Lowe's Company Inc.

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Lowe’s Company Inc.
Steven Law
Cody Lummus
Trent Gray
Andrew Landgraf
Kyle Keltz
[email protected]
[email protected]
[email protected]
[email protected]
[email protected]
TABLE OF CONTENTS
Executive Summary
2
Company Overview
3
Industry Overview
5
Five-Factor Model:
Rivalry Among Existing Firms
6
Threat of New Entrants
13
Threat of Substitute Products
15
Bargaining Power of Buyers
17
Bargaining Power of Suppliers
18
Value Chain Analysis
19
Firm Competitive Advantage Analysis
24
Formal Accounting Analysis
28
Key Accounting Policies
28
Potential Accounting Flexibility
32
Actual Accounting Strategy
34
Quality of Disclosure
36
Qualitative Analysis of Disclosure
36
Quantitative Analysis of Disclosure
39
Sales Diagnostics
Expense Diagnostics
39
47
Potential Red Flags
54
Accounting Distortions
54
Financial Analysis
56
Liquidity Ratios
57
Profitability Ratios
66
Capital Structure Ratios
75
Financial Statement Analysis
Income Statement
91
91
1
Balance Sheet
93
Statement of Cash Flows
96
Analysis of Valuations
Weighted Average Cost of Capital
99
Cost of Equity
100
Cost of Debt
101
Intrinsic Valuations
102
Discounted Dividend Model
102
Discounted Free Cash Flows Model
104
Residual Income Model
106
Long-Run Residual Income
108
Abnormal Earnings Growth
110
Credit Analysis
113
Analysis of Valuation
113
Method of Comparables
114
Appendix
124
Liquidity Ratio
124
Profitability Ratio
125
Working Capital Ratio
127
Regression Analysis
128
Cost of Equity
139
Cost of Debt WACC
140
Discounted Dividends Model
141
Discounted Free Cash Flows Model
142
Residual Income Model
143
Long-Run Residual Income Model
144
Abnormal Earnings Growth Model
145
Altman’s Z-Score
146
Sales Manipulation Diagnostic
147
Core Expenses Manipulation Diagnostic
148
2
References
149
3
Executive Summary
Investment Recommendation:Fairly Valued, Hold (November 1, 2007)
LOW – NYSE (11/1/2007):
52 week range:
$35.74
Revenue:
Market Cap:
Shares Outstanding:
Percent Institutional Ownership:
Book Value Per Share:
ROE:
ROA:
Cost of Capital est. R^2
Estimated:
3-month
.11222
1 year
.11223
2 year
.1115
5 year
.1097
7 year
.1091
10 year
.1087
Published Beta:
1.31
Kd(BT):
5.07%
WACC(BT):
9.12%
$26.15
$21.76$46,927 M
$44 B
1525 B
81.5%
$10.31
18%
12.6%
Beta
1.01
1.01
1.01
1.00
1.00
0.99
Ke
9.43%
12.22%
12.09%
12.20%
12.33%
12.44%
Kd(AT):
3.3%
WACC(AT):8.35%
Altman’s Z-Score
2002
2003
2004
2005
2006
5.43
6.33
8.33
8.85
5.47
Valuation Estimates:
Actual Share Price: $26.15
Financial Based Valuations:
Trailing P/E:
$28.94
Forward P/E:
$27.77
P.E.G.:
$30.36
P/B:
$39.17
P/EBITDA:
$25.18
P/FCF:
$68.67
EV/EBITDA:
$22.79
D/P:
$10.52
Intrinsic Valuations:
Free Cash Flow:
$43.52
Residual Income:
$25.30
LR ROE:
$15.97
Discounted Dividend:
$8.41
AEG:
$33.32
4
Industry Analysis
Lowe’s started out in 1952 in North Wilkesboro, North Carolina as a small
town home improvement store that’s big customer base was local contractors.
Now Lowe’s is the seventh largest retailer in the United States and is the second
largest retail home improvement retailer behind Home Depot. After building
their firsts modern stores in 1994, with low prices on the best products that all
customers can be satisfied with to improve their home, they have grown to 1385
stores in the United States and plan on expanding into Canada and Mexico.
While Home Depot and Lowe’s control most of the home improvement
market, Sherwin William’s and Tractor Supply also compete in this industry. The
reason they are in control of the industry is they make available products to all
ranges of customers from electricians to landscapers. Their competitors stick to
a smaller portion of the market as Sherwin William’s is mainly a paint supplier
and Tractor Supply to the rural population. The home improvement industry has
low switching costs, a low differentiation of products, large economies of scale,
and a low threat of substitute products making low prices very important to
compete in this industry. The bargaining power of suppliers is very low in this
industry as suppliers actually have to fill out an application to supply to Home
Depot, Lowe’s, Tractor Supply, and Sherwin William’s makes most of their own
product.
The main drivers in this industry to compete and grow are to be able to
have admirable cost control, economies of scale, and a supply of good quality
products. Having good cost control will keep costs of products low and help
customers save money. With low prices and superior products Lowe’s will keep
expanding internationally and take more market share from the other
competitors in the retail home improvement industry.
5
Accounting Analysis
The accounting information released by a company is very essential in
valuing a company. To be valued correctly, the company should be transparent
by not hiding anything and have no apparent “red flags”. GAAP, Generally
Accepted Accounting Principles, has regulations on financial statements, but rules
can always be flexible as managers for companies can make their numbers look
better than they really are.
To find the financial statements for Lowe’s we looked at their 10-K, which
showed to have sufficient information. The way leases are recorded is a big part
of key accounting policies for a company. Lowe’s, as stated in their 10-K, owns
a majority of their stores and we felt that the capital and operating leases on the
remaining percentage would not drastically affect the balance sheet. Deferred
revenues can also be another flexible part of a balance sheet, but Lowe’s has
accurate numbers for their gift cards and installation work in the 10-K. The only
possible flexibility they could have stretched is pension plans as they would have
to predict the discount rate and the how much money employees contribute to
their plans.
Lowe’s has also entered into an agreement with GE, and has GE servicing
the accounts receivable, and records any gains or losses at fair value. This helps
Lowe’s by having them not record any allowance for bad debt during this
agreement which creates clearer forecasts for future cash flows. Lowe’s
accounting principles are above the standard and have no real potential “red
flags” that would give a bad valuation for the company. The only possible one
listed above was the operating leases, but since the payments are spread out
over many years, we show that on a yearly basis the balance sheet would not be
severely affected.
6
Financial Analysis, Forecast Financials, and Cost of Capital Estimation
The financial analysis of Lowe’s reveals how ratios can be used to break
down numbers on the financial statements. These ratios can then be compared
to other competitors and the industry to determine the company’s liquidity,
capital structure, and profitability. First, when doing the liquidity analysis of
Lowe’s it can be seen that they are a very liquid company. In most of the ratios
Lowe’s stayed consistent with the industry or led the industry such as the case
with inventory turnover. This is important because they can quickly sell their
inventory which creates greater operating efficiency. The overall capital
structure analysis found ratios that again showed Lowe’s as a healthy company.
These ratios show that as Lowe’s expands and grows, they are doing a good job
to maintain consistency in their funding. Overall capital structure indicates that
the entire industry is able to cover their liabilities with sources of cash or incomes
showing there is little credit risk in the industry. The profitability ratio analysis
illustrates that Lowe’s is outperforming the industry as a whole for the return on
equity and return on assets. Furthermore, Lowe’s has performed consistent with
the home improvement retail industry for the gross profit margin, operating
profit margin, asset turnover, and net profit margin ratios.
Forecasting a firm’s financial statements can make analyzing its value
easier by providing a tangible view of its future numbers. To forecast Lowe’s
income statement, balance sheet, and statement of cash flows, we first
forecasted its net sales growth. We did this using Lowe’s historical sales growth
over the past five years. By calculating the net sales growth we were able to
successfully forecast most of the remaining numbers using historical values and
comparing them to liquidity and profitability ratios. Owners’ equity was calculated
using our forecasted net earnings and dividends. The historical values we used
to determine our forecasts proved to be accurate except for one area: total
7
liabilities. We had to adjust total liabilities to account for the values we
forecasted for owners’ equity using our forecasted dividends, which was different
from our forecasted owners’ equity using historical values. After the ratios were
calculated and the forecasts were done, the beta could be calculated using
regressions. Using the beta we could get the Ke using the CAPM equation, and
get the Kd using the liabilities off our balance sheet. After computing Ke and Kd
we plugged those into the WACC equation to get WACCbt and WACCat.
Valuations
Through our valuations we show that Lowe’s is a fairly valued company.
To value a stock you have to look at the current share price and compare certain
ratios to competitors, or use forecasted intrinsic values to see if the stock is
overvalued, undervalued, or fairly valued. We used method of comparables and
intrinsic valuations to derive this valuation.
For the method of comparables we got all but three to reach a fairly
valued conclusion. These five that valued the company well were the
Price/EBITDA, Forward P/E, Trailing P/E, Enterprise Value/EBITDA, and the Price
Earning Growth. The Dividend/Price model did not accurately value Lowe’s
because people do not buy Lowe’s for their dividends so it is not an accurate
comparable to look at. The Price/Book ratio and Price/Free Cash Flow were
undervalued, but since a majority of the valuations turned out to be fairly valued
we chose to favor that valuation for the method of comparables. The method of
comparables is one way to value a company, but we felt that the intrinsic values
were more reliable to make a final decision for our valuation.
The intrinsic valuations are Residual Income, Discounted Dividends, Free
Cash Flow, Long Run ROE, and Abnormal Earnings Growth. Lowe’s has mixed
results for these valuations as well as the method of comparables. The
8
discounted dividends model was extremely overvalued, but as I mentioned
before Lowe’s is not a company that people invest in for dividends, so that
valuation is irrelevant. The free cash flow model is undervalued, which we also
felt was inaccurate. The long run ROE was overvalued throughout the whole
analysis but since that model deals with perpetuity it is not as accurate as the
residual income or AEG model. The AEG model was slightly undervalued but we
decided to go with residual income as it is known as a more reliable model and it
matches up with our method of comparables valuations. The share price for the
residual income model was $25.30 which is extremely close to the observed
share price of $26.15. In conclusion, the residual income model, being the most
accurate, shows that Lowe’s is a fairly valued company.
9
Company Overview
Lowe’s started out in 1952 in North Wilkesboro, North Carolina, close to
their new headquarters of Moresville, North Carolina. They started out as a local
hardware store that had a main customer base of independent and professional
contractors. Lowe’s started to build their modern stores in 1994 and quickly
expanded into a home improvement retail store leader as they currently have
1385 stores running. Lowe’s sells thousands of products including special order
items on the internet or through the store. Lowe’s has announced that they are
expanding into Canada, building six to seven stores around the Toronto area.
Lowe’s has installation services for the do-it-for-me customers as well as
everything for the do-it-for-yourself customers. To meet these needs fully and to
stay on top Lowe’s uses, “excellent customer service, Everyday Low Prices, and
innovative operational, merchandising, marketing and distribution strategies”
(Lowe’s 10-K). Lowe’s carries a wide selection of well known brands that have
been used for years, as well as exclusive Lowe’s products that a number of
customers have been satisfied with. Lowe’s requires managers with great
training skills to train new employees the knowledge to help the customers and
give them a better experience shopping than at other home improvement retail
stores. While having low prices, Lowe’s still needs great customer service to
keep improving their sales and keep the customers coming back into the store.
The company also created a website called LowesForPros.com to gain some
business from commercial contractors. This website, “features up to date
articles, job estimators and business forms, e-newsletters, statistics and other
vital information that Commercial Business Customers can use for their business”
(Lowe’s 10-K).
10
Lowe’s net sales have increased close to 18% every year for the past 5
years except for 2006 when it increased 8.5%. Expansion is a big part of Lowe’s
plan to grab more of the market share for home improvement and increase their
net sales. Stores are being built in Canada this year and there are stores in 49
states and Mexico. Lowe’s has also built 136, 147, and 151 new stores in each
of the past three years respectively. The company invests yearly in existing
stores to be touched up and to keep them looking inviting for customers.
Another good indicator of the size of a company is to look at its total assets. As
shown in the chart below Lowe’s has had a steady increase in total assets.
Lowe’s Asset Values
Year
Total Assets
Percent Change From
(in millions)
Previous Year
2006
$27,767
11.11%
2005
$24,682
14.07%
2004
$21,209
10.22%
2003
$19,042
15.40%
2002
$16,109
N/A
www.lowes.com
Out of Lowe’s competitors in the retail home improvement industry they
have the second largest market cap of 44 billion. They are behind Home Depot
who leads the industry with a cap of 69.4 billion, then Sherwin Williams, and
Tractor Supply Co. in respective order. Lowe’s is trying to catch Home Depot as
the leader by continuous expansion and to keep the prices competitively low. As
mentioned above Lowe’s is opening several stores in Canada, they also plan on
opening up some new stores in Monterrey, Mexico in 2009. Home Depot already
has stores in Canada and Mexico, and has just acquired a home improvement
11
firm in China that had 12 stores, Sherwin William’s has stores in South America,
United Kingdom, Mexico, and is expanding in Southeast Asia, and Tractor Supply
Co. is just based in the United States. Lowe’s expanding into Canada and later
into Mexico will increase their competition with Home Depot and should increase
their market share.
