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Alti Asri Ladiba Disan 00000004347
Carrina Chittra 00000002182
Ignatius Mario 1305000977
Irka Dewi Tanemaru 00000000670
Iswandi 1305000510
Nikolas Sulistio 1305002790


Value Line Publishing, October 2002

Carria Galeotafiore, an analyst of Value Line, at July 2002 mentioned that this case is about the
competition between two major players in the industry, which are Home Depot and Lowes. Recently,
they have been operating in more of the same markets, which are seeking new ways to boost both their
top and bottom lines, such as bettering customer service, attracting professional customers, and creating a
more favorable merchandise mix.
The Retail Building-Supply Industry
Economist Intelligence Unit (EIU) estimated the size of the 2001 U.S. retail building-supply industry at
$175 billion. The size of this industry is relatively growing strong, with low interest rates and a robust
housing-construction market provided ongoing strength to the industry. EIU expected the industry to
reach $194 billion by 2006. The industry itself was dominated by two companies, which are Home Depot
and Lowes, which has total industry sales over a third. These two companies are fierce competitors
whose strategies are rapid-expansion with the opening of 1.136 new stores.
Future Growth Opportunities for Home Depot and Lowes
Galeotafiore expected that future growth for Home Depot and Lowes would come from a variety of
sources, such as: acquisition/consolidation, approaching professional market with Pro Stores, having
international expansion, alternative retail formats (to target customers with certain hobbies such as
gardening, woodworking, or other creative ideas), providing alternative products (having installation
services), and head-to-head competition (by having promotions and aggressive everyday pricing).
Financial Forecast for Home Depot and Lowes
Home Depots new CEO, Bob Nardelli enhances store efficiency and inventory turnover through ongoing
system investments with hope of generating margin improvement through cost declines from product
reviews, purchasing improvements, and an increase in the number of tool-rental centers. Home Depot
management expected revenue to grow at 15-18% through 2004, some by acquisition, whih necessitated
the companys maintaining higher cash levels. Home Depot stock was trading at around $25 per share,
which means a total equity capitalization of $59 billion.
Galeotafiores July report about the changes at Home Depot shows that the service performance
improvement program is still at the early stages, but it received positive feedback from customers. The
Pro-Initiative program currently in place at 55% of Home Depots stores, aiming to provide services that
accommodate pro customers. Home Depot shares offer compelling price-appreciation potential over the
coming 3-to-5-year pull.
Dan Wewer and Lisa Estabrooks, another analyst seem to have interest for Home Depot, and
comes to a conclusion that Home Depots comp sales fell short of plan despite a step-up in promotional
activity. They viewed that this legimitizes their concerns that Home Depot is seeing diminishing returns
from promotional efforts. Lowes is the most attractive investment opportunity in hard-line retailing.
Highlights include superior relative EPS momentum, robust comp sales, expanding operating margin,
improving capital efficiency, and impressive new-store productivity. Lowes outstanding performance
raises the hurdle Home Depot must reach to return to favor with the investment community.
Lowes management had told analysts that it expected to maintain sales growth of 18-19% over
the next two years. Lowes planned to open 123 new stores in 2002, and 130 in 2003, then 140 in 2004
(focusing on cities with populations greater than 500,000). Lowes planned to improve sales and margins
through new merchandising, pricing strategies, and market-share gains, especially in the Northeast and
West. Lowes stock was trading at $37 per share, means a total equity capitalization of $29 billion.
Jefferies analyst, Donald Trott, recently downgraded Lowes based on a forecast of a deflating housing-
market bubble and a view that the companys stock price was richly priced relative ro Home Depots.
While Galeotafiore said that Lowes could compete effectively with Home Depot, since Lowes valuation
had an expectation of ongoing improvement in sales and gross margins.
Lowes is achieving greater market share in the appliance category, and its transition into major
metropolitan areas is yielding solid results. With the positive sales trends, the homebuilding suppliers
bottom line is also being boosted by margin expansion, bolstered, in part, by power inventory costs and
product-mix improvements. Lastly, Galeotafiores financial forecast for Home Depot and Lowes are
based on her forecasts on a review of historical performance, an analysis on trends and ongoing changes
in the industry and the macroeconomy, and a detailed understanding of corporate strategy. She estimated
the cost of capital for Home Depot and Lowes to be 12.3% and 11.6%

1. What do the financial ratios in case Exhibit 7 tell you about the operating performance of Home
Depot? What additional information do the different ratios provide? Complete and compare a
similar analysis for Lowes.


