would be availed and whether the same is favorable to the company. In the absence of the terms of loan that would be availed, this criterion cannot be used to evaluate credit worthiness. Collateral is capacity to provide security and which can be declared position considering its still acceptable financial leverage. Character would refer to its refutation of the companies and could be based on past credit experience with the companies from the creditors’ point of view. This paper may judge only on their capacity based on their financial condition and profitability to determine their credit worthiness (Lasher, 1994). Companies are liquid, both are profitable and both are highly leveraged. HD should have more capacity in terms of higher liquidity and profitability. 3. Conclusion Based on the foregoing analysis and discussion, this paper concludes that HD is more liquid and more profitable. HD is however less solvent than that of LOW because of higher debt to equity ratio. Compared to industry averages, both companies’ profitability and liquidity have exceeded the industry while in terms of solvency both are less superior to the industry. HD should be therefore declared better between the two based on foregoing. Given also the higher PE ratios of the two companies than industry average, Caterpillar, there is basis to claim that their higher financial leverage than the industry was not a problem as higher stock values are generated. Since HD the two companies have very close PE ratios, HD should remain the better company between the two. 4. Appendices Source: (The Home Depot, 2011) Source: (Lowes Companies, Inc, 2011) 5. References: Lowes Companies Inc. (2011). 10K Annual Report for 2010. Retrieved April 30, 2011 from < http://investor.shareholder.com/lowes/annual.cfm?Decade=2010&AnnualArchive=Show> Reuters (2011a). Industry Ratios. Retrieved April 30, 2011 from < http://www.reuters.com/finance/stocks/financialHighlights?symbol=LOW> Reuters (2011b). Overview for The Home Depot Retrieved April 30, 2011 from < http://www.reuters.com/finance/stocks/overview?symbol=HD > Brigham, E. and Houston, J. (2002) Fundamentals of Financial Management, London: Thomson South-Western Johnson, et al (2003). Financial Accounting. Tata McGraw-Hill Lasher (1994). The perfect business plan made simple Made Simple. Doubleday The Home Depot (2011). 1OK Annual Report for 2010. Retrieved April 30, 2011 from < http://ir.homedepot.com/phoenix.zhtml?c=63646&p=irol-reportsAnnual > Read More