Lowe’s stock price performance has almost doubled in the last five years.
The stock price was at its lowest in the first quarter of 2003 at around $17 per
share and currently it is $30.60 per share. Lowe’s stock performance has been
consistent with the performance of the industry and also compared to their
competitors in the past five years as shown in the graph below
(www.finance.yahoo.com).
12
Industry Overview
Lowe’s Companies, Inc. are in the home improvement retail industry.
Lowe’s is the second highest leader in the industry behind The Home Depot, Inc.
Other top firms in the industry include Sherwin-Williams Company, and Tractor
Supply Company. Recently, the housing market has been in decline and is
expected to continue until 2009 (Forbes.com). Despite the housing market,
sales in the home improvement industry are only falling by a small percentage.
Sales in the industry totaled 149.797 billion in the last twelve months. Lowe’s
accounted for 47.956 billion of those sales trailing The Home Depot which had
total sales of 84.079 billion. The Home Depot and Lowe’s are the major
competitors in the home improvement industry accounting for 88.14% of total
sales in the last twelve months.
Lowe’s and The Home Depot dominate the home improvement industry
due to the fact that their stores contain merchandise that meet the needs of
electricians, landscapers, painters, plumbers, repair and remolding contractors,
commercial property owners, and “do-it-yourself” homeowners and renters.
Other firms either cater to niche markets or are fairly new in the industry. For
example, House2Home, Inc. offers the same type of merchandise and services
as The Home Depot and Lowe’s, but was only formed in 1989, while Lowe’s was
incorporated in 1952. Similarly, Builders Firstsource issued their IPO only three
years ago. This means they are new still new in the home improvement
industry. Tractor Supply Company is the fifth leading firm in the industry
(Investor.Reuters.com), but it specializes in merchandise that fit the needs of
rural homeowners and farmers. Other firms such as Builders FirstSource and
Building Materials Holding Corporation only offer building supplies and materials,
and don’t sell interior goods.
13
Five Forces Model
The Five Forces Model is an investment tool that allows investors to
classify the industries structure and profitability. The five forces consist of:
Rivalry among existing firms, threat of new entrants, threat of substitute
products, bargaining power of buyers, and bargaining power of suppliers. Below
is the Five Forces Model as it pertains to the retail home improvement industry.
Rivalry Among Existing Firms
The home improvement sector of retail has become a growing market
mostly dominated by two companies. A steady industrial growth over the last
ten years has made the home improvement sector very attractive to investors.
It is a highly competitive market emphasizing low costs and high quality.
However, the products offered in this industry have very little differentiation and
can be as generic as a two by four piece of wood. This sector of retail is highly
concentrated, creating an intense rivalry between the two largest competitors,
Home Depot and Lowe’s. Home Improvement stores can also be found all over
the country in “mom and pop” type establishments.
In addition, switching costs in the retail industry are historically low unless
there is some type of brand loyalty. For Lowe’s and the home improvement
sector, both companies carry identical or very similar products therefore
switching costs in this sector are low as well. Furthermore, a high fixed asset to
variable cost ratio shows that Lowe’s has exit barriers in the market.
14
Industry Growth
The growth of an industry usually correlates directly with the leaders in
that industry. The home improvement sector of retail has experienced a high
level of growth over the past five years. The sales growth rate of this industry
reflects upon the management of these firms. The managers are responsible for
using these past industry growth rates in order to forecast a company’s future
sales and growth. Expansion into new cities and new markets is a direct result
of intense financial planning, taking all sales growth models into the process
Sales Growth Rate
2002
2003
2004
2005
2006
Lowe's
20.25%
18.10%
18.25%
18.50%
8.50%
Home Depot
8.77%
11.27%
12.80%
11.50%
11.40%
Sherwin-Williams
7.90%
4.30%
13.10%
17.60%
8.60%
Tractor Supply
20.02%
21.73%
18.06%
18.93%
14.59%
Weighted Industry Average
12.45%
13.17%
14.58%
14.11%
10.40%
15
Through research and calculations of the industry growth the home
improvement industry averaged a growth rate over the past five years equal to
12.94%. This number is fairly high when considering inflation is approximately
three percent per year. The industry achieved this high growth rate due to the
expansion of all companies into new markets. By increasing the number of
stores, higher sales volume can be achieved. This growth rate shows that home
improvement has been expanding although there was a slight decline from 2005
to 2006. Lowe’s has managed to open new stores in cities nationwide and in
2006 planned to move into Mexico and Canada. This follows the precedent set
by The Home Depot who already has had great success in these countries.
Although most of Lowe’s competitors experienced growth in all of the last five
years, Tractor Supply had a negative growth rate in 2006. This was could have
been caused by the slow home building market at the time. While this company
relies on new construction of homes and general repairs to raise revenue Lowe’s,
The Home Depot, and Sherwin-Williams focus on do it yourself jobs for their
customers. This allowed them to maintain a relatively high growth rate during
the slow home building period.
16
Conversely, all of the firms in this industry are also competing for market
share. To compete in the home improvement industry a company must be large
enough to compete on cost. Larger companies can buy more from suppliers
which enables them to receive the goods at a lower cost. Low prices have
always drawn many customers in the retail industry because customers know
they are saving money. Once you draw in buyers to the firm the more they will
spend which then increases growth. Also, a competitive advantage can be used
to draw customers away from competitors. When Lowe’s began to open up the
store with wider isles for convenience many buyers preferred to do their
shopping there. Minimizing cost and gaining a competitive advantage will allow
a firm to compete for market share in the retail industry.
Concentration
The concentration of an industry is directly related to the market share a
firm controls. The concentration of the home improvement retail industry is
measured by the number of existing companies and their market share. For
example, a low concentrated industry would consist of many firms each of which
having relatively equal market share. Although, a high market share enables a
firm to be more competitive.
17
Market Share Analysis
70
Percentage of Market Share
60
50
Lowe's
40
Home Depot
Sherwin-Williams
30
Tractor Supply Co.
20
10
0
2002
2003
2004
2005
2006
Year
When analyzing the market share of these firms it was very clear that The
Home Depot stands out with the most market share. The graph shows that
between these four competitors the market share has been relatively constant
over the last five years. This is due to the level of growth the industry has
sustained over that time period. With an increase in the industry growth the
concentration level was able to remain constant because the firms were not
competing for market share.
The graph also shows that most of the industry is controlled by Home
Depot and Lowe’s. This gives them power in the industry, leading to a high level
of concentration. The two competitors face little competition from other firms
but remain competitive with each other. Furthermore, Home Depot has allowed
its market share to fall somewhat to Lowe’s in the past five years. Lowe’s is an
expanding company in the industry and will continue to pull some market share
away from Home Depot as they grow. Sherwin-Williams and Builders Firstsource
18
are not likely to pull market share away from Home Depot or Lowe’s because of
the products they offer. Lowe’s and Home Depot offer a much wider variety of
goods while Sherwin-Williams and Builders Firstsource have limited selections of
home improvement goods.
Fixed Cost to Variable Cost Analysis
Variable costs are costs to a firm that fluctuate and change over time.
Examples of these would be materials costs and labor costs. Fixed costs are
those that do not change over time. An example of this would be a lease
payment for distribution centers. Lease payments are made for an agreed upon
time period and usually are renewed at the expiration date. When a company
has a low fixed to variable cost ratio they are provided with fewer exit barriers in
the industry. A high fixed to variable cost ratio is hinders a company’s ability to
cease operations. Also, the home improvement industry must allow for bad debt
just as all retail companies have to. This is a variable cost that is disputed and
allowed for every year. This cost is unavoidable because sometimes buyers are
just not willing or do not have the means to pay for their debt accounts.
Variable costs such as this are accounted for in the financial statements of all
companies. Most companies in the home improvement industry have high fixed
costs because of their lease payments. Upon analyzing the variable costs in the
industry, two significant variable costs were identified, debts payments and labor
costs. Larger companies in this industry have higher variable costs because they
employ more people resulting in high labor costs. Since the competitors in the
industry have low ratios it would be fairly easy for them to sell their inventory
and close their doors if the situation were ever to occur.
19
Switching Costs
Switching costs in an industry come about by a low differentiation of
products. When switching costs are low a consumer can easily go through a
different company to get the same product. The home improvement retail
industry is characterized by low switching costs and low differentiation of
products. Lowe’s and Home Depot basically offer the same products and the
same brands. Other competitors such as Tractor Supply and Sherwin-Williams
offer specialty products that are aimed to compete with Lowe’s and Home
Depot’s similar items such as paint. This low differentiation of products enables
buyers to search for lower prices between companies. Unless a buyer is
extremely loyal to a certain brand or company, they would rather buy their
bucket of paint or power tools with the company with lower prices. The price
competition strategy is very important to Lowe’s and the companies in this
industry. To gain an advantage firms must regularly give sales on their products.
Once a customer feels that the company’s prices are usually the lowest the
switching costs are greatly reduced.
Excess Capacity
Companies experience excess capacity when the supply of goods exceeds
the demand for those goods. Firms that are large and have a bigger market
share usually do not have a problem with excess capacity. Sales and clearances
can be utilized by the firm to get rid of products that are not being sold regularly.
“Firms may also choose to maintain excess capacity as a part of a deliberate
strategy to deter or prevent entry of new firms” (http://stats.oecd.org/glossary).
This is a strategy that can benefit and be an annoyance to buyers. A large
corporation will lower its prices on these items eventually if it wants to maintain
their operating efficiency. However, preventing other entrants into the industry
gives a disadvantage to buyers because it creates less competition. Controlling
20
excess capacity and the firm’s inventory is essential to keep the company
thriving.
Exit Barriers
Exit Barriers “are obstacles to market players who realize that they will not
turn a profit and would like to quit the market”
(http://www.photopla.net/wwp0503/exit.php). Closure Costs, asset write-offs,
and legal ramifications all create exit barriers for businesses. Closure costs
include contracts still pending with suppliers and penalty costs from canceling
lease agreements. The businesses in the home improvement industry would
experience these exit barriers due to their large number of suppliers whom they
have contracts outstanding as well as their operating lease agreements. The
most significant exit barrier for firms in the home improvement industry would be
their asset write-offs. Larger firms with a lot of fixed assets such as property,
plant, and equipment would incur a great expense to write-off these assets.
Smaller firms who lease buildings instead of owning the real estate would have a
fewer exit barriers than companies with large retail and distribution centers.
Threat of New Entrants
The threat of new entrants is a major factor in the business world, not
only will it affect a company but it also affects the entire industry. If an industry
is in high demand and there are upstart companies making solid yearly profits
this threat is usually very high and will continue to grow. During this section we
are going to explain how easy it is for competition to increase in an industry and
what that will do to the existing industry as a whole.
21
Economies of Scale
In the retail home improvement industry new firms must come in with a
large amount of capital strength if they plan to sustain and be competitive with
the larger corporations. It is very difficult for the smaller firms to be competitive
because their money restraints do not allow them to buy large quantities of
products and distribute them as efficiently to all of the company’s stores. The
advantage the larger existing corporations have is being able to rely on their
capital strength and large economies of scale. The two largest and most
dominant retail home improvement corporations both have capital strength of
over $25 billion (www.scottrade.com). They also have better relationships with
distributors, which allow them to order larger quantities at a better price, which
in return helps make them much more price competitive. Finally, since Lowe’s
has been around since 1934 they have been able to learn and gain experience in
management and product distribution. This advantage helps the corporation be
much more cost effective because they have tested and developed the best
methods of distribution management. Since this industry has many different
ways they have to compete, the home improvement industry does have large
economies of scale.
Total Assets
Lowe's
Home Depot
Sherwin Williams
Tractor Supply
2002
2003
2004
2005
2006
16,109
18,751
21,209
24,639
27,767
30,011
34,437
38,907
44,405
52,263
3,432
3,682
4,274
4,369
4,995
458
538
678
814
1,007
* numbers in
billions
22
First Mover Advantage
The first mover advantage is a major key for corporations already in
existence. In many industries if the current major companies already present an
advantage in product invention/innovation than it will deter possible entrants in
the future. In the retail home improvement industry each company must keep up
with the current market to know exactly what the consumers want and need.
This way a corporation is able to stay more cost efficient and competitive by
knowing what products to order from their suppliers. Being cost efficient is a
major hurdle in breaking through and having a positive return on your assets. If
a new company is unable to negotiate a fair price with their supplier than as a
new entrant into the industry the company would not be able to survive. The
major companies such as Home Depot and Sherwin Williams have major
bargaining power with their suppliers because they have been in the industry so
long and have a great reputation with both their suppliers and their loyal
customers.
Distribution Access and Supplier Relationships
For first time entrants into the retail home improvement industry supplier
relationships is one of the toughest hurdles to overcome. The larger existing
firms, such as Lowe’s Company Inc. and Home Depot have great supplier
relationships that have been maturing for many years, some as far back as 1920.
These companies were able to build these relationships by making it a goal to be
loyal to their suppliers and use regional suppliers so that they help further their
communities by providing more jobs. With these types of relationships come a
certain amount of respect and loyalty to one another. Since there is such a large
amount of trust within the communities and their economies the larger firms are
able to receive price breaks because of the amount of products they buy on a
regular basis. New smaller firms find it difficult to build these deep relationships
23
and as a result are not able to receive the price breaks on products, which hurts
them in the pricing wars seen throughout the retail industry.
