11

Financial Statement Financial Statement AnalysisAnalysis

Forecasting Home Forecasting Home Depot’s fourth quarter Depot’s fourth quarter

of 2005 financial of 2005 financial statementsstatements

super freak

2

Overview of business/industry

• World’s largest home improvement retailer and 2nd largest retailer in the U.S.

• Sell assortment of building materials, home improvement and lawn and garden products as well as other services.

• Target individual homeowners, small contractors, and moving into commercial and industrial customers.

3

Industry Outlook (S&P NetAdvantage)

• Our fundamental outlook for the home improvement retail sub-industry is positive.

• In 2005, the S&P Home Improvement Retail Index posted a 1.7% gain, versus a 3.8% increase for the S&P 1500…

• We expect home improvement retailers to report strong fourth-quarter results…

• The rebuilding efforts from Hurricane Katrina bode well for home improvement retailers

• …In addition, should the housing market face a significant slowdown in 2006, we believe remodeling will remain a large focus for consumers…

• The total home improvement products market in the U.S. is expected to grow to $291.3 billion in 2005 from $271.1 billion in 2004, and is projected to grow to $369.9 billion in 2010.

4

Business StrategyKey Success Factors

• Warehouse retailing concept- Low overhead- High turnover- Purchase quantity discounts

• Focus on D-I-Y, D-I-F-M, and Professional markets.• Large merchandise assortment.• Aggressive advertising program (integration into reality show…).

• Strong recent housing market.• Several brands (e.g., Expo and HD Supply Company).• Offer expanded services.

5

Business StrategyKey Risks

• Competition (Lowe’s)!Lowe's bright, airy stores are decorated in a blue-and-white theme more reminiscent of Betty Crocker than Home Depot's earthen brown and orange colors. "Fifty percent of our shoppers are female," says Carson Anderson, a Lowe's spokesman. Lowe's focuses on the female, he says, because 70% of the buying decisions are made by women.

• Reaching end of growth opportunities.• Strategy conflict (cost leader with high level of service).

• Capital constraints.• Burst of the housing market bubble (interest rates have been

increasing, consumers spending on home improvements are declining…).• Sensitive to consumer debt levels, job security concerns

(unemployment), seasonality, weather.• Cannibalizing their own stores.

6

7

Comparing HD, LOW, industryCompany Name

Actual Actual Actual Actual Actual ActualFiscal Year End Date 1/31/2004 1/31/2005 1/31/2004 1/31/2005 1/31/2004 1/31/2005

Annual Growth RatesSales 11.3% 12.8% 16.4% 18.2% 11.7% 12.3%Assets 14.7% 13.0% 18.2% 11.4% 14.6% 15.6%Common Equity 13.2% 7.8% 24.2% 11.9% 13.3% 16.2%Earnings 17.5% 16.2% 27.6% 15.9% 24.4% 21.3%Free Cash Flow to Investors -10.9% 47.6% 3.2% 1955.8% #N/A -7.8%Sustainable Growth Rate 17.6% 18.4% 19.2% 18.9% 16.9% 17.8%

ProfitabilityReturn on Equity 0.204 0.215 0.202 0.199 0.190 0.200Return on Equity (b4 non-recurring) 0.202 0.213 0.199 0.198 0.189 0.197Return on Net Operating Assets 0.193 0.201 0.153 0.157 0.163 0.175

Basic Dupont Model Net Profit Margin 0.066 0.068 0.061 0.060 0.059 0.064x Total Asset Turnover 2.011 1.993 1.755 1.812 1.970 1.922x Total Leverage 1.527 1.575 1.889 1.843 1.635 1.639= Return on Equity 0.204 0.215 0.202 0.199 0.190 0.200

Advanced Dupont Model Net Operating Margin 0.067 0.069 0.065 0.063 0.061 0.065x Net Operating Asset Turnover 2.887 2.919 2.356 2.490 2.677 2.680= Return on Net Operating Assets 0.193 0.201 0.153 0.157 0.163 0.175Net Borrowing Cost (NBC) 0.029 0.025 0.032 0.032 0.031 0.033Spread (RNOA - NBC) 0.164 0.176 0.121 0.125 0.132 0.142Financial Leverage (LEV) 0.064 0.076 0.407 0.341 0.204 0.176ROE = RNOA + LEV*Spread 0.204 0.215 0.202 0.199 0.190 0.200

HOME DEPOT INC LOWE'S CO INC Home Improvement Stores (from Data center)

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Comparing HD, LOW, industry (cont.)

