Value Line Publishing, October 2002 Essay Example

the discounted cash flow method.The P/E method was the most accurate in the comparables valuations method for pricing Home Depot's stock. Assuming modest growth rates and a beta slightly above the market's beta, the stock is slightly overvalued. The Home Depot, Inc. is the largest home improvement retailer globally and the second-largest retailer in the United States. The company's focus on sales, service, and execution distinguishes it as an industry leader. Home Depot reported an 11.3% sales growth in fiscal year 2003 with revenues of $64.8 billion, up from $58.2 billion in 2002. Implementing a growth strategy of strengthening core competencies through store modernization, offering unique merchandise, providing high-quality service associates, and expert information technology sets Home Depot apart from industry competitors. Subsidiaries offer specialized services to individual homeowners and professional customers. Home Depot's competitive advantage lies in tight cost control and providing premium value to customers through merchandise selection and expert service. Currently, Home Depot operates 1,778 stores in the United States, Canada, and Mexico.Home Depot operates in a fiercely competitive industry that is based on price, store location, customer service, and depth of merchandise. The company estimates its share of the US home improvement industry at around 11%, while globally the sector is worth approximately $900 billion, presenting significant growth opportunities. In fiscal 2003, Home Depot experienced a 3.8% increase in comparable store sales, with an average ticket price of $51.15 - the highest in its history - driven by strong demand for lawn and garden products, particularly in the southern US where Home Depot and Lowe's are fiercely competing to win customers affected by three hurricanes within a month. To differentiate itself

in the market, Home Depot offers a combination of high-quality products at competitive prices, backed up by service-oriented associates. The company operates two types of stores: Home Depot Stores and EXPO Design Center Stores, providing specialized services to the customer market.Home Depot Stores offer various building materials for home improvement and lawn and garden products while delivering valuable services. To increase customer loyalty, HD has implemented several in-store initiatives and programs, such as the Professional Business Customer Initiative that provides additional savings by increasing available quantities of products typically purchased in bulk. Through a tight cost control system and low-cost distribution, HD has established its position as a cost leader. Additionally, HD has a Color Solutions Center that offers leading paint brands and proprietary paint matching technology. With its Appliance Sales department, HD provides premium appliances manufactured by General Electric, Maytag, and other leading brands. Along with displaying and stocking popular appliances in the store, HD has also launched the Designplace Initiative that offers an enhanced shopping experience to design customers through superior product variety, personalized service, specially-trained associates, and an expansive merchandise selection. Moreover, HD has Tool Rental Centers that rent approximately 225 commercial-quality tools in 12 categories to satisfy the needs of professional and do-it-yourself customers.This initiative helps HD maintain strict cost control and prioritize high-quality merchandise. The EXPO Design Center Store sells interior design products such as appliances, lighting fixtures, window treatments, kitchen and bathroom cabinetry, and hard and soft flooring. They also provide installation services through qualified contractors. The store differentiates itself from competitors by emphasizing its premium product value chain network and core competencies. Home Depot's unique store formats accommodate

customers' needs and interests while charging prices lower than competitors. As of Q2 2004, The Home Depot operated 1,788 stores, including 54 EXPO Design Centers, 11 Home Depot Landscape Supply SM, 5 Home Depot Supply SM, and 2 Home Depot Floor Stores. Because few direct competitors exist in the home improvement industry, The Home Depot competes with retailers outside the industry, which increases the threat of substitute products. Lowe's Companies, Inc. is one competitor.Lowe's is the second largest retailer in the home improvement industry worldwide with 2003 fiscal year revenue of $33 billion. As Home Depot's main rival, Lowe's specializes in serving the do-it-yourself (DIY) customers, appliances, lawn and garden, home decor, repair/remodeling, specialty trade contractor, and property management market segments of the industry. Despite having low switching costs for customers, Lowe's has 854 stores in 44 states with approximately 94.7 million square feet of retail selling space as of January 31, 2003. Lowe's expansion strategy focuses on metro-markets with populations over 500,000. Its home improvement warehouses offer over 40,000 products including nationally-advertised brand names needed for repair, maintenance, and construction projects for both DIY and commercial business customers. With a wide selection of merchandise available both in-store and through its special orders system, Lowe's sources products from over 7,000 worldwide vendors with no single vendor accounting for more than 4% of total purchases.The company maximizes its opportunities for product quality and gross margin by having access to alternative distribution options from multiple suppliers, avoiding dependence on a single vendor. Lowe's brand equity is built through a variety of media partnerships including its strategic alliance with HGTV network, allowing exclusive commercials during a substantial portion