Legal Barriers
In the retail home improvement industry there are very few legal barriers
that a company must face when entering into the industry. Many of the legalities
you see in the home improvement industry are seen throughout any business.
For example, new and existing companies alike must always meet government
regulations when importing and exporting goods. They also must meet
government working standards in factories overseas as well as on the mainland.
Other issues that arise are things internally within the company. Some of which
are sexual harassment, civil suits, and workers comp suits. In the retail home
improvement industry workers comp suits are seen on average more than any
other issue.
As you can see the home improvement industry is very difficult for new
entrants to succeed in. This industry is very “top heavy” and controlled primarily
two major corporations. These existing companies already have the established
relationships needed for them to keep good quality and pricing in their stores.
Without these competitive advantages it is very tough for a new firm to enter the
industry and compete successfully. Finally, any company no matter how big or
small must always be conscious of all the legal regulations that surround them.
Legal issues are major for any new entrant into an industry because they could
very easily violate laws and regulations that could close them down before they
even get started.
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Threat of Substitute Products
The home improvement retail industry is comprised of two major firms
which compete relatively close with each other. With companies such as Lowe’s
and Home Depot taking a majority of the market share, the relative price of
home improvement products are very similar. Also, home improvement retail and
commercial business customers tend to be very loyal to brand and firms, so a
buyer’s willingness to switch in this industry is relatively small. This shows that
the threat of substitute products is relatively low considering home improvement
goods.
Relative Price and Performance
Customers in the home improvement retail industry understand they will
get what they pay for. These customers will obviously still be somewhat price
conscious, but most are very aware of the price and brand they are dealing with.
This tends to be a good thing for large existing firms such as Lowe’s and Home
Depot. The threat of a superior or cheaper product will be identified between
these large corporations before they have a chance to compete with price or
performance of the product. In turn, small home improvement retailers suffer
from customers being knowledgeable about what they are trying to attain
because they cannot compete with large firms cost advantages.
Buyers’ Willingness to Switch
A customer within the home improvement industry knows they will find
similar brands and prices in any of the large retail stores such as Lowe’s and
Home Depot. Consumers in this industry are willing to pay a premium for a
higher quality product. On the other hand, most customers know what they can
afford to spend less on within home improvement. As mentioned earlier, this is
25
an industry dealing with a majority of knowledgeable consumers with a “Do-ityourself” attitude. Therefore, they would not be as open to switch products due
to price or brand detail.
In conclusion, due to consistency in relative price and vast customer
brand loyalty, the threat of substitute products in the home improvement retail
industry is relatively low.
Bargaining Power of Buyers
Lowe’s provides products and services to 13 million customers a week
(www.Lowe’s.com). These 13 million customers are comprised of electricians,
landscapers, painters, plumbers, repair and remolding contractors, commercial
property owners, and “do-it-yourself” homeowners and renters. When
determining the bargaining power of these customers it is important to look at
two factors: price sensitivity and relative bargaining power. Price sensitivity
means how much the buyers in a market are actually willing to try to drive down
the price of products and services. Relative bargaining power means how much
actual power the buyers have over the firm to successfully drive the prices of
products and services according to their price sensitivity.
Price Sensitivity
Buyers’ price sensitivity will be high if products and services in a market
are all the same and if the cost of switching from buying from one firm to
another is low. If buyers are looking for a very specific product or service, that is
important to their cost structure and would cost them a lot to switch from their
original firm to another, they will have low price sensitivity. There are a couple
26
of other things that determine the price sensitivity of a customer: the percentage
the product or service comprises the buyer’s cost and how important the quality
of the product or service is to the buyer’s finished product or service. If the
product or service is a small percentage of the buyer’s cost then they might not
bother to look elsewhere for lower prices and buy from the most convenient firm.
Also, if the quality of the buyer’s finished product is not a big factor, then the
buyer won’t worry about bargaining for the price of the products and services.
All of these factors point towards buyers possessing high price sensitivity
in the retail home improvement industry. Only two firms dominate the market:
The Home Depot and Lowe’s. Lowe’s has half the market share that The Home
Depot possesses and is continuously trying to emulate that firm. This means
that as Lowe’s tries to emulate The Home Depot, it emulates its products and
services, and the majority of products and services in the industry are going to
be the same with minor differences resulting in low product differentiation.
Switching costs to buyers in the industry are extremely low. As both dominant
firms compete over price, a buyer’s choice of firm usually boils down to which
firm has the lower prices and is closer or which firm has lower prices and better
customer service in a certain area. In most places except extremely rural areas,
a Lowe’s retail warehouse won’t be far from a Home Depot retail warehouse.
In the home improvement retail industry any certain buyer is looking to
buy products and services that will improve his/her home. On any given project
the products and services purchased at a firm represent 100% of the costs for
home-owners and renters, and all of the costs besides labor for commercial
customers. Also, home-owners and renters, and commercial customers are
usually looking for the highest quality products and services because of the fact
that they are building onto homes. Home-owners and renters don’t want to buy
low quality products for their homes because they have to live with the results of
their projects. Commercial customers want to buy high quality products to make
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sure they have a good reputation with their customers. These high percentages
of costs and the need for high quality goods result in high price sensitivity of
buyers in the market.
Relative Bargaining Power
Although buyers in an industry might have a lot of need to bargain for the
price of their desired products and services, this doesn’t mean they are able to
actually do so. Relative bargaining power is determined not only by the cost to
the customer of not doing business with the firm, but also by the cost to firm of
not doing business with the customer. Customers in the home improvement
retail industry, despite their high price sensitivity, have a low relative bargaining
power. Customers buying a product from any firm in the industry cannot bargain
for its price at the check-out counter. The prices are labeled on the product.
Also, even commercial customers buying at high volumes have to accept any
certain firm’s discount rates. External factors that affect a firm in this industry’s
prices are hurricanes and highs or lows in the housing market, not customers
bargaining for prices in the aisles. The Home Depot and Lowe’s usually offer
differing degrees of products in each category of home improvement. When a
customer thinks that a certain product costs too much, they can buy the same
type of product at a lower quality. The Home Depot and Lowe’s usually have
three or four choices of quality for each type of product and the smaller firms
usually have two choices. So while the cost of buyers switching from one firm to
another in the home improvement retail industry is simply the fuel it takes to
drive a few blocks to the next store, the switching cost is low to the firms as well
because with the high level of competition and low level of product and service
differentiation, customers quickly learn that there really isn’t any point in
spending those extra dollars to drive to the next store.
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Bargaining Power of Suppliers
In the retail home improvement industry the power of suppliers has little
to no effect. Therefore the suppliers have very little power. Home Depot and
Lowe’s actually choose their suppliers for multiple products, as the suppliers can
fill out an application on the website. According to the Lowe’s 10-K, “not one
supplier accounts for more than five percent of total purchases.” This industry
almost has the power over them, as they choose carefully and find which one fits
their needs. Lowe’s makes sure that all the lumber comes from, “well-managed,
non-endangered forests” (www.Lowes.com). There is not much differentiation in
many products in the retail home improvement industry to give the suppliers
much power also. Switching suppliers is not an issue either because one supplier
is not going to be much different than the next. While the costs and quality is
real important for the top companies in this industry, they still have power over
the suppliers because the market is so great in their stores. This makes it hard
for the suppliers to get what they want. While Home Depot and Lowe’s have
multiple suppliers for their stock, Sherwin William’s manufacture most of their
products. Since suppliers are barely needed they have virtually no power either.
The retail home improvement industry has almost the Wal-Mart affect with
picking suppliers for their stores.
Conclusion
The five forces model indicates that the retail home improvement industry
continues to be a highly competitive industry between the two top firms Lowes
Company and Home Depot. As competition increases nationwide between the
industry leaders, smaller more regional firms struggle to survive due to their lack
of capital strength.
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Value Chain Analysis
The Overall Classification of the Industry
As stated above the home improvement industry is one in which there
exists high rivalry among firms, moderate threat of new entrants, low threat of
substitute products, high bargaining power of buyers, and low bargaining power
of suppliers over the firm. In order to be successful in this industry a firm must
be able to offer all forms of home improvement products and services to not only
“do-it-yourself” homeowners and renters, but also to commercial business
customers of all kinds. Niche market firms, while helpful to their specific
customers, don’t stand any chance of catching up with the two major firms (The
Home Depot and Lowe’s) offering one-stop-shops to customers across the entire
market. Cost leadership is also a must to stay competitive and product
differentiation helps to swing loyal customers from one firm to another.
Competitive Strategies
There are several competitive strategies used by firms in the home
improvement industry in order to stay ahead of the competition. The main
strategies include taking advantage of economies of scale and scope, lower input
costs, tight cost control systems, product quality and variety, investments in
brand image, and investments in research and development.
Economies of Scale and Scope
Economies of scale are a big advantage in the home improvement
industry. New entrants to the industry will most likely be opening stores in areas
with one or two stores from leading firms. The average size of those stores is
102,000 square feet with over tens of thousands of items on the shelves.
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Economies of scope are equally important. Besides all of the products for sale,
each store provides many services to homeowners and commercial business
customers. They also contain brand name items that are exclusive, cannot be
found at any other stores, and with which most customers are familiar and have
learned to trust. The size of these stores and their inventories, coupled with
their services and entrenched customer base make it very hard for new entrants
to bare the initial cost of entering the industry and start making profits while
offering competitive prices.
Lower Input Costs
It is crucial to keep input costs low in the home improvement industry. To
stay competitive it helps to order materials such as lumber, steel, paint and
gardening supplies in bulk because suppliers offer discounts on large orders.
This cannot always be the case for every type of item in each store because of
the wide variety needed to stock the shelves, but strategically placing regional
distribution centers can make it possible to evenly distribute items to stores in an
area without driving up transportation costs. It is also important for firms to
have an excellent supplier program so that firm will compete with each to deliver
their goods to your stores. This type of competition can also establish good
relationships with suppliers while always looking for new sources that could
provide the same quality goods at lower prices. Additionally firms can hire
workers at moderate salaries in order to keep costs down while ensuring quality
performance.
Tight Cost Control System
A tight cost control system is needed to ensure not only lower input costs
but also low costs in running every aspect of each store. As mentioned above,
one strategy is to place distribution centers in locations that will minimize
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transportation costs. A good cost control system will ensure that each store
follows the same procedures to minimize costs across the entire firm. This
usually means that each store will be stocked with the same items and offer the
same services. However, leading firms have started a trend called
“cannibalization.” This strategy entails opening two stores fairly close to one
another. Initially the competition of the two stores hurt sales, but profits
increase in the long run because of increased customer service and local market
dominance. It can be cheaper to send most of a certain item to one store in an
area. If the other store does not have what a customer needs the salespeople
can direct them to the store “across town.”
Product Quality and Variety
Product quality and variety is a must in the home improvement industry.
As mentioned above, one strategy of leading firms is to secure certain brand
names and make them exclusively available only at their firm’s stores. As with
most industries, low quality products will not sell well. In order to ensure that a
firms products maintain the industry standard for quality, a firm must watch its
input costs and develop tight cost control systems. The scope of the needs of
homeowners and commercial business customers is so vast that a variety of
products on the shelves is crucial. Different types of services, materials, tools,
and even brand names are needed by different customers for certain tasks they
perform. A few strategies that leading firms utilize in this area are offering
thousands more items that cannot be found in stores on the internet and at instore kiosks, installation services, and credit financing. Any firm offering only one
type of service, lumber, tool, or brand name will find it impossible to gain market
share.
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Investment in Brand Image
Since variety is important in the home improvement industry firms are
forced to emphasize brand images to their customers. With so many types of
products and different brand names on the shelves, customers do not usually
pick up products with brand names they do not recognize. Key strategies to stay
competitive with brand recognition involve in store do it yourself workshops,
advertising through TV, radio, newspapers, specialty cable channels such as
Home and Garden Television, and ensuring that the exact target demographic is
reached through each type of media. Multicultural marketing plays a key role
with brand recognition as well because of the growing number of AfricanAmerican and Hispanic customers in the industry (www.Lowes.com).
Lowe’s: Cost Leadership, Differentiation, or Both?
Lowe’s would be considered in the cost leadership strategy for their
competitive strategy. Their client base has a large population as they provide
products at low prices that most people need. The focus of Lowe’s is, “excellent
customer service, Everyday Low Prices, and innovative operational,
merchandising, marketing and distribution strategies” (www.Lowes.com). This
focus shows that Lowe’s is not relying on differentiation of products to get
people in the door, but low prices and efficient strategies.
By expanding out to Canada this year Lowe’s is taking advantage of global
sourcing opportunities. Home Depot already has stores in Canada that are doing
well, so Lowe’s is expanding to grab some of the Canadian market. Lowe’s does
not have to produce or design any products, and therefore has no research and
development cost either. Lowe’s advertising cost was $873 million, which is not
much of an investment for a large company. Lowe’s promises that if there is a
everyday price at a competitor that is lower than theirs then they will beat it by
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10% according to the 10-K. As mentioned above in the bargaining power of
suppliers Lowe’s has suppliers fill out applications to be their supplier, this helps
Lowe’s pick the best price at all of their stores. To keep the stores stocked
efficiently Lowe’s has eleven regional distribution centers that are highly
automated. “This provides savings for our customers and both brand building
and gross margin improvement opportunities for Lowe’s.” (www.Lowes.com). In
conclusion, Lowe’s is very much based on a cost leadership strategy to keep
expanding in the retail home improvement industry.
