Lowe’s and Home Depot Companies Analysis Case Study

Background of the two companies

Background of Home Depot

Home Depot was started in 1978 in North America. It retails products and services utilizing the improving and constructing houses. The firm has markets in the United Kingdom, China, Canada, and Mexico. It is characterized by big stores equipped with materials for improving and building houses. The firm hoped to achieve growth and exemplary performance by using strategic initiatives. First, the management envisaged growing sales by acquiring new stores in different locations. An increase in the number of stores could increase sales turnover. Second, the organization strategically planned to make workers concentrate on customers during working hours and replenish empty shelves only after the close of business. Although the firm hoped that the strategy could work to improve the performance of the company, it came under intense criticism because of declining customer service. Home Depot’s share price was $25, and it implied that the firm was characterized by a total equity capitalization of $59 billion. The Pro-Initiative program launched by Home Depot as an excellent promotion strategy did not give good returns. The growth trend projected by the management, approximately an average annual growth rate of 16%, was not achieved.

Background of Lowe’s

Lowe’s is a chain of stores specializing in home appliances and equipment for improving homes. Although it is based in North America, the organization has stores in Canada and Mexico. The case study shows that it is the main business rival of Home Depot. Lowe’s strategy was based on opening new stores that would enable the firm to achieve growth rates of 18% to 19%. It also planned to focus on urban centers marked by large human populations, i.e., greater than 500,000. Some of the cities that were targeted were New York, Boston, and Los Angeles. Also, the management of Lowe’s planned to grow sales through a new merchandising system that would make many customers buy products from the company. Pricing strategies were adopted to attract customers with competitive prices of various products. Also, the management envisaged improving the sales of the firm by gaining significant market shares, especially in the Northeast and West.

It appears that the plan to venture into big cities paid off. The firm’s share price was at $37, which implied that the company was marked with equity capitalization of about $29 billion. Although the figures show that Lowe’s had a lower equity capitalization that was lower than that of Home Depot, the share price of the company was higher than that of its business competitor. Based on the case study, Lowe’s was gaining a significant market share in the home appliances segment. Its sales were also boosted by its expansion plans into major metropolitan areas in the US, Canada, and Mexico. Margin expansion also helped the company achieve positive sales trends that were essential in supporting the bottom line. The solid results achieved by Lowe’s were supported, in part, by decreased costs of inventory and the firm endeavor to improve product mix. Although the housing-market bubble affected many companies in the housing segment of the economy, Lowe’s proved that it could use sound strategic measures to improve its sales. The management of the firm hoped that the organization could achieve better results based on expansion plans and other strategic growth plans.

Ratio analysis for Home Depot

Generally, the ratios for Home Depot show that the firm declined in performance in the year 2001, compared to the year 2000. NOPAT ratio was 3,028, which was a slight improvement from 2,565 in the year 2000. NOPAT/total capital ratio was 15.2%, up from 15.1% in the year 2000. Net earnings per share equity ratio was 16.8%, down from 17.2% in 2000. This implies that shareholders’ value of investment declined. The decline is not a healthy trend in business organizations because shareholders expect their investments to achieve good returns. Gross profit per sales ratio improved slightly from 31.2% in 2000 to 31.6% in 2001. The increase in the ratio was good because it shows that gross profit increased marginally. Expenses per sales ratio were up by 0.02% to 20.9% in 2000. This implies that the firm incurred more expenses in selling a product. Increased sales expenses could result in fewer profits. EBIT per sales ratio stagnated at 9.2%. Depreciation per P and E was 5.0%, up from 4.6% in 2000.

The increase in the ratio indicates that the firm’s earnings continued to depreciate in 2001. Sales per capita ratio remained constant at 2.7, and this was a good financial trend because it shows that the capital invested in obtaining the sales did not depreciate. The working turnover ratio improved to 13.9. This could be expected based on inflation rates in the countries in which the firm was operating. The receivable turnover ratio increased to 58.2 up from 54.8 in 2000. This was a good trend because it shows that the firm could use the receivables to deal with urgent business needs throughout the fiscal year. Inventory turnover increased to 5.4 up from 4.8 in 2000. This increase in the ratio shows that the company incurred more inventory costs associated with its products. Sales per store decreased from $40.3 million in 2000 to $40.2 millions in 2001. This is an indication that the general sales of the firm decreased in 2001. Finally, the leverage ratio of Home Depot dropped to 1.10 in 2001 from 1.13 in 2000. The decline shows that the company reduced its ability to meet its financial requirements.

Other ratios for Home Depot

1. Current ratio = current assets/current liabilities = 1.59
2. Operating cash flow = operating cash flow/total debts = 0.42
3. Asset turnover = net sales/total assets = 0.64
4. Return on assets = net income/average total assets = 0.115
5. Debt ratio = total liabilities/total assets = 1.0

In summary, the above ratios show that Home Depot has an adequate number of current assets and limited current liabilities. The asset turnover and return on assets are good values that make the company have a bright future of operations. However, the debt ratio is alarming because it shows that the number of assets and the value of debts are the same. Firms that aim to maintain financial growth should always have more assets than liabilities.