of commercial airtime. Meanwhile, Sherwin-Williams Company's revenue primarily comes from the manufacturing, distribution, and sale of coatings and related products to customers in North and South America. The company relies heavily on trademarks and trade name recognition to supplement its sales. It manufactures OEM product finishes which are sold through dedicated paint stores and direct outside sales representatives, building strong relationships with both buyers and suppliers. Overall, Sherwin-Williams is a top manufacturer and retailer of paints, coatings, and related products for professional, industrial, commercial, and retail customers.Sherwin-Williams holds an edge over EXPO Design Centers as they remain the foremost manufacturer and retailer of paints. However, the sustainability of their advantage is influenced by various factors such as product offerings and market conditions. Tractor Supply Company specializes in supplying recreational farmers, ranchers, tradesmen, and small businesses. Their unique market niche and exclusive top-notch private label products ensure a strategic advantage over other specialty stores and home centers. TSCO implements an “everyday low price” strategy and has established a uniform store layout for better sales and operational efficiency. By catering to the particular needs of its target customer base, TSCO sets itself apart from big-box retailers. This strategy has enabled them to strengthen their value chain in comparison to Home Depot’s lawn and garden segment. With annual sales of over $1 billion, Building Materials Holding Corporation is one of the leading residential construction service firms in the US. They specialize in providing high-quality materials, manufactured building elements, and construction services to residential builders and contractors.BHMC focuses on gaining high-volume repeat customers among professional builders and contractors, offering manufacturing and installation services, on-time job-site delivery, and volume purchasing

which are not typically found in smaller consumer-oriented retailers. As the “baby boomer” generation moves into the do-it-for-me (DIFM) segment of the market, sustaining a competitive advantage will become increasingly important. Griffin Land & Nurseries, a wholly owned subsidiary of GRIF, is among the 20 largest landscape nursery growers in the fragmented industry. The company aims to increase return on assets for its growing operations by increasing the percentage of products sold to retail garden centers as they tend to have more favorable margins than sales to mass merchandisers. Seasonality and increased shipping costs through distribution channels have impacted the company’s growing operations. In the retail (home improvement) industry, The Home Depot, Inc. and Lowe’s Companies, Inc. have few direct competitors due to its highly fragmented nature.Home Depot dominates the U.S. home improvement industry with over 30% market control, with Lowe's as their sole competitor. Home Depot has various store formats including the traditional Home Depot store, EXPO Design Center store, The Home Depot Supply store, Home Depot Landscape Supply, and The Home Depot Floor Store to compete in the highly fragmented industry. The estimated market share for Home Depot in the industry was 11% at the end of fiscal year 2003, but due to the industry's fragmentation, measuring sales against competitors is difficult. The "Five Forces Model" determines competition intensity and potential for profits within the industry. The retail (home improvement) industry has global growth opportunities worth approximately $900 billion. Home Depot has 102 stores in eight Canadian provinces and 18 stores in Mexico, capitalizing on these opportunities by opening new stores near existing ones to increase customer base and service levels.

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Home Depot adopts a strategy referred to as ‘cannibalization,’ which may initially impact store sales negatively, but eventually leads to long-term profitability. This is achieved by improving customer service levels, incremental sales, and enhancing market penetration. The retail (home improvement) industry is concentrated, with only a few publicly traded direct competitors. Home Depot differentiates itself through an operating strategy based on core competencies, premium merchandise, and lower costs. It provides product category leadership and premium merchandise through exclusive agreements with manufacturers, high-quality service through free how-to clinics, and kiosks that allow customers to identify projects and print step-by-step instructions in-store. Home Depot remains a cost leader by controlling costs tightly; tool rental centers offer 225 commercial-quality tools in 12 categories. Most premium merchandise is bought directly from the manufacturer. Furthermore, Home Depot has strategic alliances and exclusive relationships with suppliers to offer products and gain an absolute cost advantage over new entrants. For inventory of competitively priced premium products, it relies on the timely execution and delivery of products to its stores.

Home Depot has established central distribution centers to better handle their globally-sourced merchandise and compete on a national level. The use of 10 transit facilities throughout the United States has effectively reduced the number of distribution centers needed in both the US and Canada. At these transit facilities, Home Depot receives and processes merchandise before quickly cross-docking it onto trucks for delivery to specific stores. This approach lowers distribution costs by processing approximately 40% of store merchandise through the distribution centers and transit facilities for seamless efficiencies. Home Depot also maintains a global merchandise program that sources high-quality products directly from overseas manufacturers, offering

customers a broad selection of innovative products at better value while boosting gross margins. However, smaller retailers outside of Home Depot still hold the advantage of catering to specific customer needs and providing personalized service and knowledge.The distribution of exclusive products through strategic alliances with manufacturers in dedicated home improvement stores, like Sherwin-Williams' partnership with Dutch Boy paint, reduces the use of Home Depot's paint mixing stations, which are a significant part of their store modernization efforts. Home Depot aims to expand its market share by offering unique installation services, based on their core competencies and value chain, and by recognizing and responding to growth trends in the Hispanic and aging populations. As most homes in the US were built before 1980 and will require frequent repairs, Home Depot sees significant opportunities in the "do it for me" sector. They offer installation services for carpeting, hard flooring, cabinets, water heaters, and solid surface countertops through qualified independent contractors in the US and Canada, distinguishing themselves as service providers to consumers. Home Depot's bargaining power with vendors is high because they purchase merchandise directly from manufacturers located globally and use transit facilities for efficient delivery to stores.Home Depot has integrated a global sourcing merchandising program into its core strategy to directly source high-quality products from overseas manufacturers. To achieve this, product development associates travel internationally to identify opportunities for purchasing items and eliminating “middleman” costs, allowing the company to offer price-sensitive product selections to consumers and increase its gross margin. Home Depot has also formed strategic alliances with certain suppliers to market products under proprietary and exclusive brands. The company has established two sourcing offices in