Firm Competitive Advantage Analysis
Over the last five years, Lowe’s has experienced an above average growth
rate compared to the existing home improvement retailers. This has much to do
with maintaining the competitive strategy of cost leadership in the home
improvement retail industry. Although there are many ways to create a
competitive advantage in this market, Lowe’s decides to use economies of scale
and scope, lower input costs, and a tight cost control system to create value for
its customers and investors.
Economies of Scale and Scope
Economies of scale, as stated above, provides large companies with a
significant advantage in the home improvement retail industry. Lowe’s is a
Fortune 50 company and the second largest retail corporation in this division
following Home Depot. This enables them to purchase large quantities of goods
which give them a high bargaining power in the industry. At the end of the fiscal
2006 period Lowe’s had 1,385 stores in forty nine states
(www.Finance.yahoo.com). With the expansion of Lowe’s out of the United
States and into Canada, their bargaining power and cost leadership will grow to
new levels. Furthermore, Lowe’s has invested equally in the economies of scope
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by offering exclusive brands. Kobalt, Perfect Flame, and Harbor Breeze are only
a few of the brands found only at Lowe’s. Providing buyers with exclusive
brands ensures that they will keep coming back to Lowe’s stores if they like the
product. Increases in Lowe’s economy of scale and scope offer a great balance
to consistently compete as one of the industry’s top two firms.
Lower Input Costs
Lower input costs are very important when it comes to being the low cost
provider in an industry. Lowe’s has implemented numerous strategies in the last
few years to cut out trying expenses that are an annoyance to normal
operations. A major development in Lowe’s cutting of input costs is keeping up
with new technology by continuously updating information systems. For
example, Lowe’s uses a point-of-sale system and an electronic bar code scanning
system in each of their stores. These systems are almost crucial in a large retail
firm because they offer perpetual real time inventory information to managers
and suppliers. This helps in driving unnecessary expenses down, and Lowe’s
employees may spend more quality time improving customer relations and
maintaining a better store appearance.
Another expense that Lowe’s has continued to decrease is the cost of
product sourcing. They use around 7,000 vendors worldwide to maintain a
variety of products and competition. Management believes this improves supplier
competition, and drives costs lower for the firm. They also insist on cutting out
the middle man by purchasing directly from foreign manufacturers when
appropriate. This helps cut the cost for Lowe’s and its customers on a consistent
basis. Using these techniques to lower input costs helps Lowe’s create a cost
advantage compared to its relative competitors (www.yahoo.finance.com).
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Tight Cost Control System
Lowe’s companies have made additional changes to their inventory
strategies to keep a tight cost control system in place. Lowe’s has eleven
regional distribution centers nationwide and plans on adding three more in the
fiscal 2007 year (www.finance.yahoo.com). The addition of three regional
distribution centers (RDCs) will facilitate faster maintenance of in-stock levels for
the Lowe’s companies in those regions. The significance of the additional RDCs
will be seen next year. However, Lowe’s can speculate that transportation and
shipping costs will be reduced. Increasing accessibility to inventory and lowering
transportation costs can be recognized with strategically placed distribution
centers.
In addition, Lowe’s has begun to implement self checkout machines at a
number of their stores. Cutting down on employee labor costs by having an
automated checkout machine helps Lowe’s reduce small percentage of their
labor costs for the year. In the future Lowe’s expects to implement self checkout
machines at all their stores further decreasing labor costs to the company.
Gross Profit Margin
Year
2002
2003
2004
2005
2006
Lowe's
0.3044
0.3115
0.3373
0.342
0.3452
(www.finance.yahoo.com)
In accordance with the tightening of cost control, the gross profit margin
for Lowe’s has increased over the last few years. Gross profit margin reflects the
extent to which revenues exceed direct costs associated with sales. This shows
36
that Lowe’s has been making improvements on cost controls regularly and
efficiently over the past five years. The trend is likely to increase further in the
next few years as Lowe’s implements more self checkout machines and adds
additional distribution centers.
Key Accounting Policies
In the retail home improvement industry there exists moderate threat of
new entrants, low threat of substitute products, high rivalry among firms, low
bargaining power of buyers, and low bargaining power of suppliers over the firm.
In order to be successful a firm must emphasize cost leadership while
maintaining a level of differentiation or the illusion of differentiation in products
and services to curve the low switching cost of consumers. In the first draft it
was established that Lowe’s, in accordance with the nature of the industry, has
become the second largest home improvement firm by concentrating on staying
competitive with economies of scale and scope, lower input costs, and tight cost
control systems. It is important for firms to match key accounting policies with
key success factors in order to produce accurate and transparent numbers which
help emphasize their strengths to investors.
Net Sales Growth and Expansion
Home improvement retail firms must be competitive with costs because of
the high level of competition that exists in the industry. As mentioned above,
firms in this industry can use economies of scale to help achieve the goal of
reducing costs while maintaining the quality of the offered products. In order to
take advantage of economies of scale a firm must make larger purchases and
this is made possible through continuous growth and expansion. Over the past
five years Lowe’s reported an average net sales growth of 16.31%. Lowe’s had
a steady 18% net sales increase until 2007 in which sales only increased by
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8.5%. An 18% net sales increase is excellent and even an 8.5% growth rate is a
healthy amount to take advantage of economies of scale by increasing purchase
volumes each year. Lowe’s net sales growth should return to its higher historical
rate after 2009 when the housing market slump is forecasted to come to an end.
Net sales growth is vital to taking advantage of economies of scale. Of
course, nets sales growth will reach a plateau if it isn’t accompanied with
expansion. Lowe’s is doing a good job of expanding its amount of stores at a
rate that will sustain its net sales growth. In Lowe’s 2006 10-K, it reports that it
opens over 100 new stores each year with 155 new stores opened in 2006 and a
projected 150 to 160 new stores to open in the 2007 fiscal year. Lowe’s ended
2006 with 1,385 stores and reported in its September 5, 2007, quarterly report
that as of August 3, 2007, it had 1,424 stores. Also in the 2006 10-K, Lowe’s
reported that it believes it can expand its number of stores in North America to
2,000 and that its real estate committee had already approved 400 new store
locations. In North America alone, this means that Lowe’s can continue its
expansion rate of over 100 stores a year for the next five to six years leaving
plenty of room for its net sales growth to continue increasing at a healthy rate.
Expansion is a key accounting policy for Lowe’s because it needs to
emphasize to its investors how well it is building new stores to accompany its net
sales growth. Lowe’s does a good job of reporting its net sales growth and store
expansions and it also does a good job of making these areas transparent in its
financial statements. There is a line item included on Lowe’s income statements
that reports the store opening costs for each year. Lowe’s explains a little bit
about the opening expenses in the notes section as well towards the end of the
reports. When a firm is growing it can be difficult to determine from without
whether that growth is from sales or expansion. Lowe’s disregards the ease in
which competitors could follow and be proactive against its expansion plans and
opts to report transparent figures to its investors.
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Operating and Capital Leases
Another key accounting policy in the retail home improvement industry is
how a firm discloses its operating and capital leases. It is important when
analyzing a firm to keep an eye on its leases. Operating leases do not show up
on the balance sheet. This will make it seem that the firm has fewer liabilities
and less future obligations than it realistically possesses. If a firm does not
disclose enough information, it can be extremely difficult to determine how to
undo the distortions its operating leases have caused. Firms may be tempted to
allow these distortions to occur without disclosing information on their operating
leases because it will appear that they have lower costs than other firms utilizing
capital leases. Firms who use capital leases appear to have more costs because
they report the leases on their balance sheet. This is because capital leases
have the characteristics of assets.
Lowe’s doesn’t seem to be trying to hide its leases. In its note sections
toward the end of its 10-Ks it discusses its operating and capital leases in detail.
It shows a graph that discloses how much it has spent in rent expenses over the
last three years, shows the details of how much payment on both types of leases
will be over the next five years, and then lists how much the total payment will
be over the remaining years of the leases. The section on leases also discloses
that Lowe’s usually signs 20 year leases informing the reader of their long-term
nature. On the balance sheet, Lowe’s includes references to the note that
explains operating and capital leases on the line item labeled, “long-term debt,
excluding current maturities.” This shows that Lowe’s is not trying to hide any
information regarding its leases and regards this area as a key accounting policy.
We do not believe that Lowe’s obligations in operating and capital leases are
substantial. The average number of Lowe’s obligations over the past three years
and the next five years is $384 million. This was somewhat significant in 2003
when it was about 5% of total liabilities, but today it is about 3%, and will be
39
about 1% in 2017. At the same time Lowe’s fully discloses its lease obligation
amounts in order to make it easy to undo any distortions that might be deemed
significant. As an investor in the retail home improvement industry it is
important to be informed on a firms operating and capital leases. When a firm is
growing its obligations with leases can also grow and make a firm increasingly
look like it is reducing costs while expanding. With a 3% to 1% level of
difference we do not believe that the operating leases will significantly distort the
financial reports.
Conclusion
It is important to pay close attention to any firms accounting policies in any
industry. It is especially important to look at key accounting policies that are
linked to key success factors. Firms know how they need to stay competitive in
their respective industries and some may decide to distort their financial reports
in order to make them seem better than the competition. If a firm does not
discuss in detail how it has determined the numbers on its financial statements it
can be hard to determine whether if that firm is disclosing numbers that are
consistent with reality. If there are sufficient explanations included in the
reports, however, then it is easier to identify problem areas and to affirm the
reported numbers. A good firm should report transparent reports with key
accounting policies that support its key success factors. Lowe’s supports its key
success factors of economies of scale and scope, lower input costs, and tight
cost control systems with its key accounting policies in its reports. With a little
knowledge of financial reports, the transparency and high level of disclosure can
be noticed easily in Lowe’s 10-Ks.
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Potential Accounting Flexibility
General Accepted Accounting Principles (GAAP) are guidelines that publicly
traded companies follow in recording and disclosing their public information.
Although GAAP tries to keep things similar on the financial statements of
companies there are many flexible parts to the principles. This flexibility in GAAP
is used by companies to better value their company or in some cases make their
company look more valuable for investors. “All firms have to make choices with
respect to depreciation policy, inventory accounting policy, and policies regarding
the estimation of pension and other post-employment benefits (Palepu and
Healy).” By analyzing the flexibility of the key accounting policies of Lowe’s and
the retail home industry we can see how these companies use these flexibilities
to show how much the wealth of the firms are.
Recording leases is a one way of flexibility in GAAP for recording
purposes. Companies record leases as either operating or capital leases in their
reports. Operating leases are the most commonly reported in the retail home
industry as this reduces assets and liabilities. Since operating leases are basically
just paying rent and the company does not own the property it is not placed on
the balance sheet. When reducing the liabilities this increases the retained
earnings which in turn, make the firm look more valuable to investors. While
Lowe’s and its competitors do have capital leases listed, they are considerably
lower than the operating leases. Capital leases are recorded on the balance
sheet, therefore increasing the assets and liabilities, and reducing the retained
earnings.
Deferred revenue is also a flexible part on the financial statements of
Lowe’s. The deferred revenues are shown as increased liabilities on the balance
sheet. Lowe’s deferred revenue includes installation work and gift cards. The
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gift cards are recognized when they are redeemed at one of the retail stores.
The gift cards that are purchased have no expiration dates on them and can be
redeemed by the customers at any time. Installation work revenue is not
counted until the work is done at the location. Home Depot’s services and gift
cards act the same way. Tractor Supply Company also has a merchandise return
card for some return transactions. These cards are also not recognized until
they are redeemed, or expire after a year. Tractor Supply also, according to
their 10-K they recognize the gift card when there is a remote chance that the
customer is going to redeem it. According to their 10-K they believe that the
redemption of the gift card is remote.
Another flexible part on the financial statements according to GAAP is how
the companies record the pension plans. The companies have to record how
much they believe will be paid in the future in the benefit plans they give out to
their employees. The most common benefit plan for employees is the 401-k,
which takes out a certain amount of money from their salary and it is put in a
mutual fund of the employee’s choice. Since the discount rate value is uncertain
in the future, these numbers are “flexible” on the balance sheet. The lower the
rate the higher the firm’s asset value will be because they will have a lower
expense to pay the employees.
In conclusion, while GAAP is very strict in most aspects while recording
companies’ figures, there are certain parts that can be flexible. Since these parts
are so flexible the managers can use it by improving the way their firm looks on
paper. While some may argue that the financial statements are incorrect but the
flexible nature of GAAP keeps the statements informative for the investors on
“understanding the firm’s economics” (Palepu and Healy).
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Accounting Strategy
The Lowe’s Company Inc. has been a publicly traded company for more
than 20 years. As a publicly traded corporation they follow all the key accounting
principles generally accepted in the United States. This also mean The Lowe’s
Company follows all of the GAAP guidelines provided for their accounting
disclosure. Currently The Lowe’s Company uses the Deloitte and Touche
Accounting firm to audit all their financial reports.