Ratio analysis for Lowe’s

Figure 1. A summary of ratio analysis for Lowe’s

The above ratio analysis figure for Lowe’s indicates that the organization is on a good growth trend. It has expanded its number of stores as it aimed to venture into major cities that have high human populations, which could help the organization record increased sales. Although the sales per stores have decreased, this could be due to the ambitious expansion plan that resulted in many beings of the firm. However, it is alarming that the total capital per equity ratio has decreased. This means that the firm’s ability to meet its financial requirements reduced marginally.

Other ratios for Lowe’s

1. Current ratio = current assets/current liabilities = 1.63
2. Operating cash flow = operating cash flow/total debts = 1.08
3. Asset turnover = net sales/total assets = 0.46
4. Return on assets = net income/average total assets = 0.075
5. Debt ratio = total liabilities/total assets = 1.0

The ratios for Lowe’s firm indicate that the firm is based on a solid financial ground that would support it to improve its operations in the future. For example, the good asset base of the firm, in comparison to its liabilities, would make the firm improve its performance in the future by using assets as collaterals when applying for credit facilities.

The sensitivity of financial assumptions

Sensitivity in financial assumptions is used to how different financial parameters could affect the outcome variable. For example, one could assume that expenses would affect the amounts of profits to be achieved by a company. Therefore, the assumption should be sensitive so that it can predict various outcomes (profits) that could result from changes in the independent variable (expenses). In exhibit 8, there is a high level of sensitivity in return on capital to the forecast assumptions. All the parameters in the assumptions are correlated correctly with the elements in the forecast segment. The assumptions about the growth in new stores have a direct correlation with net sales. The assumption on the sales growth in existing stores is sensitive to the number of stores and the projected net sales. Current liabilities per sales ratio is expected to have an impact on returning on capital projected for the firm. Due to the high level of sensitivity, the projected performance outcomes of Home Depot are in very small ranges. The narrow ranges could help achieve the forecasts because various financial parameters were put into consideration when they were being projected.

ROC and WACC for Home Depot versus Lowe’s

Return on capital (ROC) is the amount of return that business organizations generate by investing capital into the business. The weighted average cost of capital (WACC) is used to show the average rate at which a company would compensate all its investors. The exhibits show that ROC for Home Depot is smaller than that for Lowe’s. This indicates that Lowe’s is getting more value for its investments. In financial analyses, ROC is compared to WACC so that one could know the direction the management is taking an organization. ROC and WACC values have important implications for financial analyses. For example, organizations that are marked by higher values of ROC than those of WACC could be shown to have made good investment plans because they would pay their investors from the proceeds realized from the business.

On the other hand, if firms that are characterized by a higher value of WACC than that of the ROC, then it could imply that the value of investments is destroyed because such a firm could not afford to pay its investors. In such a scenario, a company incurs more costs in expenses than the value of sales. It is advisable for companies to work on ways of improving their ROC before they commit more capital into various projects. If more capital is invested in a firm that has higher WACC than ROC, then the trends of destroying capital would continue to be experienced, and this would cause dissatisfaction among investors.

ROC and WACC figures are also used by the management to learn about investments that do not bring good returns. Investment managers could make changes in their investment plans based on indications of ROC and WACC. Also, ROC and WACC figures are utilized by investors in companies to determine their investment trends. For example, investors could plan to pull based on small compensation they get from companies in which they have committed their capital. On the other hand, investors could decide to inject more capital into a firm because it gives good returns to its shareholders. It is very easy for the management of firms that have greater ROC than WACC to convince their shareholders to invest more capital in some new projects.

Conclusion

Lowe’s and Home Depot are major companies involved in selling products for improving homes in the US, Canada, Mexico, and China. The two companies have been rivals in the housing industry. The strategy of Home Depot has been aimed at using the excellent promotional framework to increase customers’ awareness of the firm’s products. Home Depot missed its growth projections. However, it made good profits. On the other hand, Lowe’s seems to be on a good growth trend that could be supported by its aggressive expansion plan, pricing strategy, and other strategies aimed at increasing market share. Based on the financial analyses conducted in this paper, several recommendations would be made for each company.

Recommendations for Home Depot

• Aim to increase the bottom line.
• Redesign the promotional materials that did not produce good results.
• Focus on improving operating margins.
• Aim to reduce its inventory turnover.
• Conduct a thorough SWOT analysis to assess the various factors that could impact its performance either negatively or positively.

Recommendations for Lowe’s

• The management should continue investing in big cities that are characterized by high human populations, which could provide a ready market for its products.
• Redesign its merchandising strategy in new markets so that it would significantly increase its market share.
• Focus on using pricing strategies so that it would outperform its business rival, i.e., Home Depot.
• The management should ensure that new stores break in the first year of operations so that there would be growth in sales per store and square foot.