Post of the Day
September 16, 1998

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Subject: HD Too Good?
Author: Jeifri19

Home Depot (HD) fiscal 97 reported total sales of $24,155,746,000. Their weighted average weekly sales per store were $829,000. They had 624 stores opened as of February 1, 1998. To arrive at their estimated sales for the month of January 1998 (the last month of their fiscal year) I multiplied $829,000 times 4.3 weeks in the month, times 624 stores = $2,224,372,800 sales per month weighted average. I multiply this by 12 months in the year to annualize sales at $26,692,473,600. The U.S Department of Commerce estimates shows that about 6.2 sales for a year take place in January. $26,692,473,600 times 6.2% equals $1,654,933,000 for the estimated sales for the month of January 1998.

HD cost of goods was 71.9%. If you take January sales times 71.9% you get a dollar cost of goods of $1,189,897,000. This is the estimated cost of the goods sold for the month January 1998. A reasonable assumption would be that HD would have at least bought an equal amount of goods to replace those sold in January not taking in account a build up of inventory for the upcoming spring. And also, that they would buy those goods with terms of 30 to 60 days. One may argue that HD possibly reduces their inventory for year-end to save on inventory cost. Through my investigation this is not true. Due to the size of HD, cycle counts are taken throughout the year.

Accounts payable on the balance sheet would include the amounts owed on inventory purchased. In addition it would include office supplies, maintenance supplies, certain non-reoccurring services, and other non-accrued expenses for both in store and the support center. HD reported year-end accounts payable to be $1,358,000,000.

  "What I find disturbing is this. I believe the reported accounts payable figure is too low and under reported."

What I find disturbing is this. I believe the reported accounts payable figure is too low and under reported. The reported figure is only about 114% of the $1,189,897,000. Needed to just replace the goods sold for the month or roughly just 35.3days (114% x 31 days) worth of purchases. These figures do not include other payables as mentioned above. In comparison, Lowes (LOW) shows sales of $685,742,500. , cost of goods 73% ($500,592,025.), and accounts payable of $969,777,000. This calculates to 42.5 days worth of purchases using the same formula.

My findings below appear to confirm;

1. Inventory per store averages about $5.8 million per store. HD annual report states that $2.2 million of a new store inventory is vendor financed. HD opened 112 new stores. Vendor financing on new stores alone would equal an estimated $246 million. The report states and I quote, "Additionally, a significant portion of the Company's inventory is vendor financed under vendor credit terms."

2. Dun & Bradstreet report shows that out of 367 accounts, 69% are paid within terms but 31% are not paid within terms. The D&B reports this;

"CREDIT SCORING The Commercial Credit Score predicts the likelihood of a firm paying in a delinquent manner (90 + Days Past Terms) during the next 12 months, based on the information in Dun & Bradstreet's file. The score was calculated using statistically valid models derived from D&B's extensive data files.


CREDIT SCORE PERCENTILE: 10 (Highest Risk: 1; Lowest Risk: 100)

The Credit Score Percentile above means this firm scores the same as or better than 10 percent of the businesses currently available in D&B's Information Base."

According to the above, 90% of the businesses in D&B's data files have a better "Credit Score" than HD.

3. Industry vendors tell me that HD is one of the hardest negotiators for not only price but also terms. We know in this industry that extended dating (vendor approved delayed billing) is common. We know that common terms for this industry is 30 and 60 days and dating can be as long as an year. HD accounts payable figure does not appear to have any indication that any deferred payments are taken.

4. HD peers in the retail do not seem to share the same "low payables". I calculated a ratio for comparison. Total annual sales divided by accounts payable equals "Accounts Payable Ratio". As Peter Lynch mentions in his book, a high payable dollar figure is good because it shows that management is getting the best use of the funds flowing through their business. It should also be noted that growing business should have an advantage using this ratio because of the ever-expanding base of the annual sales figure. A lower ratio would show that a business is holding their funds as long as possible to put this cash to work for them for growth and investment income. I have also included ratios for companies in other industries for comparison;

Lowes          9.41    Eagle Hardware 13.76    HD            17.93
Walmart       13.75    Circuit City   10.63    Sears          5.29
Dell           7.46    GE              7.76    Merck          6.75
Hughes Supply 13.5     Wilmar Ind.    11.4     Camaron Ashley 11.0

  "The evidence seems to show that HD does not have the ability to extend their payables out further. The D&B implies that they have their vendors pushed out as far as they can go and still maintain a good relationship."

On the "Motley Fool" investment Web site they write this;

"We want companies that we invest in to bring money in quickly, but to pay it out slowly. More cash coming in today, less cash going out today. If that makes sense, then let's go to the balance sheet and dig up some relevant entries. The Cash-King investor wants what are called the current liabilities (short-term debts) to run rather high. Those are the bills that have to be paid in the next year, and we'd like the company to be strong enough to hold off those payments as long as possible."

After reviewing the above I think one would have to ask themselves "how do they do it?" and "why?" Certainly HD could use the extra money. If they defer payments enough to knock 5 points off their ratio to 12.93 they could raise nearly $500 million dollars. They wouldn't need the $1 billion dollar, 3 �% Convertible Subordinated Note that is dilutive to earnings and will cause HD to give away equity cheap.

The evidence seems to show that HD does not have the ability to extend their payables out further. The D&B implies that they have their vendors pushed out as far as they can go and still maintain a good relationship. However, their payables ratio says they are paying vendors quicker than any company shown and many others that I sampled. In fact, out of about 30 companies sampled I could not find one that had a better payables ratio. These two factors do not go hand in hand. Something seems to be wrong!

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