Complying with GAAP begins with a company’s internal accounting
policies. With this in mind Lowe’s views their internal controls as effective.
Deloitte and Touche viewed Lowe’s internal control as effective and “is fairly
stated, in all material respects, based on the criteria established in Internal
Control—Integrated Framework” (Lowe’s 10-k). However, there were concerns
over the limitations and possibilities of improper management and misstatements
due to error and possible fraud. Deloitte and Touche only audits the fact that
financial statements are in accordance with GAAP and does not guarantee that
the numbers are completely accurate
Overall, Lowe’s Company Inc. has a moderate to high level of disclosure
within their financial reports. Lowe’s discloses information about current litigation
issues they are facing. However, Lowe’s does state that these litigation issues
are immaterial in regards to their earnings (Lowe’s 10-k). Another major key
accounting policy (KAP) they mention is their partial operating and partial capital
lease expenses. It is important to note that Lowe’s Company Inc. has 8.5 times
more money is operating leases over capital leases. Other accounting policies
Lowe’s maintains is the disclosure of merchandise inventory which has increased
steadily of the last five years by approximately 80%. Lowe’s also discloses to its
shareholders vendor expenses, revenue recognitions, and self insurance
liabilities. Over the past few years Lowe’s has recorded a significant increase in
43
self insurance liabilities due to their overall growth of stores, employees, and
company vehicles. By reading these disclosures we find that Lowe’s gives a
moderate to high disclosure to its investors.
After evaluating The Lowe’s Company’s accounting strategy we feel they
have semi-aggressive approach to their financial statement reporting. The
excessive use of operating leases over capital leases lowers the expenses Lowe’s
accrues annually. This would imply a higher net income within their financial
reports. Even though this strategy causes a higher net income neither the
income statement nor balance sheet are affected. This is possible because
Lowe’s specifically explain the effects of the lease numbers in their 10k notes and
shows what little effect the lease numbers have on their bottom line. The fact
that Lowe’s views their litigations issues as immaterial also implies an aggressive
approach to undermining their expenses. However, it is impossible to determine
the actual cost of these litigations so they may likely be irrelevant to their
shareholders.
Quality of Disclosure
The amount of information a company discloses to investors is dictated by
the Securities and Exchange Commission. Although the SEC gives companies
guidelines for disclosure of financial data, the companies must take on the task
of informing investors to the best of their ability. It is crucial for financial data to
be easy to read and understandable because private investors do not always
know the inner workings of a firm in which they intend to invest.
44
Qualitative Analysis of Disclosure
Over the past five years the home improvement retail industry has grown
increasingly from year to year. This result does not only come from increased
sales by firms in the business, but also the growing trend of increased investing
in these firms as well. This is achieved in some part due to the high quality of
disclosure of accounting policies that attempt to convince investors the industry
is in good shape. Notes in the discussion of consolidated financial statements
shed light on key concepts not covered directly in the statement. The extent to
which the company goes into detail in these notes should be the best the
company can offer without giving away competitive advantages to competitors.
The company historically uses very conservative accounting practices in their
financial statements. Conservatism provides justification for understating
benefits and overstating obligations and risk under uncertainty.
Accounts Receivable
All companies that are publicly traded must submit filings to the SEC every
year. The level of disclosure is monitored but is given leeway for some business
entities. However, Lowe’s has an overall high level of disclosure and this is
shown in their annual 10-K documents. For example, the accounts receivable of
Lowe’s has been relatively insignificant on the balance sheet because of an
agreement they entered into with General Electric in 2004. Most of Lowe’s
receivables exist due to their relationship with commercial business customers.
In this note on the 10-K annual report they explain the process of selling these
accounts receivable to General Electric at face value. GE then services these
accounts for Lowe’s and records any gains or losses at fair value. This however
does come at some expense to Lowe’s due to the servicing costs associated with
the receivable transfers to GE.
45
(in millions)
2004
2005
2006
Account Receivables sold to General Electric
1200
1700
1800
-34
-41
-35
Losses associtated with sale
The losses recorded by Lowe’s are expensed in the general, selling, and
administrative expenses on the balance sheet for these years. If Lowe’s had
chosen not to show this on the 10-K the company may look unattractive to
investors. The company also showed the losses associated with the sale. By
disclosing these numbers Lowe’s might be putting the company in a bad light but
this does improve their level of disclosure. This creates a clearer forecast of
future cash flows by eliminating any bad debt expense associated with accounts
receivable that would otherwise be on the income statement. Any other account
receivables not bought by General Electric are reported as insignificant and are
not reported on the financial statements.
Market Risk
Lowe’s also puts time and effort into informing their investors about
market risk. Based on data given in the 10-K the primary market risk appears to
be the fluctuation of interest rates on long-term debt. The long-term debt is by
far their greatest liability to the company and has increased over time. In order
to off-set this risk, Lowe’s uses a variety of fixed interest rates and variable rates
associated with their lines of credit, to satisfy long-term debt each year.
Although Lowe’s changes the interest rates they use, no evidence of hedging is
found anywhere in their company.
In addition, Lowe’s discloses other forms of market risk arising through
changing market conditions. Adverse changes in the economic factors affecting
real estate industry affect the home improvement retail industry as well.
Housing turnover, slowing home price appreciation, and rising mortgage rates all
cause changes in the home improvement industry. When the real estate
46
industry slows down or has poor market conditions this directly affects the
choices people make for improving their homes. When housing turnover is high
consumers will readily make improvements in an attempt to sell their house as
soon as possible. The opposite is true for rising mortgage rates and slow home
price appreciation because some consumers are not as willing to improve
something that is associated with a slow market. Eventually sales will decrease
in home improvement retail if market risks remain high. Lowe’s disclosure of the
market risk associated with their products gives investors crucial knowledge for
future changing market conditions.
Overall, the financial statements along with notes that go along with each
entity are very informative. The company explains each point in depth in the
notes but it would be more useful to show some things they did not on the
balance sheet. The balance sheets of Home Depot, Sherwin Williams, and
Tractor Supply Company go more into depth in their analysis of property, plant,
and equipment. Lowe’s only shows property less depreciation while the other
three competitors breakdown this into property, plant, any equipment, and finally
accumulated depreciation. Lowe’s does disclose these numbers in their notes
just not directly on the consolidated balance sheet. As years progress Lowe’s
annual reports and financial statements have become more in depth. Stricter
guidelines by the SEC and new accounting policies have led to more informed
investors. Lowe’s quality of disclosure is high although their strongest
competitor, Home Depot, has a high level of disclosure as well. The quality of
disclosure is different from company to company and from risk to risk. Lowe’s,
like other companies, evaluates what it can and can’t disclose to the public while
keeping the confidence of investors in mind.
47
Quantitative Analysis of Disclosure
Evaluating a firm can be a great task considering all financial statements
from every year should be analyzed to tell the story of that firm. This section will
help in uncovering the truth about financial data reported in the home
improvement retail industry.
Using diagnostic ratios, we are able to manipulate important numbers
from financial statements to tell us how well Lowe’s compares relative to the
industry. To do this, we will separate sales manipulation ratios and expense
manipulation ratios over a five year span for each firm in the home improvement
industry. Using a five year analysis gives us a much better look at what each firm
is trying to explain in their financial statements then simply looking one year in
the past. This will help in uncovering potential outliers and deviants from the
industry that may prove to be using accounting strategies to boost or reduce
financial values. This is not always a bad or purposeful move that firm’s make,
but we must be able to uncover the truth about these companies’ disclosure
techniques. We will attempt to do this using these manipulation diagnostic ratios
below.
Sales Manipulation Diagnostics
Using sales diagnostic ratios allows us to understand if and how certain
other variables can explain a sales increase or decrease throughout a period of
time. They help analysts to attempt to find discrepancies in reporting from year
to year against the rest of the industry. This section will examine such ratios as:
Net Sales/Cash from sales, Net Sales/Net Accounts Receivable, Net
Sales/Unearned Revenues, Net Sales/Warranty Liabilities, and Net
Sales/Inventory. These ratios and graphs will allow us to draw conclusions about
how these variables have affected the reported Net Sales in the firm’s financial
48
statements, and they will let us evaluate the believability of the reported
financials.
Net Sales/Cash from Sales
2002
2003
2004
2005
2006
Lowe's
1.00
1.00
1.00
1.00
1.00
Home Depot
1.00
1.00
1.01
1.01
1.01
Sherwin-Williams
0.99
1.01
1.03
1.01
1.01
Tractor Suppy
1.00
1.00
1.00
1.00
1.00
Net Sales/Cash From Sales
1.1
1.08
1.06
1.04
Lowe's
1.02
Home Depot
1
Sherwin Williams
0.98
Tractor Supply Co.
0.96
0.94
0.92
0.9
2002
2003
2004
2005
2006
Year
This ratio explains the difference of sales to the actual cash received from
these sales. The cash from sales amount is explained by taking the difference of
accounts receivable from the previous year and subtracting (or adding) this
number to net sales in the denominator. We can then divide this number by
49
actual Net Sales from that year to get to the ratio that tells us how much actual
cash we received compared to our operating sales year to year. The ideal
situation for any firm would be a ratio right around 1:1. Although, many home
improvement firms offer store credit cards that could increase this ratio because
it would steadily increase their accounts receivable from year to year. In
contrast, some home improvement firms extract their accounts receivable to an
alternate financial firm. This would manipulate this ratio to a value less than 1,
and eventually be equal to 1 after all receivables have been transferred.
While attempting to identify manipulations in the numbers, a noticeable
increase in the ratio for Sherwin-Williams can be seen in 2004. This was due to
a large increase in the accounts receivable for the firm. Although this is still an
asset, a large increase in accounts receivable leads to an increase in the
allowance for bad debt. This could be bad for the firm if bad debt expense
continues to increase. Also, a noticeable difference is the mainstream lines of
Lowe’s and Tractor Supply Company. As mentioned earlier, Lowe’s sold off their
accounts receivable to GM Financial in 2004. This explains their constant 1:1
ratio with a slight dip involving getting rid of the final amounts of receivables in
2004. This type of manipulation in the ratio is shared by Tractor Supply Company
who did the same thing in 2002 (extracting accounts receivables to CitiGroup
Financial). Their ratio dips in 02’ and 03’ result from releasing their small
remaining receivables. Overall, there were no significant manipulations designed
to improve the numbers of the companies.
50
Net Sales/Net Accounts Receivable
2002
2003
2004
2005
2006
151.81
211.29
N/A
N/A
N/A
54.33
59.08
48.76
34.02
28.18
Sherwin-Williams
10.5
9.94
8.44
8.89
9.03
Tractor Suppy
N/A
N/A
N/A
N/A
N/A
Lowe's
Home Depot
The ratios of net sales to net accounts receivable are farily
straightforward. Consistency is the main focus in examining this graph because
changes indicate manipulations in the numbers. Instead of using cash from
sales, we now look straight at accounts receivable in relation to net sales. Two
outliers were eliminated from the graph, one of which was the ratio for Lowe’s in
2004 and the other for Tractor Supply in 2002. These outliers were eliminated
because they did not show true ratios that can be examined. In these years
51
both companies sold off their accounts receivables as mentioned earlier. For the
ratios shown in this graph Lowe’s looks as if they were beginning to understate
their accounts recievable from 2002-2003. This may have been due to their
knowledge that they were going to be selling off their receivables in the coming
years. On the other hand, Home Depot and Sherwin Williams have a steady ratio
in respect to sales and accounts receivable. Their ratios are consistent although
Home Depot’s is steadily declining. While their accounts receivables account for
more and more of their net sales, this may create a problem for the company.
Sherwin-Williams manipulation from the net sales/cash from sales in 2004 can be
seen here as well. Their ratio dips slightly as they recognized more receivables
in that year.
Net Sales/Unearned Revenue
2002
2003
2004
2005
2006
N/A
N/A
137.6
114.7
128.92
58.36
50.59
47.28
46.39
55.59
Sherwin-Williams
N/A
N/A
N/A
N/A
N/A
Tractor Suppy
N/A
N/A
N/A
N/A
N/A
Lowe's
Home Depot
52
When analyzing the ratio of net sales to unearned revenue analysts first
must know what they are looking for. Unearned Revenue is a current liability
found on the balance sheet. However, the companies in the home improvement
industry do not recognize this liability directly. Instead, unearned revenue is
accounted for in the deferred revenue entry on the balance sheet. This made
analyzing this ratio difficult because many liabilities are thrown into the deferred
revenue account.
Furthermore, this ratio is important because it shows the how sales
recognition affects unearned revenue. If a company wanted to boost their
earnings, they simply recognize revenue that has not been incurred. This type of
accounting policy would drastically increase the ratio because sales would
increase while the unearned revenue account decreases. Lowe’s and The Home
53
Depot were the only companies that had any statistical information involving
unearned revenue. Lowe’s sudden rise from 2003 to 2004 is explained by the
insignificance of the values in the previous years. Before 2004 Lowe’s did not
disclose their any unearned revenue on the financial statements. SherwinWilliams and Tractor Supply Company made notes to their financial statements
explaining their poor disclosure. Tractor Supply Company does not offer store
credit or gift cards as some home improvement retailers do. Instead they have a
customer layaway program where all they require is a deposit. Finally, SherwinWilliams believed their unearned revenue liability was insignificant and did not
record it on the balance sheet.