China and a product development merchant in Germany, enabling the advancement of product features and quality, importation of new products, and offering premium products at lower costs than third-party vendors. Home Depot sources products from over 500 factories across approximately 40 countries and has initiated a quality assurance program to measure vendor performance based on product quality, timely shipments, and fill rate.The Home Depot has established a rigorous quality assurance program with strict standards for product performance. In order to ensure compliance with these policies, product testing is conducted prior to purchase. The company systematically evaluates product quality and factory performance through inspections at the factory to maintain compliance with HD's requirements. Due to its large buying power and low switching costs, Home Depot wields considerable power over vendors in the highly competitive retail industry. Its strategy of cost leadership enables it to earn above-average profitability by dictating prices from suppliers, reducing input costs, and eliminating middlemen through minimized distribution transactions. To monitor vendor compliance with Home Depot requirements, the company has developed a tight-cost control system through its quality assurance program. Additionally, Home Depot has positioned itself for future business by creating distinctive store formats designed to accommodate a diversified customer base, enabling it to compete in niche markets such as lawn and garden, and private contracting for home installation.Home Depot is known for its ability to deliver premium products to its stores in a timely manner, making sure to consistently provide competitively priced inventory. To sustain its competitive advantage, Home Depot must introduce new business segments and services while maintaining its high-quality product image. Key success factors for the company include controlling costs

at the source, finding stable sourcing channels, monitoring vendors to reduce input costs, and improving efficiency across all levels of the company. Home Depot's inventory management and customer service have led to lower shrink levels and increased average ticket growth across all selling categories.To maintain profitability, The Home Depot, Inc. faces various deterrents including fluctuations in the U.S. economy, the need to retain highly qualified associates, unexpected weather conditions, and competition. The company's value chain is expanding to cater to a wide range of customers with initiatives such as paint centers, tool rental centers, trained associates, technological advancements, and store modernization tailored to meet market needs. The cost competitive strategy has been instrumental in maintaining competitiveness by offering low transaction costs, quality merchandise, and specialized services to niche markets. The company aims to grow by assessing opportunities to increase customer loyalty, sales, and market penetration. In fiscal year 2003, HD acquired White Cap Construction Supply Inc. and its 74 Pro distribution branches nationwide to strengthen its core competencies through quality assurance and competitive pricing.com/investors/financial-information/annual-reports), it is stated that Home Depot's success and competitive cost strategy have led to the expansion of tool rental centers in the U.S. to 925 stores, purchase of 20 Home Mart stores in Mexico, and operation of 1,788 stores in the U.S. The retail industry, which presents high price competition and low product differentiation, creates a challenging market for retailers. However, home improvement retailers have the opportunity to differentiate themselves through specialized services. To maximize sales and increase revenue, Home Depot combines product variety, quality, and price with specialized services. Accounting policies adopted by Home Depot are critical in measuring factors

and risks for financial analysis, as discussed in the company's 2003 Annual Report.Management of The Home Depot identified three areas of critical accounting policy which were merchandise inventories, self-insurance, and revenue recognition. The management discussed the adoption of four different accounting pronouncements and identified four major accounting policy changes in the “Notes to Consolidated Financial Statements”. These changes included the adoption of accounting pronouncements relating to service revenue recognition, vendor allowances, goodwill amortization, and stock-based compensation. The treatment of merchandise inventory was specifically addressed in the “Management’s Discussion and Analysis of Results of Operations and Financial Condition”. It was assessed in two ways – approximately 93% of total inventory was valued using the FIFO method under the retail inventory method while the remaining 7% was valued using the cost method. This information was included in the Notes section of the Financial Statements, which also explained that the 7% of inventory valued under the cost method was due to inventory policy of certain subsidiaries and distribution centers.The Home Depot regularly conducts physical inventory counts at each store to confirm the accuracy of inventory amounts in the Consolidated Financial Statements. The company accounts for possible inventory shrinkage or swell based on historical results and industry trends. Additionally, Home Depot's Self Insurance accounting policy covers losses related to general liability, product liability, workers’ compensation, and medical claims. The total liability estimate is based on historical data and actuarial estimates, and it is reviewed by both management and third-party actuaries quarterly to ensure accuracy. Finally, The Home Depot follows the industry norm of revenue recognition by recognizing revenue when the customer takes possession of the merchandise. If a customer

makes payment prior to taking ownership of the merchandise, the sale is recorded as Deferred Revenue on the balance sheet until the customer takes possession of the paid merchandise.