Growth rates capture the year-on-year percentage change in a particular line item. The
revenue growth for Home Depot is due to an increase in number of existing stores, new
stores, and square footage per store. So the growth rates help us to see the development of
both companes from their sales growth that is calculated based on new and existing stores
growth. So we can say that in this case, the calculation of growth is using the unit stores

Margin ratios capture the percentage of revenue accounted for by profit or, alternatively, the percentage of
revenue not consumed by business costs. The margin also measures the cost structure of business. How to
measure margins is we used what we want to measure divided with sales or total revenue. For example, if
you want to measure Gross margin, the formula is Gross margin = Gross profit/Sales. From this ratio we
can calculate the cost that is used to get profit. We calculate how much cash spent to receive revenue. So
we get the ratio to calculate the margin through profit / sales.

Turnover ratios measure the productivity, or efficiency, of business assets. The turnover ratio is
constructed by dividing a related measure of volume from the income statement by a measure of
investment from the balance sheet. This ratio calculates how fast the turnover of units.

Return on investment captures the profit generated per dollar of investment. This ratio measures how fast
the investment we used makes profit. So usually investors use this ratio to know how long they might be
receiving profit from their investments.

Leverage measure how much total capital is provided by equity. This ratio measures whether the company
is using more from its own capital or capital from investors (like stocks).

Financial Ratio Analysis Comparison between Home Depot and Lowes.

As we can see the result of the calculation, we can say that receivable turnover for Lowe is higher
than Home Depot. It means Lowes credit sales are more likely to be collected than Home Depot. For
the growth of both companies, Home Depot was increasing in 1998-1999, but slowly decreasing from
2000-2001. From the leverage ratio, we can see that Lowe had the higher ratio than Home Depot, it
means Lowes capital is much more come from debt than Home Depots capital. From the margins,
Home Depot is higher than Lowe except for depreciation/sales and depreciation/P&E. It means that it
has higher profitability from the sales and Home Depot was efficient because Home Depot sales was
lower than Lowes, but it nevertheless it had a higher profit. The profitability tells that Home Depots
performance is better than Lowes, and it tells us that how fast investment generates the capital.

From ratio analysis that has been done, we can say that Lowes gave smaller accounts receivable
than Home Depot and thats why the receivable turnover for Lowes is bigger than Home Depot.
Lowes held cash more than Home Depot as the result of its receivable turnover. If the economic is
declining, the declines of Lowes will not as much as Home Depots, even though Lowes growth not
as high as Home Depots either.

Investors surely will be more interested in Home Depots, looking at its return on investment, but
like the phrase always said, high risk high return. Receivable turnover for Lowes is bigger than
Home Depot so the refund of receivables will be faster at Lowes than Home Depot, this why we
think it will be more safe for investors to invest in Lowes. The long period in return of receivables
will make greater chance for credit default. Besides, we consider that Lowes is better for investors
than Home Depot because it has stable growth.
Table. Ratio Analysis for Lowes

Fiscal year
1997 1998 1999 2000 2001
Working capital (CA-NIBCL*) 771.537 1011.833 1459.585 1538.598 2062.821
Fixed assets 3109.675 3758.968 5319.167 7200.741 8815.827
Total capital 3881.212 4770.801 6778.752 8739.339 10878.648
Tax rate 0.359975 0.3639134 0.3671562 0.3679992 0.3697822
NOPAT (EBIT*(1-t)) 399.4485 529.9599 741.91244 886.23248 1132.9978

Return on capital (NOPAT/Total capital) 10.29% 11.11% 10.94% 10.14% 10.41%
Return on equity (Net earnings/S. Equity) 13.75% 15.38% 14.33% 14.74% 15.35%

Gross margin (Gross profit/Sales) 26.53% 26.91% 27.54% 28.17% 28.80%
Cash operating expenses/Sales 18.00% 17.88% 18.05% 18.53% 18.25%
Depreciation/Sales 2.38% 2.22% 2.12% 2.18% 2.42%
Depreciation/P&E 8.02% 7.48% 6.53% 5.82% 6.17%
Operating margin (EBIT/Sales) 6.16% 6.80% 7.37% 7.47% 8.13%
NOPAT margin (NOPAT/Sales) 3.94% 4.33% 4.66% 4.72% 5.12%