Net Sales/Warranty Liabilities
2002
2003
2004
2005
2006
Lowe's
N/A
N/A
424
209.92
148.97
Home Depot
N/A
N/A
N/A
N/A
N/A
334.29
326.65
337.82
312.6
309.59
N/A
N/A
N/A
N/A
N/A
Sherwin-Williams
Tractor Suppy
54
Only Lowe’s and Sherwin William’s have a net sales/warranty liabilities
ratio. Sherwin William’s ratio is very consistent, but Lowe’s didn’t begin doing
extended warranties until 2003. According to Lowe’s 10-K they use straight line
depreciation to depreciate their extended warranties each year. Since Lowe’s
had just begun to offer warranties in 2003, they had a very low value for
warranties in that year. This made their ratio extremely high and thus was
eliminated as an outlier. Sherwin Williams bases their warranties on estimates
by the managers and periodic checkups that are accrued into the figure making
their ratio constant. Since Sherwin William’s rarely comes out with new products
the manager’s estimates are usually relatively close, making the ratios accurate.
This type of accuracy results in no manipulations by the Sherwin-Williams for this
ratio. Home Depot and Tractor Supply Co. offer no warranties for their products
making both of their ratios zero.
Net Sales/Inventory
2002
2003
2004
2005
2006
Lowe's
6.58
6.73
6.1
6.52
6.57
Home Depot
6.99
7.14
7.25
7.15
7.08
8.3
8.47
7.91
8.89
9.46
4.18
4.54
4.51
4.49
3.99
Sherwin-Williams
Tractor Suppy
55
The Net Sales/Inventory ratio shows how much sales are supported by
the amount of inventory in the company year to year. Every one of the four
competitors in the retail home improvement industry has a fairly steady ratio.
This means the sales they are accumulating increase and decrease consistently
with the inventory that they have on hand. Although, Sherwin Williams’ ratio has
increased in the last few years, meaning that the change in inventory did not
support the change in sales growth. This, in fact, is correct because in 2005 and
2006 inventories only increased by 4.6% and 2.1%; while sales grew at 17.6%
in 2005 and 8.6% in 2006. This happened because Sherwin Williams recorded a
reserve for obsolescence of around $75 million in both 2005 and 2006 to reduce
inventories to their net realizable value (Sherwin Williams 10K). As an industry,
the results for this ratio do not indicate that any company has overstated sales in
respect to inventory.
56
Expense Manipulation Diagnostics
The expense diagnostic ratios are similar to the sales diagnostic ratios in that they
are attempting to discover any reporting discrepancies in the financial statements. This
section will examine such ratios as: Declining Asset Turnover, Changes in CFFO/OI,
Changes in CFFO/NOA, Total Accruals/Change in Sales, and Other Employment
Expenses/SG&A. These ratios and graphs will help in drawing conclusions about the
relevance of these numbers on the firm’s financial statements.
Asset Turnover (Sales/Assets)
2002
2003
2004
2005
2006
Lowe's
1.62
1.64
1.72
1.76
1.69
Home Depot
1.94
1.88
1.88
1.84
1.74
Sherwin-Williams
1.51
1.47
1.43
1.65
1.56
Tractor Supply
2.64
2.74
2.56
2.54
2.35
57
The asset turnover ratio helps to determine how well a company uses its assets to
provide sales. Obviously, a high ratio is ideal because this would mean the company
would have high sales when using a minimal amount of their total assets. Supprisingly
Tractor Supply Company has the highest ratio in the market. To explain this one must
know the market in which they operate. Tractor Supply has a small number of assets
and their product is much more expensive. They also have little inventory because most
of their product is expensive.
One thing companies must be protective of is a declining asset turnover. This
means the company is growing their assets at a faster rate than their sales. Home Depot
and Tractor Supply must be cautious not to increase their assets so much that they do
not produce enough revenue for the company to run smoothly. As seen in the graph
Lowe’s is slowly catching up to their main competitor Home Depot. This can be
explained by the rapid growth of Lowe’s into areas where Home Depot has claimed most
of the market share. This increases the sales and consequently the asset turnover ratio
of the company. In addition, capital leases and operating leases effect the asset
turnover for these companies. As mentioned earlier the capital leases for Lowe’s are
58
immaterial and do not affect the total assets as a whole. However, if all operating leases
were capital leases this ratio would decrease because of the increase in assets. No other
distortions or manipulations of the numbers can be found for this ratio in the home
improvement retail industry.
Change in Cash Flow from Operations/Change in Operating Income
Lowe's
Home Depot
Sherwin-Williams
Tractor Supply
2002
2003
2004
2005
2006
1.6
0
0.07
0.8
1.33
-1.28
1.71
0.33
-0.29
N/A
0.69
0.04
-0.24
2.02
0.51
0.8
0.55
2.16
0.63
-1
59
Cash Flow from Operations/Operating Income
2002
2003
2004
2005
2006
Lowe's
1.49
1.17
0.83
0.83
0.87
Home Depot
0.82
0.96
0.84
0.71
0.79
Sherwin-Williams
1.01
0.97
0.86
0.98
0.93
Tractor Supply
0.71
0.65
0.76
0.73
0.59
The change in cash flows from operating activities compared to the change in
operating income provides a ratio worth analyzing. Operating income is also known as
earnings before interest and taxes, or EBIT, and can be found on the income statement.
CFFO, or Cash flows from operating activities, is a measure of the cash generated by the
operating activities of the company. If this ratio is declining the result is that income is
not supported by cash. Therefore, from 2002 through 2004 Lowe’s net income was not
supported by cash. This shows that some expenses that are incurred by Lowe’s are not
60
being recognized on the income statements. In 2003 there is a significant manipulation
of the numbers so much that it created a ratio of approximately 0 for the change in
CFFO/change in OI. This was because their CFFO changed by only a few thousand
dollars while their operating income changed by several million. Again this is proof that
Lowe’s did not recognize some of their expenses in this year in attempt to boost
earnings.
Changes in CFFO/ Changes in Net Operating Assets
2002
2003
2004
2005
2006
0.97
0
0.02
0.31
0.25
-0.33
0.61
0.13
-0.19
0.69
Sherwin-Williams
0.78
-0.07
-0.2
N/A
1.19
Tractor Supply
0.51
0.63
0.21
0.49
-0.28
Lowe's
Home Depot
A company’s ratio between the changes in cash flows from operating activities
and the changes in net operating assets relates cash flows with fixed assets such as
61
property, plant, and equipment. The greater this ratio, the better the firm utilizes those
fixed assets. The home improvement retail industry proves to keep a consistently low
average with respect to this ratio, but larger firms such as Lowe’s, Home Depot and
Sherwin Williams have utilized their fixed assets to produce positive cash flows as of last
year. Although the graph seems to be all over the board, there is no sign of any
accounting distortions for any firm in this industry. This has been a consistent average
ratio of right around 0.3 in the last five years.
Total Accruals/Sales
2002
2003
2004
2005
2006
Lowe's
0.10
0.10
0.09
0.08
0.09
Home Depot
0.11
0.11
0.12
0.15
0.19
Sherwin-Williams
0.32
0.33
0.39
0.35
0.34
Tractor Supply
0.10
0.09
0.09
0.10
0.11
This ratio helps look at the financial stability of a company at one point in time.
62
Accrual accounting helps firms account for expenses and revenue that have not been
accounted for. An investor might perceive a high ratio as a bad thing because it could
mean they do a lot of business on credit. Overall, the industry seems very stable within
this ratio, and Lowe’s has stayed right around the industry average for the last 5 years.
Sherwin-Williams would be considered an outlier because it is so far above the industry
average. There is no sign of any accounting distortions within the industry due to the
consistency and relative industry average.
Other Employee Expenses/S,G,&A
Lowe's
Home Depot
Sherwin-Williams
Tractor Supply
2002
0.025
0.009
0.007
0.01
2003
0.015
0.008
0.008
0.005
2004
0.009
0.007
0.008
0.004
2005
0.015
0.008
0.007
0.004
2006
0.004
0.009
0.006
0.004
This ratio relates other employee expenses with selling, general, and
administrative expenses. Selling, general, and administrative expenses are operating
expenses incurred by companies each year. This ratio was not relevant in attempting to
detect any accounting distortions due to the insignificant low values for the home
improvement retail industry.
Potential Red Flags
A red flag is anything that points to questionable accounting practices that
make the firm look better by boosting profits or increasing performance.
Shareholders should always be aware of these types of practices because they
can lead to false reporting which could overvalue the company and its stock
prices. When analyzing a firm’s financial reports red flags usually show up as
63
discrepancies found while performing a ratio analysis. If historical ratios begin to
change dramatically over a short period of time then distortions might be
present. We examined the past five years of financial reports to determine if
there exist any such distortions. After examining Lowe’s past five annual reports
we determined that there were no potential red flags that would mislead
investors. Since 2003, Lowe’s annual reports have actually improved consistently
in their amount and quality of disclosure of all financial information. For
example, as stated above, Lowe’s discloses a lot of information about its
operating and capital leases, which can easily be used to distort financial data.
In fact, Lowe’s has been disclosing this information as far back as 1995 far
beyond the reach of our ratio analysis. Lowe’s also discloses the present value
of its minimum lease payment. This makes it possible to determine any
distortions without guessing. Overall, the accounting principles used in preparing
the financial reports for Lowe’s Company Inc. are transparent and accurate. As
you can see in the table below Lowe’s spreads out their payments over several
years, which in turn causes a very minimal expense on the yearly balance sheet
and income statement.
Payments Due by Period
Contractual Obligations
(In millions)
Long-term debt (principal and interest amounts, excluding discount)
Capital lease obligations 1
Operating leases 1
Purchase obligations 2
Total contractual obligations
Total
$ 7,865
644
5,527
2,307
$ 16,343
Commercial Commitments
(In millions)
Letters of credit 3
Total
$ 346
Less than
1 year
$ 281
62
323
1,079
$ 1,745
Amount of Commitment Expiration by Period
$ 344
1-3
years
$ 438
124
645
834
$ 2,041
4-5
years
$ 870
123
642
382
$ 2,017
Less than
1 year
$2
1-3
years
$ -$ -
Of course, when analyzing a firm solely using financial reports, it is always
important not to assume that all conclusions are 100% correct.
Undo Accounting Distortions
When analyzing a firm, one must be able to take a fair look at all the
financial statements and give an unbiased assessment of where the company is
64
headed in the future. These reports can be distorted by aggressive accounting
policies or human error. Lowe’s seems to be in good standing when reporting
their financial statements. This means that we do not believe that there are any
distortions on the reports that actually need to be fixed. As stated above, Lowe’s
reports financial data that is transparent and without distortions. This data is
transparent because Lowe’s goes into detail and explain areas of its balance
sheets, income statements, and statements of cash flows. These explanations
uncovered areas that could be successfully distorted if no information was
disclosed and curved any suspicion we had that these distortions existed.
Operating leases could have distorted Lowe’s numbers, but with the explanations
provided we found these leases to be insignificant. As stated above, Lowe’s
reports that its average annual lease payments total $384 million. This is a
minuscule figure compared to Lowe’s sales coming in at about 1% today and
0.2% at the end of our forecasts in 2017.
Financial Analysis
Performing ratio analysis on a company is very helpful when charting a
company’s performance over a certain period of time. The analysis produced
when evaluating and implementing these ratios sets a benchmark which is a
useful tool in comparing different companies within the same industry. There are
three major classifications of performance ratios: Liquidity Ratios, Profitability
Ratios, and Capital Structure Ratios. While using these different ratios analysis
we are able to pull information from all three financial statements. This allows for
a complete cross-examination of all the companies the statements.
Included in the final portion of the ratio analysis is the financial
forecasting model. A forecast is a prediction of the company’s future
performance based on their past performance. Financial forecasting, like the
65
ratio analysis, is done by examining the companies past balance sheets, income
statements, and statement of cash flows.
Liquidity Analysis
Liquidity ratios are one of the most important ratios to consider when
evaluating a firm. These ratios relate how quickly a company can convert assets
into cash to cover their obligations in a timely manner. Lenders will usually prefer
a higher liquidity ratio because this indicates that the company has enough
resources to pay off its debt if they became financially inefficient. The most
relevant liquidity ratios to evaluate these firms include: Current Ratio, Quick
Asset Ratio, Accounts Receivable Turnover, Inventory Turnover, and Working
Capital Turnover.
Current Ratio (Current Assets/Current Liabilities)
The Current Ratio measures the relationship between all current assets to
all current liabilities. A higher ratio is preferred in this case because it means a
firm has enough liquid assets to pay off its recent payables.
2002
2003
2004
2005
2006
Lowe's
1.56
1.55
1.22
1.34
1.27
Home Depot
1.48
1.4
1.35
1.2
1.39
Sherwin Williams
1.39
3.19
1.17
1.22
1.18
Tractor Supply
1.73
1.9
1.9
1.83
2.58
66
The Current Ratio for the home improvement retail industry seems quite
stable with some expansion and peaks for the smaller firms. Lowe’s has held a
consistent ratio of 1.4:1, while the industry has kept a steady 1.6:1 ratio for the
last five years. This is a satisfying average for the industry because for every one
dollar in liabilities, it has approximately $1.60 to cover it. The only outcast in the
group seems to be Tractor Supply. As noted earlier, Tractor Supply Co. is a
smaller firm in the industry that has been doing well in recent years. Although, it
seems that each developed company seems to level out right under 1.5:1 in the
home improvement retail industry. We should expect to see Tractor Supply do
the same in the coming years.