Margin AnalysisGross Margin 0.334 0.352 0.312 0.338 0.327 0.347EBITDA Margin 0.122 0.126 0.128 0.127 0.123 0.126EBIT Margin 0.106 0.108 0.103 0.102 0.104 0.106Net Operating Margin (b4 non-rec.) 0.066 0.069 0.064 0.063 0.065 0.066Net Operating Margin 0.067 0.069 0.065 0.063 0.066 0.067

Turnover AnalysisNet Operating Asset Turnover 2.887 2.919 2.356 2.490 2.677 2.757Net Working Capital Turnover 15.877 18.377 13.813 17.035 14.192 16.498Avge Days to Collect Receivables 6.107 6.482 1.793 0.701 5.648 5.623Avge Inventory Holding Period 73.634 73.825 73.592 79.857 73.798 75.680Avge Days to Pay Payables 41.811 43.021 38.189 40.537 40.410 41.889PP&E Turnover 3.482 3.416 2.766 2.821 3.261 3.258

Analysis of Leverage -Long-Term Capital StructureDebt to Equity Ratio 0.061 0.089 0.364 0.320 0.159 0.166FFO to Total Debt 4.577 3.843 0.754 0.888 1.710 1.803CFO to Total Debt 4.724 3.800 0.799 0.807 1.767 1.710

Analysis of Leverage - Short-Term LiquidityCurrent Ratio 1.395 1.348 1.531 1.219 1.476 1.347Quick Ratio 0.413 0.348 0.402 0.144 0.433 0.303EBIT Interest Coverage 110.419 113.229 16.297 19.333 37.527 42.626EBITDA Interest Coverage 127.774 132.071 20.303 24.125 44.532 50.800

Company Name

Actual Actual Actual Actual Actual ActualFiscal Year End Date 1/31/2004 1/31/2005 1/31/2004 1/31/2005 1/31/2004 1/31/2005

HOME DEPOT INC LOWE'S CO INC Home Improvement Stores (from Data center)

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What are your forecasted Sales, Net Income and EPS?

Collect forecasts

Home Depot Q4 2005

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What’s my forecast?First, let’s get some relevant information from

Q3 2005 10Q (November 15, 2005)

• The Home Depot Announces Record Third Quarter 2005 Results

• Lifts fiscal 2005 sales and earnings per share growth guidance Fiscal 2005 sales growth guidance 10-12 percent, earnings per share growth guidance 17-18 percent - Record Third Quarter Sales of $20.7 billion - Record Third Quarter Operating Margin of 11.9 percent - Record Third Quarter Net Earnings of $1.5 billion - Record Average Ticket of $58.92

• Sales for the period increased $2.0 billion, or 10.5 percent, to $20.7 billion. Growth in comparable store sales was 3.6 percent.

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What did you learn from “The Home Depot Investor and Analyst Conference” held on

January 13, 2005 ?http://ir.homedepot.com/releases.cfm

ATLANTA, Jan 19, 2006 : (Carol Tome, CFO)- Sales growth of 10% to 12% (80.4 to 81.9 billion)

- comps of 3.3% - Gross margin “above” 33.4% (ytd through Oct)- total expenses between 21.6% and 22.6% (depr+sga)- EPS at “high end” of 2.64-2.67 for year- inventory to grow 11%- SCF: 8.2B CFO, 1B Debt Issuance, 4B capX, 2.6BM&A, 3B stk

repurchase, .9B dividend, leaving .9B in cash at end of year (vs 2.2 in 2004)

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Seasonal Sales EffectsHD Quarterly Sales Per Store

Sales/average number of stores

$7,000

$8,000

$9,000

$10,000

$11,000

$12,000

$13,000

$14,000

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Home DepotStep 1: Forecasting sales growth

A Naïve forecast:Sales = (avg weekly sales per store (10Q, Q3) x13 weeks x #stores)

Sales = $765,000 x 13 x (2043+1972)/2 = $19,965 mil

However, there are other relevant factors:- Sales are seasonal!

- HD is growing, so need to factor in new stores.

- Separate between (1) same-store or comp sales growth, (2) new store sales growth (Same stores are those that were in operation for the entire quarter in both qtrs!)