Total capital turnover (Sales/Total capital) 2.61 2.57 2.35 2.15 2.03
P&E turnover (Sales/P&E) 3.37 3.37 3.07 2.67 2.56
Working capital turnover (Sales/WC) 13.14 12.10 10.90 12.20 10.72
Receivable turnover (Sales/AR) 85.61 85.08 107.54 116.65 133.54
Inventory turnover (COGS/M. inventory) 4.34 4.25 4.10 4.11 4.36
Sales per store ($ millions) 21.25 23.55 27.61 28.89 29.72
Sales per sq foot ($) 254.31 256.20 279.14 277.08 273.98
Sales per transaction ($) 43.88 45.65 53.16 54.88 55.96

Total sales growth 20.80% 29.90% 18.06% 17.75%
Sales growth for existing stores 10.81% 17.27% 4.62% 2.87%
Growth in new stores 9.01% 10.77% 12.85% 14.46%
Growth in sq footage per store 9.99% 7.63% 5.40% 4.03%

Total Capital/Equity 1.492 1.521 1.444 1.590 1.630

2. a). How sensitive is return on capital to the forecast assumptions in case Exhibit 8? b). What
independent changes in Carrie Galeotafiores estimates are required to drive the 2002 return-on-
capital estimate below Home Depots cost-of-capital estimate of 12.3%? Look specifically at gross
margin, cash operating expenses, receivable turnover, inventory turnover, and P&E turnover. c). What
effect does sales growth have on return on capital? Explain your findings.
a) Return on capital consists on so many items in financial forecast that are:

Cash Operating Expense

Depreciation & Amortization

Net Sales

Cost of Sales

Working Capital


Other Assets

So we can say that return on capital is quite sensitive because with the change of the items
above, the return on capital will change too. When total operating expenses increase,
NOPAT will decrease and it will make ROC decrease too. If COGS increase then ROC
also decrease because the cost is greater than the income. Inventory turnover can also be a
factor that will affect ROC because when inventory turnover decrease then ROC will also

b) Independent changes in Carrie Galeotafiores estimates are required to drive the 2002 return-
on-capital estimate below Home Depots cost-of-capital estimate of 12.3% are taxes, interest
in current asset and current liablities, depreciation, sales.

c) We can get Return on Capital by dividing NOPAT to Total Capital.


EBIT = Gross Profit Cash Operating Expense Depreciation & Amortization.

Gross Profit = Net sales Cost of sales.

Total Capital = Working Capital + P&E + Other Assets

So we can get the conclusion that Sales growth will increase the percentage in Return on
3. Do you agree with Galeotafiores forecast for Home Depot? How would you adjust it?

Not entirely, because there are several values in forecasted ratio that should be affecting one
another, that Galeotafiore didnt consider it well. In order to do the adjustments, we are using the
available information from companys historical financial relationship, macroeconomy condition,
industry, and corporate strategy.

Historical Financial Report

Table Historical Financial Data: Home Depot from 1998 2001

1998 1999 2000 2001 Linear Regression
Total Sales Growth 25.1% 27.2% 19% 17.1% Y = 29.85 3.04X
Sales growth for existing stores 2.6% 4.1% -2.4% -0.4% Y= 4.85 1.55X
Growth in new stores 22.0% 22.2% 21.9% 17.5% Y = 24.35 - 1.38X
Growth in sq foot per store 0.6% 1.0% 0.9% 1.0% Y = 0.6 + 0.11X
Using historical data, we conduct linear regression to see the trend from the past 4 years, with the
function of y = a +bx, we can use the calculation as one of the input in determining the value of
growth. The table below shown the value of regression (blue) and Galeotafiores forecast (red) on
Table Comparison with Regression & Galeotafiore Forecast
2002E 2003E 2004E 2005E 2006E
Growth in new stores
Regression 17,5% 16,1% 14,7% 13,3% 11,9%
Galeotafiore 15,0% 9,0% 9,0% 7,0% 5,5%
Average 16,2% 12,5% 11,8% 10,2% 8,7%

Sales growth for existing stores

Regression -2,9% -4,5% -6,0% -7,6% -9,1%
Galeotafiore 3,0% 4,0% 8,3% 8,3% 8,3%

Total sales growth

Regression 14,7% 11,6% 8,6% 5,5% 2,5%
Galeotafiore 18,0% 17,2% 17,3% 15,3% 13,8%
Average 16,3% 14,4% 12,9% 10,4% 8,2%

Despite of the calculation above, we also consider the other informations that nearly describe the
current condition and corporate strategy in doing their business. Here are the information we gather
from the case.
Macroeconomy, Industry, and Corporate Strategy