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Quick Asset Ratio (Quick Assets/Current Liabilities)
The Quick Asset Ratio is very similar to the Current Ratio except it
excludes inventories from the current assets. These “quick assets” give an
investor a clearer view of the firm because inventory can be difficult to turn into
cash in a given period. It is still relevant that a larger ratio is better in this case,
but the ratios will be significantly lower than the current ratio due to excluding a
large number like inventory from the equation.
2002
2003
2004
2005
2006
Lowe's
0.36
0.42
0.14
0.15
0.12
Home Depot
0.41
0.41
0.35
0.25
0.3
Sherwin Williams
0.61
0.73
0.51
0.54
0.65
0.092
0.12
0.13
0.07
0.14
Tractor Supply
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As with any retail industry, inventory is usually a big piece of their
reported current assets. This is why there is not as much concern that the
industry average is around .33:1 in the last five years. One noticeable difference
is how low Tractor Supply’s Quick Asset Ratio is compared to its Current Ratio.
The reason is because Tractor Supply carry’s an average of almost 86% of its
current assets as inventory every year. This explains the astonishing .11:1
average of its Quick Asset Ratio. At first sight, Lowe’s and Tractor Supply might
seem to be much too far under industry average, but both companies transferred
their accounts receivables in 2002 and 2003. This explains Lowe’s recession in
2004 and Tractor Supply’s consistent .11 average for the Quick Asset Ratio.
Accounts Receivable Turnover: (Sales/Accounts Receivable)
2002
2003
2004
2005
2006
151.81
211.22
N/A
N/A
N/A
Home Depot
54.33
59.08
48.76
34.02
28.18
Sherwin-Williams
10.52
9.94
8.44
8.89
9.02
Tractor Supply
11.85
N/A
N/A
N/A
N/A
Lowe's
The accounts receivable turnover of a firm measures how effectively the
firm generates cash from the sales it makes on credit. This ratio is derived from
dividing the net sales of the company by the accounts receivable. This ratio is
hard to come by for Lowe’s and Tractor Supply since they no longer carry
accounts receivable in their books. A higher ratio is more attractive to investors
because the company then makes most of their sales on a cash basis rather than
extending credit to the customer. The ratios in the industry indicate that most
companies that do have accounts receivable have been eager to issue more do
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to the fact that their ratios are declining. This indicates more merchandise is
being sold on account in firms such as Home Depot and Sherwin-Williams.
Days Sales Outstanding: (365/Accounts Receivable Turnover)
2002
2003
2004
2005
2006
2.4
1.73
N/A
N/A
N/A
Home Depot
6.72
6.18
7.49
10.73
12.95
Sherwin-Williams
34.7
36.72
43.25
41.06
40.47
Tractor Supply
30.8
N/A
N/A
N/A
N/A
Lowe's
The days sales outstanding is found by dividing the number of days in a
year (365) by the accounts receivable turnover found in the previous section.
This number shows the amount of time it takes for a company to get paid when
it extends credit to customers. A fewer amount of days is preferred because the
less time the customer takes to pay back the sale the better. In 2002 and 2003
Lowe’s very low days sales outstanding may be part of the plan of the company
to sell off all their accounts receivables. This plan led them to stop extending
credit to their customers and thus undervalued the accounts receivables it should
have had during the period. The low numbers of Home Depot indicate they are
too efficient in converting sales on credit to cash with an average over the last
five years of 8.81 days. The days sales outstanding is also important because it
is part of the cash-to-cash cycle of the firm which is discussed later in the report.
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Inventory Turnover: (Cost of Goods Sold/Inventory)
2002
2003
2004
2005
2006
Lowe's
4.58
4.64
4.05
4.29
4.3
Home Depot
4.82
4.87
4.83
4.75
4.76
Sherwin Williams
4.55
4.63
4.42
5.03
5.33
3
3.16
3.15
3.1
2.73
Tractor Supply
Inventory Turnover
6
5
4
Lowe's
Home Depot
3
Sherwin Williams
Tractor Supply
2
1
0
2002
2003
2004
2005
2006
Year
Inventory turnover measures the number of times the firm sells and
repurchases inventory during the year. This measure of operating efficiency is
found by taking the cost of goods sold and dividing the number by inventory at
the end of the year. The ratio is better when it is high rather than low, although
it can be seen as negative if the ratio is too high. A high ratio means the
company is selling goods quickly, however when the ratio is uncharacteristically
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high the company may not have enough inventory to satisfy their sales demand.
The industry average over the last five years is 4.25 while Lowe’s average is
4.37. This shows Lowe’s turns over their inventory more times a year than the
industry average. While this is good for Lowe’s, Home Depot has consistently
had a higher turnover due to their large volume of sales each year. Tractor
Supply has had the lowest inventory turnover each year but this may be due to
the high priced and specialized machinery they offer. Analysts who better
understand a company’s inventory turnover benefit by knowing how quickly the
company sells excess inventory.
Days Supply of Inventory: (365/Inventory Turnover)
2002
2003
2004
2005
2006
Lowe's
79.69
78.66
90.12
85.08
84.88
Home Depot
75.73
74.95
75.57
76.84
76.68
Sherwin Williams
80.22
78.83
82.58
72.56
68.48
121.67
115.51
115.87
117.74
133.7
Tractor Supply
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Days Supply of Inventory
160
140
120
Lowe's
Days
100
Home Depot
80
Sherwin Williams
Tractor Supply
60
40
20
0
2002
2003
2004
2005
2006
Year
The days supply of inventory measures the time it takes to sell a product
or the amount of time an item is “on the shelf” in a store. By again taking the
number of days in a year and dividing that by the inventory turnover found for
each company results in the number of days supply of inventory. The number of
days found is also important to investors because it is another part of the cashto-cash cycle. Lowe’s is doing well when compared to the industry because their
average days supply is 83.67 days while the industry average is 89.27 days. The
amount of days has declined for Lowe’s since their peak in 2003; although they
are still behind their leading competitor Home Depot.
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Working Capital Turnover (Sales/Working Capital)
Working Capital Turnover is used to show the relevance of the funds a
firm uses toward operations, and the sales it actually produces. Working capital
is simply current assets minus current liabilities. A company would like to have a
high Working Capital Turnover because it would like to produce a high volume of
sales compared to the money it uses to finance these sales operations.
2002
13.12
15
12.27
8.62
Lowe's
Home Depot
Sherwin Williams
Tractor Supply
2003
13.28
17.17
9.64
8.13
2004
29.05
19.97
23.35
8.02
2005
22.11
31.47
21.15
8.59
Working Capital Turnover
35
30
25
Lowe's
20
Home Depot
Sherwin williams
15
Tractor Supply
10
5
0
2002
2003
2004
2005
2006
The Home Improvement Retail Industry has increased its Working Capital
Turnover significantly since 2002. This is a good sign, not only for Lowe’s, but as
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2006
26.44
17.92
20.8
5.69
an industry in itself. The industry averaged around 16:1 in the past five years,
and nearly 20:1 in the last three years. This means that for every $1 spent on
working capital, they are receiving nearly $20 in sales. Again, Tractor Supply
seems to be the only firm working against the industry average. This is because
they are a growing firm, and while their sales are continuously increasing, so are
their current liabilities to pay for expansion.
Conclusion
Lowe’s seems to be steadily in the mix within the industry averages
considering liquidity. The only exception is the quick asset ratio, which Lowe’s is
considerably lower than the industry average after 2003 due to the transferring
of their receivables to GE Financial. Lowe’s proves to be a very liquid firm in
comparison to the industry, and seems to run ratios relatively similar to its
largest and closest competitor Home Depot.
Profitability Analysis
Profitability ratios are used to determine where and how a firm is
producing its profit. Gross Profit Margin, Operating Profit Margin, and Net Profit
Margin are all used to determine operating efficiency. The next three include
Asset Turnover, Return on Assets, and Return on Equity.
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Gross Profit Margin (Gross Profit/Sales)
The Gross Profit Margin shows the percentage relationship between Sales
minus Cost of Goods Sold. A firm would prefer a higher percentage for Gross
Profit Margin because it would mean they are selling more while cutting costs for
the products.
2002
2003
2004
2005
2006
30.00%
31.03%
33.57%
34.20%
34.52%
31.0%
32.0%
33.0%
34.0%
33.0%
Sherwin Williams
45.10%
45.40%
44.19%
42.84%
43.72%
Tractor Supply
28.28%
30.48%
30.17%
30.93%
31.71%
Lowe's
Home Depot
Lowe’s has stayed within the industry average in relation to Gross Profit
Margin. The industry average has been around 35% in the last five years; While
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Lowe’s is operating near 33%, and increasing every year. This can be explained
by Lowe’s Sales growing by an average of 16% per year, while Cost of Goods
Sold are slowly growing at a 14% per year rate. Sherwin Williams is the only
company that throws the industry average off considering this ratio. They have
such a high margin because their primary product is paint. Paint is a very cheap
substance that Sherwin Williams uses the raw materials to mix on their own.
This, in turn, substantially reduces Cost of Goods Sold for Sherwin Williams
compared to the other three firms who must spend more when dealing with
numerous distributors.
Operating Profit Margin (Operating Income/Sales)
Operating Profit Marging is found by taking Income from Operations and
dividing it by Sales for the given year. This is another ratio that shows the
operating efficiency of a firm. A higher percentage means that a firm is able to
control the amount of operating expenses it reports year to year.
2002
2003
2004
2005
2006
9.08%
9.55%
9.65%
10.40%
10.65%
10.01%
10.56%
10.84%
11.49%
10.65%
Sherwin Williams
9.59%
9.67%
9.49%
9.13%
10.68%
Tractor Supply
5.33%
6.50%
5.84%
6.60%
6.25%
Lowe's
Home Depot
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The home improvement retail industry has maintained a steady 9.1%
Operating Profit Margin in the last five years. Lowe’s has been operating at
around 9.87%, and has been on the rise in recent years. This is a good sign for
Lowe’s because it remains above industry average meaning they are keeping
their operating expenses low (compared to revenue) relative to the industry
standard. It also tells investors and analysts that Lowe’s has been operating
efficiently for the last five years, and that Tractor Supply might be in some
trouble relying heavily on operating expenses compared to the industry.
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Net Profit Margin (Net Income/Sales)
Net Profit Margin is calculates by dividing Net Income by Sales. This ratio
gives an analyst a good look at how much money the company actually retained
compared to its sales dollars from year to year. Firms and investors would like
this ratio to be higher than previous years because this means the company is
retaining the sales and controlling its cost obligations.
2002
2003
2004
2005
2006
Lowe's
5.66%
5.93%
5.94%
6.39%
6.62%
Home Depot
6.29%
6.64%
6.84%
7.16%
6.34%
Sherwin Williams
2.46%
6.14%
6.43%
6.44%
7.38%
Tractor Supply
3.15%
3.78%
3.68%
4.14%
3.84%
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Lowe’s has been increasing its Net Profit Margin every year since 2002. In
the last five years, Lowe’s has had an average of 6.11% margin; While the home
improvement retail industry has averaged 5.56%. This means that Lowe’s is
operating efficiently due to the steady rise year to year, and being above the 5year industry average. An analyst would look at this from the perspective that in
2002 Lowe’s was receiving 5.7 cents in profit per sales dollar, and in 2006 Lowe’s
is retaining almost 6.7 cents per dollar. As an investor and analyst, this steady
increase could prove to be profitable in years to come. Sherwin Williams is the
only firm to raise suspicion, in which they jump back into the industry average
after a 2.46% margin in 2002. The reason for this was a $183 million change in
accounting principle that drove Sherwin Williams Net Income down to nearly
$127 million. Although, the firm proved to be efficient by striking within industry
average the following year.
Asset Turnover: Sales/Total Assets
2002
2003
2004
2005
2006
Lowe's
1.62
1.64
1.72
1.76
1.69
Home Depot
1.94
1.88
1.88
1.84
1.74
Sherwin Williams
1.51
1.47
1.43
1.65
1.56
Tractor Supply
2.64
2.74
2.56
2.54
2.35
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The asset turnover of a firm, as discussed earlier in the report as an
expense diagnostic, is the ratio of sales to total assets of a company. With the
vast size of the two entities used in the ratio, the asset turnover will almost
always be a low number. The industry average measuring asset productivity is
1.91 while Lowe’s average over the last five years has been 1.69. Lowe’s has
steadily improved from where they were five years ago by increasing their asset
productivity by 0.07. This means they are improving their profitability by
converting assets into sales.
