Rahzeena Steward Ratio and Cash Flow Analysis PDF

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The Home Depot Company Ratio and Cash Flow Analysis Assignment #1

FINC 430 6380 Financial Management Rahzeena Steward

Introduction The Home Depot Company is one of the largest home improvement retailer companies in terms of current financial performance. The company provides a wide range of home improvement goods, assortment of construction materials, and decoration productions, among other installations and home improvement related services. The company was incorporated in 1978 with its headquarters in Atlanta, Georgia. The company recorded net sales revenue of 108.2 billion in the fiscal year 2018, which was an increase from 100.9 billion it recorded in 2017. The net profit increased from $8.6 billion in 2018 to $11.1 billion in the fiscal year 2018. Further, Home Depot generated $12.2 billion in cash

flow

from

operating

activity

in

the

2018

financial

year.

The eVal excel software provides a financial ratio calculator. This report describes the result gathered from the eVal software with regards to the financial ratio and cash flow analysis for Home Depot Company. The report covers the company’s growth rate, profitability ratios, DuPont models, analysis of leverage, and cash flow analysis. 1. Growth rate The Home Depot has generally recorded a positive performance in terms of annual growth rate. The company's most recent annual sales growth rates were 6.4%, 6.9%, 6.7% and 7.2% for the fiscal years 2015, 2016, 2017, and 2018. The earnings grew significantly from 8.5% in 2017 to 28.9% in 2018. The form 10-k report for the fiscal year 2018 attributes the increased sales to the company's growth across its stores and increased online sales, among other factors.

2. Profitability The return on equity assesses the company's capability to generate profits from the shareholders' investments efficiently. The return on equity was 0.896, 1.5, and 2.98 between 2015, 2016, and 2017. However, the ROE significantly declined to -52.5 in the fiscal year 2018 as a result of the total stockholder's equity deficit of $1.878 billion in 2018. The stockholders' equity deficit occurred due to the significant stock repurchase program and dividend payments during the last two financial years. On the other hand, the company recorded consistent growth in the return on net operating assets. The ratio shows that the company has recently been improving its ability to

use

operating

assets

to

generate

profits.

3. Basic DuPont model The basic DuPont model breaks down the return of equity formula into; leverage, operating efficiency, and asset efficiency. Home depot recorded a consistent rise in net profit margin as 0.079, 0.084, 0.086, and 0.103 for financial years 2015, 2017, 2017, and 2018. Similarly, the basic DuPont model indicates that the company recorded increasing asset turnover rations as 2.16, 2.23, 2.31, and 2.44 for the financial years 2015, 2017, 2017, and 2018 respectively. However, the company's leverage ratio significantly declined from 15.12 in 2017 to -208.8 in 2018, resulting in a return on equity for the financial year 2018 of -52.46.

4. Advanced DuPont model The ROE using the advanced DuPont model leads to similar results of -52.46 as with the basic DuPont model. However, the advanced model considers the return on net operating assets. The results indicate a significant decline in financial leverage in the financial year 2018 that results in negative

ROE.

5. Profit Margins Home depot has recorded an increasing net operating margin over the last four years. The net operating margin was 0.086, 0.091, 0.092, and 0.110 for the financial years 2015, 2016, 2017, and 2018 respectively. The consistent rise in net operating margin could be a reason for increases in gross margins and EBIT margins for the last four financial years. Moreover, the company continues to enjoy a steady rise in sales revenue. The significant rise in net earnings in the financial year 2018 was also a result of a reduced effective income tax of 23.6% compared to the rate in the financial year 2017, which was 37%. The change in the combined income tax rate was primarily a result of the enacted of a new Tax Act (Form 10-k, 2018). 6. Turnover ratios Turnover ratios are ratios where annual income items are divided by the asset amount of a given year. A larger turnover ratio is preferable since it is an indicator of higher efficiency in the company's management. Home Depot reported higher turnover ratios over the period between 2015 and 2018. The average inventory holding period declined from 71.4 days in 2016 to 68.5 in

2018, signaling that it was becoming more aggressive in managing its inventories. The net increasing PP& E turnover could be due to the company's increasing ability to generate more sales from its fixed assets. The average days to collect receivables were more than 6 over the period of review. In 2018, the company recorded an average days to collect receivables of 68.5, which was a decline from the previous years. However, the difference in days to collect receivables was not significant, which indicates that the company did not significantly change practices

over

the

period

under

review.