A. Economic condition in 2002

i. Slow but positive economic growth
ii. Low interest rates
iii. Strong housing market
iv. Rising unemployment
v. Uncertain consumer confidence
vi. Concern over corporate misdeeds
B. Company
i. Planning on 20011 there will be 11 new stores in international market.
ii. Acquisition in Mexico by US$ 12.5 billion.
iii. The total store in international market is 10%.
iv. Home Depot open in densely populated markets.
v. Expansion in its productline and make another acquisition.
vi. Product line: At-home grow at annual rate of 30%.
vii. Competitor such as Lowe, starts to do head-to-head competition in metropolitan area.
C. Forecasting
i. CEO intent to focus on enhancing store efficiency and inventory turnover.
ii. Margin improvement through cost decline from R&D (product review, purchasing,
improvement tools rental center, etc.)
iii. Operating cost or overhead cost increase due to higher occupancy for new stores and
energy cost.
iv. Revenue growth about 15% - 18% through 2004 by acquisition and maintaining higher
cash levels
D. Expert Opinion
i. Galeotafiore argues that Home Depot is still in early stages in at-home product lines but
seems promising in capital gain over 3-5 year.
ii. Estrabooks believes that there is diminshing return through promotional efforts, since the
corporate strategy tends to open many new stores.

We can conclude from all the informations above, the main focus of Home Depot is to increasing the
margin expansion and cutting the cost, in order to improve store efficiency and inventory turnover.
Therefore, we use the financial ratios as the focus of our adjustments.
- Gross Margin
- Inventory Turnover
- P&E Turnover.
Before we determine the key ratios, we have to see the potential growth for the next 5 years (2002-2006).
Determining sales growth:
- From the market sales in the industry forecast, (1997 2006) the annual growth from the sales
keep declining from 7,7%, 6,8%, 5,2%, 3,7%, and 2,3%. This event cause the relatively small
growth in terms of sales growth for existing stores. Eventhough the industry annual growht shows
lack of improvement, from the historical data of sales (1997-2001) the annual growth are 25%,
27%, 19%, and 17% respectively. With the market share of 22, 09% the sales from Home Depot
still dominating.
- The use of online shopping helps to increase the accesibility from any stores to improve the sales.
- To improve the gross margin, we have to increase the sales. We use the average calculation,
combine the regressin and Galeotafiore forecast, but in the year 2005 and 2006 as the impact of
online shopping, help to maintain the growth stable.
- Home Depot expected revenue growth to be 15% to 18% through 2004. Some of it be by
Determining gross margin:
- Gross margin is proportional to the changes in sales. Thus, we get the decrease in sales impact
decrease in gross margin.
- The international market, can cause the risk of currency exchange. In fortunate condition the
company can benefit from the strong current currency over the foreign currency. But in
unfortunate condition can reduce the gross profit of the company.
Determining Inventory Turnover (COGS /Inventory)
- The corporate strategy is to increase the store efficiency, due to addition of product lines and
focusing cost on overhead cost.
- The methods of selling demand Home Depot to give the best effort in availability and delivering
the package. So, the reliability and speed are challenged and Home Depot should be able to keep
up with the competitor as a respond to head-to-head competition in metropolitan area.
- The online shopping also act as a 24/7 open store and demand can happen in anytime. Inventory
turnover can be roll even faster than the traditional store does.
Determining P&E Turnover (Sales / P&E)
- The property and equipment cannot be remain stable, due to growth in sales and increase in the
number of new stores. Thus, the P&E turnover can be varied through time to time.
The decrease in sales impacts the increase in PE turnover.
The summary of the key ratios adjustments:
Table Summary of Key Ratios Adjustments
Assumptions Fiscal year
2001 2002E 2003E 2004E 2005E 2006E
Total sales growth 17.1% 17.3% 17.8% 18.0% 17.4% 17.8%
Gross margin 31.6% 32.0% 32.2% 32.3% 31.7% 31.8%
Inventory Turnover 5.4 5.0 4.8 4.8 4.5 4.0
P&E Turnover 3.5 3.8 4.0 4.2 4.6 4.8
Return on Capital 15.2% 16.6% 17.8% 18.4% 18.3% 18.0%
4. How would your forecast assumptions differ for Lowes? Complete and recommend a five-year
Lowes forecast to Galeotafiore.
Percentage change growth in new stores for Lowes is expected to increase from the yesteryears
because the company wanted to open 123 stores in 2002, 130 stores in 2003, 140 stores in 2004, and
continue to emphasis on cities with populations greater than 500,000 like NY, Boston and Los
Angeles. For 2005-2006 and other forecasts, we will use nave forecasting and considerate the other
factors that might influence the forecasts (like macroeconomy, ratio, and consideration from the other
analyst). We choose nave forecast because it is the most cost-effective forecasting model, and provide
a benchmark against which more sophisticated models can be compared. Using the nave approach,
forecasts are produced that are equal to the last observed value. This method works quite well for
economic and financial time series, which often have patterns that are difficult to reliably and
accurately predict.
Table . Financial Forecast for Lowes
Fiscal year
ASSUMPTIONS 2001 2002E 2003E 2004E 2005E 2006E
Growth in new stores 14.5% 16.5% 15.0% 14.0% 11.3% 4.3%
Sales growth for existing stores 16.2% 5.8% 4.2% 3.4% 2.9% 2.5%
Total sales growth 30.6% 22.3% 19.2% 17.4% 14.2% 6.8%