- What else? (cold weather, disruptive renovations, 14 week quarters)

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computing annual comparable store sales growth

10

15 16

10

5

4 3

10

5

4

3 2

1 2 3 4 5

close 3

new

newnew

new

new

mid

midmid

mid

oldold

old

Comparable store sales growth is the growth in sales from stores that have been open for two full years (and are currently still open).

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Computing Quarterly Comparable Store Sales

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

fiscal 2004 fiscal 2005

2.1 4.0 3.6 3.3

??

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past seasonal comp growth

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

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Use Seasonal variation on simple %’s model:

Sales Growth %

= (1+growth % in stores)(1+ comp growth) -1

how many new stores were opened between 2004 Q4 and 2005 Q4?

seasonal growth in average # stores: 2043/1890 -1 = 8.1% growth.

I used forecasted Q4 comps of 3.3% (webcast)

(1+.081)(1+.033) – 1 = 11.67% seasonal growth

16812 Q4 2004 sales X (1.1167) = $18,773M

Sales Estimate – option 2

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Sales Estimate – Option 3(trust management forecast)

Options 3:Annual sales fiscal 2003, per HD's guidance 81,150Sales for Q123 62,022

Sales for Q4 19,128

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Next, forecasting CGS and SG&A:Are they also seasonal?

29.5% 29.6%29.9% 30.0%

29.7%30.2%

30.5% 30.4%

31.6%32.0%

31.2% 31.3%

32.9%33.4%33.3% 33.5%

31.9%

30.8% 30.8%

32.0%

32.7%

34.2%33.6%

33.2%

20.3%

18.6%

20.8%

21.5%

19.2%

20.7%21.0%

18.9%

21.3%

22.4%

19.7%20.3%

22.9%

21.1%

22.4%23.0%

20.5%

21.6%21.9%

23.8%

22.5%

23.7%

22.8%

24.3%

15%

17%

19%

21%

23%

25%

27%

29%

31%

33%

35%

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Gross Margin SG&A / Sales

20

Gross Margin and SGA Estimate

“33.4% or above”

GM=% (Q3 this year of 33.6) x 34.2%/33.3% = 34.5% go with 34%

between 21.6 and 22.6 annual (depr is included in sga in eVal data). Using 18,773,000 Q4 sales and past SGA rates, implies 24.1%

SGA = (Q3 this year of 21.6) x (24.3/22.4) = 23.4%go with 24%

21

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So, my forecasted Sales and EPS are…

Sales = $ 19,000,000

Net income = $1,216,679 • shrs outstdg Q3 = 2124M, less 5M repo

EPS = NI/2,122 = 0.57/per share

02/21/06 - 9:00 AM ETHome Depot Inc. 4th Quarter 2005 Earnings Conference Call

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What are the analysts predicting? http://biz.yahoo.com/z/a/h/hd.html

http://www.earningswhispers.com/stocks.asp?symbol=HD

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HD Earnings Surprise HistoryHOME DEPOT INC

Actual Mean Surprise

Quarter EPS Forecast Amount

Oct-05 0.73 0.68 0.05

Jul-05 0.82 0.79 0.03

Apr-05 0.57 0.55 0.02

Jan-05 0.47 0.47 0.00

10/2004 0.60 0.57 0.03

7/2004 0.70 0.64 0.06

4/2004 0.49 0.43 0.06

1/2004 0.42 0.39 0.03

10/2003 0.50 0.46 0.047/2003 0.56 0.54 0.024/2003 0.39 0.37 0.021/2003 0.30 0.27 0.03

10/2002 0.40 0.40 0.007/2002 0.50 0.47 0.034/2002 0.36 0.33 0.031/2002 0.30 0.28 0.02

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Common behavior of quarterly earnings

• Seasonal random walkEt = Et-4 + t, where t is zero, on average

• Seasonal autoregressive model

Et = Et-4 + .34(Et-1 – Et-5) + t

Et+1 = Et-3 + .19(Et-1 – Et-5) + t

Et+2 = Et-2 + .06(Et-1 – Et-5) + t

Et+3 = Et-1 - .24(Et-1 – Et-5) + t

Positive surprise

Positive surprise

Positive surprise

Negative surprise

26Abarbanell and Bernard, Journal of Finance 1992

Stevie Wonder – Sir Duke