The Home Depot, Inc. Case Analysis
1. The Home Depot’s competitive strategy is based on merchandise strategy. The company offers low prices by exploring the concept of the warehouse retailing. The warehouse stores located in the suburban places, the high volume of inventory displayed on the industrial racks and the simple facility design, allowing the company to pass savings on the customers. In order to increase convenience and out-of stock issues all inventory presented on the sales floor of the store. The Home Depot assures that the quality of the product offered is best and satisfied customers of different test, experience and knowledge of home improvement projects.
The Home Depot practices decentralized management, especially for its buying function. Regional buyers and merchandisers from six regions make product mix and inventory decisions. Consequently, while product categories are similar from store to store, suppliers can differ. The sheer sales volume of the Home Depot stores enables them to exert considerable influence on suppliers, even dictating such important aspects of the buyer-suppliers relationship as delivery terms and product labeling. The company’s power over suppliers, though, is tempered by the need to maintain adequate inventory in so large a distribution channel.
Finally, the company provides training for their employees that help to
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The Home Depot buys its products in orders in advance of shipment with arrangements similar to futures contracts. That keeps a stable supply coming onto store shelves. It also locks Home Depot into paying prices that might be months out of date. Because of the huge amount of the warehouse store that company has it makes difficult and inflexible to manage such orders by buying the products in cash market at spot prices.
2. The Home Depot profit margin decrease sharply in year ending February 1986. The decrease in profit margin results from of increasing cost of goods sold to sales percentage, and increasing selling and administrative expenses to sales percentage. The increasing in the selling, administrative expenses, store operating and pre-opening expenses as percentage of sales may result from increasing advertising expenses, and also due to opening large percentage of new store with lower sales, and the related cost of building market share.
The Home Depot profit margin and operating asset turnover both steadily decreased that reflect in following decrease in RNOA for year-ends in February 1986. Operating asset turnover ration increased between January 1985 and February 1986. It follows that average number of days that accounts receivable were outstanding almost doubled for this period. In the same time account receivables were increased more that double. Even so, The Home Depot doesn’t appear to have a major problem with collecting its accounts receivable. Many firms transact business with terms of 30 days.
Inventory Turnover decreased and average number of days in Inventory increased but very slightly and sufficient. However, the significant numbers of days in Inventory (>80 days) were cause The Home Depot merchandise strategy is to keep all inventories in stock and on shelves. Fixed Assets Turnover decrease between year-end January 1985 and 1986 results from rapid expansion and continued growth of the Home Depot. Decreasing in the fixed assets turnover may also indicate problem in operating efficiency. However, the company made significant investments in fixed assets in anticipation of higher sales in the future. The Home Depot expansion includes acquiring more land, buildings, furniture and equipment for the opening of 20 new stores, and also leasehold improvements.
The rate of return on common shareholders’ equity (ROCE) measures the return on common shareholders after subtracting from revenues operating assets, cost of financing debt and preferred stock. The income from operations that is not allocated to creditors or preferred shareholders belongs to the common shareholders as the residuals claimants. ROCE incorporates the results of a firm’s operating, investing, and financial decisions. ROCE can be disaggregating on its components as follows: ROCE = RNOA + Wd/We (RNOA – NBC)
The Home Depot had decreasing trend on ROCE. It also had down trend of RNOA in years ending Feb. 1986, 1985, 1984. NBC had jump up in year ending February 1985 and came back to even lower position in the end of the same fiscal year. The net borrowing cost depends on risk-free rate, the risk of debt and the corporate income tax rate. In year-ends Feb.1986 the inflation didn’t have an effect on sales or results of operations. But effective income tax rate declined from 46.2% to 29.3% resulting from an increase in investment and other tax credits.
ROCE was below RNOA whenever RNOA below the cost of capital provided by creditors and preferred shareholders. For fiscal year 1985 the cost of capital appears to exceed RNOA slightly (6.15 against 6.14) and reduced the return to the common shareholders (6.13). Wd/We is measure of leverage or capital structure leverage. However, leverage was stable prior 1985 fiscal year, when it went up. Leverage increased the variance of ROCE.
Financial leverage had disadvantage for the Home Depot shareholders in fiscal year 1985, and year 1984 because its ROCE lies below its RNOA. 3. The Home Depot generates negative cash flow from operations of $41,803, $2,143 and $10,574 in 1985, 1984, and 1983 fiscal year respectively. The company experienced positive working capital from operations in all three years $16,398, $18331 and $12,342 in years 1985, 1984 and 1983. Investing activities consumed $93,343, $82,568 and $16,330 in fiscal years 1985, 1984 and 1983 respectively. The negative cash flow from operations coupled with negative cash flow from investing required the Home Depot to obtain the cash from financing sources. The company primary relied on long-term borrowing in 1984 and 1985 fiscal years and on issuing common stocks in 1983 fiscal year.
It used long-term debt to finance the acquisitions. The Home Depot made a significant corporate acquisition on Bowater Home Center, Inc. in 1984 fiscal year for which it needed external financing. Debt is less expensive source of capital that equity. Also the Home Depot used debt because of collateral value of its stores and store equipment, and predictability of cash flows of large retailer. 4. During the 1985 year the Home Depot entered into the unsecured revolving line of credit agreement. This agreement put interest coverage restrictions that company has to meet. Among other things, the company is required to maintain a minimum tangible net worth of $150,000, a debt to tangible net worth ratio of no more that 2:1, a current ratio of not less than 1.5:1, and a ratio of earning before interest expenses and income taxes to interest expenses of not less that 2:1.