Gross margin 28.80% 29.54% 29.85% 30.08% 30.28% 30.46%

Cash operating expenses/Sales 18.25% 19.77% 20.27% 20.62% 20.89% 21.11%
Depreciation/Sales 2.42% 2.45% 2.46% 2.47% 2.47% 2.48%
Income tax rate 38.6% 37.6% 37.5% 37.5% 37.5% 37.5%

Cash & ST Inv/Sales 3.9% 4.5% 4.7% 4.7% 4.9% 5.1%

Receivable turnover 133.2 140.6 146.3 153.6 159.1 160.7
Inventory turnover 4.36 4.35 4.53 4.47 4.55 4.51
P&E Turnover 2.555 2.464 4.310 4.505 5.713 5.136
Payables/COGS 10.89% 10.11% 9.92% 9.89% 9.86% 10.03%
Other curr liab/Sales 4.17% 4.20% 4.57% 4.86% 5.06% 5.20%

Number of stores 744 867 997 1,137 1,266 1,320
Net sales 22,111 26,019 27,638 28,880 29,927 30,850
Cost of sales 15,743 18,448 20,429 21,792 22,876 23,299
Gross profit 6,368 7,571 7,209 7,088 7,051 7,551
Cash operating expenses 4,036 4,760 5,009 4,867 5,185 5,245
Depreciation & amortization 534 500 411 346 211 175
EBIT 1,798 2,311 1,789 1,875 1,655 2,131
NOPAT 1,104 1,442 1,118 1,172 1,034 1,332

Cash and ST investments 853 1,183 1,319 1,424 1,590 1,725

Accounts receivable 166 185 192 199 204 212
Merchandise inventory 3,611 4,245 4,508 4,880 5,030 5,166
Other current assets 291 367 399 423 444 463
Total current assets 4,921 5,980 6,418 6,926 7,268 7,566
Accounts payable 1,715 1,865 2,026 2,156 2,255 2,338
Accrued salaries and wages 221 272 294 310 324 336
Other current liabilities 922 1,092 1,263 1,405 1,513 1,605
Current liabilities 2,858 3,229 3,583 3,871 4,092 4,279
Working capital 2062.821 2,422 2,781 2,873 2,222 2,870
Net property and equipment 8,653 10,558 6,517 6,784 5,682 6,632
Other assets 162 185 194 202 208 213
Total capital 10,878 13,165 9,492 9,859 8,112 9,715
Return on capital 10.15% 10.95% 11.78% 11.89% 12.75% 13.71%
After growth in new stores, we forecast other items in financial forecast using with forecast package
that is nave forecasting. There are some number we choose by ourselves instead of following the
output of , because some of them might not fit the situation.
Our forecast assumptions for Lowes is based on the Lowes managements plans to expand their stores
on some countries too. Thats why we believe that Lowes will do better on the next years to come. As
number of stores increases, the sales will increase too, so does the NOPAT and resulting the increasing
return on capital.

Analysis & Recommendation

Now we want to compare between two largest companies in retail-building-supply industry, Home Depot
and Lowes. We see that the main question in here is comparing between Home Depot and Lowes about
how their performances in years ahead. Galeotafiore used the historical data to forecast the financial
report of Home Depot and she was very optimist that Home Depot will be doing great in the next years to
come. We are given task to do the forecasting for the other company, that is Lowes. We use different
approach from Galeotafiores (see in Questions). So our analysis will focus more on whats the best
approach to forecast the performance between Home Depot and Lowes.