7. Analysis of Leverage – Long-Term Capital Structure The Home Depot increased its debt to equity ratio between 2014 and 2017. This indicated that the company continued to an increasing part of its operation and growth by using borrowings. The debt to equity ratio was -15.55 in the fiscal year 2018. The negative debt to equity ratio resulted since the company registered a negative net worth in 2018 due to its large dividend payments and stock repurchases. 8. Analysis of Leverage – Short-Term Liquidity The current ratio results are higher than one. The results indicate that the company can pay its short term obligations. However, the current ratio has been declining over the years due to the company’s increasing total current liabilities compared to the increase in total assets. The EBIT and EBITDA interest coverage 14.8 and 16.5 respectively for the financial year 2018. This is an indicator of the company’s strong financial ability to pay its interest obligations from the operating income. The company’s performance in terms of EBIT interest coverage was higher than the online retailer Amazon which recorded EBIT interest coverage of 8.95 according to its 2018 form 10-k report. 9. Cash flow from Operations Home Depot reported an increase in cash flow from operations over the years. The positive growth in cash flow from operations could be due to the company's rising net income. The cash flow from operations is $9.02 billion in 2015, $9.4 billion in 2016, $11.3 billion in 2017, and $12.2 billion in 2018. The results show that Home Depot is consistently generating positive net cash flow from the core business of retailing home improvement products and services. 10. Cash Flow from Investing

Cash flow from investing refers to the cash used or earned by an organization from the sale or purchase of income-producing assets. The company recorded negative net cash flow from investing activities between 2015 and 2018. The situation was as a result of the company’s significant investment in capital expenditure. The company spent $2.2 billion to fund its capital expenditures

in

the

financial

year

2018.

11. Cash Flow Financing The cash from financing outlines the cash transactions between the company’s shareholders and creditors. The cash flow from financing is -$ 6 billion in 2015, -$7.6 billion in 2016, $-8.1 billion in 2017, and -$12.3 billion in 2018. The company's negative cash flow from financing activities is attributable to its stock repayment and payment of dividends. In 2018 alone, the company paid $4.7 billion dividends on common stock while the repurchase of common stock cost the company $9.96 billion. Further, the company spent $1.2 billion to repay long term debt.

12. Free Cash Flow to Common Equity (FCFE) Free Cash Flow to Common Equity refers to cash available to shareholders and can be distributed as dividends or stock repurchases. Home Depot recorded a significant increase in FCF to common equity from $11.5 billion in 2017 to $14.5 billion in 2018. The FCFE for Home Depot is equal to the sum of dividend payments and stock repurchases. Home Depot fully pays its stock repurchases and dividends using the FCFE, which makes it attractive to the investors.

13. Free Cash Flow to all Investors FCF to investors analyze the net cash distributable to the providers of capital in a company. The FCF is $6.6 billion for 2015, $8.2 billion for 2016, $8.7 billion for 2017 and $13.2 billion for fiscal 2018. The results show that the net cash distributable to investors has been growing since the financial year 2015. This makes the company's investment more lucrative and attractive to investors

since

it

shows

greater

financial

prospects.

14. Conclusions Home Depot is a leading home improvement retail company based in the United States of America. The company's success has mainly been in its financial strategy to minimize cost while maximizing its sales. To achieve cost minimization, the company endeavors to a unique and close relationship with the suppliers. Further, the company has, in recent periods, attempted to reduce their inventory holding period. The company further has enjoyed a significant increase in its net sales, which has led to the rise in the gross margins and further the net income. The rising trend in cash flow from operations portrays the significant increases in net earnings. Home Depot's ratios show a company enjoying positive growth. The profitability ratios, margin analysis, and turnover ratios show a trend of improvement. Moreover, the negative return on equity in 2018 should not worry about an investor since its payment to investors caused it through stock repurchases and dividends. The analysis of the free cash flow to equity illustrates that the company did not borrow additional funds to pay dividends or repurchase stocks. The results from eVal software portray Home Depot as a growing company. Home Depot's estimated share price is $210.17, while its market value on 5/30/2020 is 248.48 (Yahoo finance). The market value for Home Depot is higher than the estimated value, indicating strong demand from investors.

15. Reflection The assignment on ratio and cash flow provides a practical approach to financial analysis. The student was able to review the performance of Home Depot and rely on the available literature to understand the reason behind the financial trends. Further, the assignment makes the learner appreciate the importance of cash flow analysis in decision making. The cash flow can be read in different

ways,

depending

on

the

reader's

need

for

the

statement.

16. References Home Depot (2018) Form 10-K https://ir.homedepot.com/~/media/Files/H/HomeDepotIR/2019_Proxy_Updates/HDAnnualReport2018.pdf Home Depot https://finance.yahoo.com/quote/HD/ Amazon https://finbox.com/NASDAQGS:AMZN/explorer/interest_coverage

17. Appendix...