ANALYSIS
Nathan Morgan
11/9/15
Recommendation
The market price is overvalued due to ineffective cost cutting and sales growth initiatives, despite
a favo...
In the first fiscal quarter of 2015, Home Depot authorized a new $18 billion share repurchase program to be
completed by t...
Appendix
Discount Rate
Yahoo 6.83%
FactSet 6.64%
Fidelity 5.36%
Beta process
1- yr T bill 0.0204
S&P 1 yr 6.78%
Beta 1.01 ...
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Nathan Morgan_Home Depot analysis

Published on: Mar 3, 2016
Source: www.slideshare.net


Transcripts - Nathan Morgan_Home Depot analysis

  • 1. ANALYSIS Nathan Morgan 11/9/15
  • 2. Recommendation The market price is overvalued due to ineffective cost cutting and sales growth initiatives, despite a favorable economic outlook and a large, short-term share repurchase program. Sell Favorable outlook of U.S. economy and sales drivers The positive outlook of the United States economy and macro-economic sales drivers project high short-term growth that will level off in the long-term. The short-term growth rate is calculated by revenue projections from the sales drivers of housing starts, the value of residential construction, and the national unemployment rate. These factors were chosen due to high correlations of 0.70, 0.75, and -0.74, respectively, with Home Depot’s annual sales growth percentage change. Based on the macro-economic factors, the short-term sales growth rate is 13.5 percent. The health of the United States economy is crucial in determining positive consumer confidence, which is key at spurring investment into home improvement. The sales dependence on the United States economy causes the long-term sales rate to trend downwards towards 2.4 percent, the projected GDP annual percentage growth rate. Management initiatives Management has implemented numerous initiatives, both cost cutting and sales generating, but these have not translated to the bottom line. Cost cutting initiatives integrate technology to enhance customer service, optimize the supply chain, and increase cyber-security. Sales generating initiatives strengthen the product portfolio and partnerships. However, there is little evidence to support that these initiatives have material impact on the bottom line. Managing Costs  Customer service: Improve the online platform and increase wireless connectivity o Added features, like store maps and mobile checkout, to improve the application and large investments, like acquisitions and a new IT center, to grow online sales.  Supply chain: Streamline processes to achieve sustainability goal o Implementation of a new ordering system that increases communication along the supply chain, which decreases time needed to react to a change in demand and seasonal issues.  Cyber-security: Enhance safety for company and customer proprietary information o Large investment for an IT campus and the recent hiring of Linda Gooden, former Lockheed Martin EVP of Information Technology. Generating Sales  Domestic market-share: Expand professional segment base o Acquired company to broaden professional segment offering because of increased domestic competition.  Portfolio offering: Leverage new partnership brands o Improved partnerships with popular and quality brands, while also offering more proprietary products.  Shift in consumer age and international investment: 1.4 percent decline in 2014 home ownerships with increased domestic competition o Bulk of the population are spending more time at home with their families, while recent trends indicate that millennials have a preference for renting, despite advertising to sustain the Do-It-Yourself consumer base. o Increased domestic competition resulted in Home Depot focusing investment in the Mexico market. Nathan Morgan November 9th , 2015
  • 3. In the first fiscal quarter of 2015, Home Depot authorized a new $18 billion share repurchase program to be completed by the end of the 2017 fiscal year. As a result of the $9 billion annual share repurchase program, the effective dividends over the next two years will be $7.03 and $7.46. The effective dividends represent 71 percent and 72 percent of the total dividend, cash flows of $9.71 and $10.50. The favorable economic and macro-economic outlook contributes to a high short-term growth rate of 13.5 percent. The initial rapid rise and steady decline towards the long-term rate of 2.4 percent is behavior indicative of the H-DD model. The discount rate varies from 5.36 percent to 6.84 percent due to Beta ranges of 0.7 to 1.1, with the concentration around 1.00. Using a discount rate of 6.64 percent, from a Beta of 0.97, the 13.5 percent short-term growth rate leveling off over 6 years, and the share repurchase values above the intrinsic value ranges from $75.74 to $172.36. The price volatility is driven mainly by changes in the long-term growth rate. The change in short-term sales drivers has less of an impact on the intrinsic value compared to the long-term growth rate change. The best valuation, using a proprietary model with the short-term 13.5 percent growth rate decreasing over 6 years to the 2.4 percent long-term rate, results in a value of $95.77, well below the current market price of $122.74. Although the P/E valuation returned a value of $127.93, indicating the market price can appreciate more, the closeness of those values supports the argument that the market price is near its high. Management has implemented numerous initiatives to cut costs and generate sales. There is no evidence to support that these actions have impacted the bottom line. Positive macro-economic factors and a two year, $18 billion share repurchase program are the main contributors to the market price. Home Depot’s increased EPS is attributable to the share repurchase program reducing the number of shares in the market and not by increasing its earnings at the same rate of the stock market value. This inflated EPS value is used in the P/E model and, therefore, I am skeptical of its undervalued result. Despite the short-term advantages from a positive economic outlook and large share repurchase program, ineffective cost cutting and sales growth initiatives implemented by management fail to create true, bottom line growth. The current market price is overvalued compared to the intrinsic value of $95.77, and should not be bought. Valuation Summary Summary
  • 4. Appendix Discount Rate Yahoo 6.83% FactSet 6.64% Fidelity 5.36% Beta process 1- yr T bill 0.0204 S&P 1 yr 6.78% Beta 1.01 Yahoo Beta 0.97 90 day beta Beta 0.7 Fidelity Effective Dividend 2016 2017 7.03$ 7.46$ * cost of shares repurchased / shares O/S at begin of yr Repurchase program Amount $18 B Duration 2017 S/OS 1.28 B * Home Depot website, 2015 10K P/E Model 1 2 3 4 5 5 d1 d2 d3 d4 d5 P5 $9.71 10.50 3.45 3.72 3.93 139.31 9.11 9.23 2.85 2.88 2.85 101.02 127.93 H-DDM 1 2 3 4 5 5 d1 d2 d3 d4 d5 P5 $9.71 10.50 3.45 3.72 3.93 94.95 9.11 9.23 2.85 2.88 2.85 68.85 95.77 ks 95.77$ 5.36% 6.64% 6.83% 1.00% 97.81$ 77.95$ 75.74$ glong 2.40% 132.44$ 95.77$ 92.12$ 3.20% 172.36$ 112.44$ 107.14$

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