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Return on Assets: (Net Income/Total Assets)
2002
2003
2004
2005
2006
Lowe's
10.20%
11.40%
11.55%
13.03% 12.60%
Home Depot
12.81%
14.34%
14.52%
15.01% 12.97%
Sherwin Williams
4.22%
9.02%
10.68%
10.84% 13.18%
Tractor Supply
9.57%
12.14%
11.90%
12.63% 11.17%
Return on assets, or rate of return on assets, is a ratio that is very useful
to investors. First, corporations want the ratio to be as high as possible since a
higher ROA yields higher net earnings. To compute this ratio the net income for
a given year is divided by the total assets of the firm from the previous year.
This way the net income is shown as an investment of the previous year’s total
assets. As shown in the graph, Lowe’s is up to par with their other competitors
with an average of 11.76% compared to the industry average of 11.69%.
Lowe’s has also been consistent in their ROA numbers which may result from a
management plan to keep their total assets at a proportionate level with net
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income. Only Home Depot has managed to consistently have a ROA higher than
Lowe’s over the last five years.
Return on Equity: (Net Income/Total Owner’s Equity)
2002
2003
2004
2005
2006
Lowe's
21.10%
22.03%
21.21%
23.97%
21.72%
Home Depot
22.14%
21.74%
22.32%
24.17%
21.41%
Sherwin Williams
10.35%
24.75%
26.96%
28.12%
33.29%
Tractor Supply
19.16%
24.44%
22.02%
23.12%
19.05%
35.00%
30.00%
25.00%
Lowe's
20.00%
Home Depot
Sherwin Williams
15.00%
Tractor Supply
10.00%
5.00%
0.00%
2002
2003
2004
2005
2006
The return on equity for a firm measures the amount of net income per
one dollar of equity. This ratio is important because it gives the investors of the
company a clear view of the return generated their equity they have put into the
firm. Also, like return on assets, the ratio is found by dividing the current year’s
net income by the previous year’s equity. When analyzing the home
improvement industry it is evident that three of the four competitors have very
83
similar ROE ratios. Sherwin Williams has done the most to improve its return on
equity by increasing the ratio to over 30%. Over the five year period three of
the four competitors remained relatively unchanged in their return. This shows
that as equity rises, the company becomes more valuable which causes income
levels to rise. The industry average for return on equity is 22.65% however
these numbers are somewhat bias because of the improving success of Sherwin
Williams and their ROE percentages. Lowe’s averaged 22.01% return on equity
over the five year span which shows they are remaining consistent with the
market.
Conclusion
The overall profitability of Lowe’s, shown by these ratios, enhance the
reasons they are a very profitable company. If one word were to describe
Lowe’s compared to the home improvement industry it would be consistency.
Although Lowe’s never leads the way in any of the profit ratios, they usually
remain at second or third when taking the averages of each firm over the five
years. Overall the industry numbers should all be pleasing to investors because
the yearly industry averages are increasing overtime. Lowe’s is no exception to
this and should be pleased with the ratios they have. As Lowe’s moves forward,
they increase profits even further as they expand into the global market.
Capital Structure Analysis
The capital structure of a company refers to the sources of financing used
to acquire assets and is shown by the liabilities and owners’ equity section of the
balance sheet (Financial Statement Analysis Handout). Firms grow by gaining
assets, but growing is not possible if the firm does not have the money to invest
in these assets. Therefore, they must pay particular interest in capital structure
ratios that relate information about servicing their financial obligations. There are
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three ratios that analysts take into account: Debt to Equity, Times Interest
Earned, and Debt Service Margin.
Debt to Equity (Total Liabilities/Total Owners’ Equity)
The debt to equity ratio explains a companys total liabilities divided by
total owners’ equity. This ratio is a good way to look at credit risk of a firm,
which means the possibility that interest and debt repayment cannot be satisfied
with available cash flows (Fin. Stat. Analysis Handout). In perspective, it shows
for every $1 of equity, how much are actually liabilities.
2002
2003
2004
2005
2006
Lowe's
0.94
0.84
0.84
0.72
0.77
Home Depot
0.52
0.54
0.61
0.65
1.09
Sherwin williams
1.56
1.52
1.59
1.52
1.51
Tractor Supply
1.01
0.85
0.83
0.71
0.68
85
Debt to Equity
1.80
1.60
1.40
1.20
Lowe's
1.00
Home Depot
0.80
Sherwin williams
Tractor Supply
0.60
0.40
0.20
0.00
2002
2003
2004
2005
2006
Lowe’s has a very favorable debt to equity ratio compared to the industry
average of .97. They have been running at around .82. Meaning that for ever $1
of equity, .82 cents are liabilities. Home Depot has the lowest average ratio at
.68, but increased substantially in 2006 to 1.09. Sherwin Williams’ debt to equity
ratio average of 1.54 would be considered unfavorable as it is around 60%
higher than the industry average.
86
Times Interest Earned: (Operating Income/Interest Expense)
The times interest earned ratio indicates the dollars of earnings available
for each dollar of interest payments. If the times interest earned ratio were one,
which would be very risky, it would indicate a firm is barely covering their
interest expense with income from operations. The higher the ratio the less risky
the situation is because interest can be paid more easily.
Lowe's
Home Depot
Sherwin Williams
Tractor Supply
2002
2003
2004
2005
2006
14.03
17.36
21.00
29.46
33.45
157.58
110.42
113.23
65.48
24.68
13.28
14.50
15.52
14.23
13.42
13.7
27.78
70.52
83.61
55.07
180.00
160.00
140.00
120.00
Low e's
100.00
Home Depot
Sherw in Williams
80.00
Tractor Supply
60.00
40.00
20.00
0.00
2002
2003
2004
2005
2006
Year
87
Upon first glancing at the graph, the huge 2002 ratio for Home Depot
stands out. The reason for their large ratio is partly due to how Home Depot
runs their business. They pay for things with increases in equity as opposed to
increases in debt. This causes the interest expense to be low and thus resulting
in a high times interest earned ratio. By identifying this point as an outlier
because it is so much higher than the other ratios, a better picture of the
industry can be seen. The industry average for the data is 39.51 when
eliminating the outlier. While Lowe’s average is significantly less at 23.06, there
is no need to worry because they can still disburse their interest payments with
operating income.
Debt Service Margin (Operating Cash Flow/Notes Payable)
This ratio determines how well a company can cover its principal amounts
of long-term liabilities every year with the cash flows provided from operations.
The margin number is the amount of cash provided by operations to cover $1 of
long-term debt.
Lowe's
Home Depot
Sherwin williams
Tractor Supply
2002
2003
2004
2005
2006
51.41
104.62
39.91
6.10
140.69
935.00
13.03
601.82
14.93
37.26
51.40
63.91
77.75
187.96
227.33
112.45
83.07
N/A
37.26
N/A
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Debt Service Margin
1000.00
900.00
800.00
700.00
Lowe's
600.00
Home Depot
500.00
Sherwin williams
400.00
Tractor Supply
300.00
200.00
100.00
0.00
2002
2003
2004
2005
2006
The debt service margin average for the home improvement retail
industry is very high. Not including obvious outliers like Home Depot, the
industry seems fair off when it comes to covering their installment payments.
Lowe’s is doing very well within the industry, and should be able to maintain a
debt service margin around the average for years to come.
Conclusion
In conclusion, Lowe’s has been consistently average within the capital
structure analysis. While the home improvement retail industry competes
relatively close within these ratios, Lowe’s has a noticeable expansion from 2005
to 2006 in each case. As for their debt to equity ratio, there was an expansion in
2006, but it has declined since 2002 overall. Lowe’s capital structure as a whole
reveals how debt and equity of the firm consistently service obligations.
89
IGR and SGR Analysis
Internal Growth Rate: (ROA(1-Dividend %))
Internal growth rate is defined as the highest level of asset growth
achievable for a business without obtaining outside funding. This ratio proves to
be very helpful to investors because they get an idea of how the company is
growing their total assets without outside funds or financing. Asset growth is
generated instead by cash flows retained by the company. These cash flows are
known as retained earnings, and are put back into the firm at the end of the
accounting period.
Lowe's
Sherwin Williams
Home Depot
2002
2003
2004
2005
2006
9.74% 10.86% 10.93% 12.22% 11.48%
1.21% 6.56% 8.05% 8.18% 10.08%
11.09% 12.36% 12.43% 12.81% 9.83%
During this five year span, Lowe’s has yielded an overall increase in their
internal growth rate. This is a good sign that the company is becoming ever
more able to grow assets using internal funds. These numbers are even more
impressive when analyzed further because Lowe’s is expanding their company.
Tractor Supply does not offer dividends and therefore cannot be analyzed with
the rest of the market. The internal growth rate is a crucial ratio when
estimating the overall growth of a company.
90
Sustainable Growth Rate: (IGR(1+D/E))
The sustainable growth rate of a company measures the rate at which a
firm can grow while keeping its profitability and financial policies unchanged.
Sustainable growth rates can be linked to many other ratios described in this
report; although, the main driver is the internal growth rate.
Lowe's
Sherwin Williams
Home Depot
2002
2003
2004
2005
2006
18.89% 19.98% 20.11% 21.02% 20.32%
3.09% 16.53% 20.85% 20.61% 25.30%
16.86% 19.03% 20.01% 21.14% 20.54%
The trend for Lowe’s is once again an increasing rate over the past five years.
The average SGR for Lowe’s over the time period from 2002-2006 has been
20.06%. This means that on average Lowe’s can grow up to 20.06% without
taking on additional debt or equity. If they want to grow at a rate higher than
the SGR they must acquire some type of funding for the company. Sustainable
growth rates can rise and fall but ultimately the company would not worry about
the fluctuations unless they are not expanding. An analyst might say a higher
SGR is preferred because it reflects fewer obligations on the company; however,
a low SGR as a result of aggressively expanding a company is not always a bad
thing.
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Financial Statement Forecasting
Financial statement forecasting is a very important and interesting part of
determining a firm’s value. It provides a tangible view of a firm’s future based
on forecast able numbers. We used the past five 10-K reports in order to
forecast the next ten years of Lowe’s income statements, balance sheets, and
statements of cash flows. The income statement was forecasted using historical
growth rates. While forecasting the balance sheet, we looked at growth rates
along with liquidity and profitability ratios. For the statement of cash flows we
looked at the CFFO/NI ratio to determine what we thought would be the most
accurate forecast. Both Lowe’s and the retail home improvement industry’s
averages were taken into consideration for each forecast.
Income Statement Forecast
Lowe’s net sales were increasing at a steady 18% from 2003 through
2006 but dropped to 8.5% in 2007. To forecast Lowe’s net sales for the next ten
years we used a moving average of the past five years sales growth rates. This
means that each year after 2007 was calculated using the five previous years
average growth rates. Our forecasted growth rates over the next ten years
came out to an average of 15.27%. We believe that although the growth rate
was 18% for the first four years of our historical figures, by including the 8.5%
growth rate in our moving average, it will forecast numbers that will be accurate
and account for future drops in the growth rate. We also thought that having a
below average growth rate will account for the recent decline in the housing
market.
Net earnings were forecasted by using the same moving average to
calculate the remaining future percentages from the common size income
statement. Once these percentages were calculated we were able to forecast
92
gross margin, total expenses, and income taxes for the next ten years. We used
the moving average for the percentages in order for our numbers on the income
statement to match our net sales.
93
Lowes Income Statement
(In Millions)
Actual Financial Statements
2003 2004 2005 2006
Net Sales
Cost of Sales
Gross Margin
Expenses:
SG&A
Store Opening Costs
Depreciation
Interest
Total Expenses
Pre-tax Earnings
Income Tax Provision
Net Earnings
2007 2008 2009
Forecast Financial Statements
2010 2011 2012 2013
2014
2015
2016
2017
26,112 30,838 36,464 43,243 46,927 54,581 63,288 73,111 84,063 96,047 110,842 127,715 146,971 168,999 194,331
18,164 21,269 24,224 28,453 30,729 36,705 42,267 48,509 55,761 63,814 73,856 84,941 97,666 112,339 129,232
7,948 9,569 12,240 14,790 16,198 17,876 21,020 24,602 28,301 32,233 36,986 42,774 49,305 56,660 65,099
4,625
129
640
182
5,576
2,372
901
1,471
5,578
128
739
180
6,625
2,944
1,122
1,822
7,562 9,014 9,738 10,713 12,664 14,911
123 142 146 206 224 250
859 980 1,162 1,304 1,504 1,735
176 158 154 268 285 310
8,720 10,294 11,200 12,491 14,677 17,205
3,520 4,496 4,998 5,385 6,343 7,397
1,353 1,731 1,893 2,056 2,424 2,829
2,167 2,765 3,105 3,329 3,919 4,569
17,086 19,422
288 332
1,998 2,303
346 404
19,718 22,462
8,584 9,772
3,279 3,727
5,305 6,045
22,297
390
2,641
487
25,815
11,171
4,267
6,904
25,816
443
3,041
548
29,848
12,926
4,938
7,988
29,768
508
3,501
625
34,402
14,903
5,692
9,211
34,182
586
4,029
719
39,515
17,145
6,547
10,598
39,267
675
4,636
832
45,410
19,689
7,518
12,171
Forecast Financial Statements
2010 2011 2012 2013
2014
2015
2016
2017
Common Size Income Statement
Actual Financial Statements
2003 2004 2005 2006
Sales Percentage Growt
Cost of Sales
Gross Margin
Expenses:
SG&A
Store Opening Costs
Depreciation
Interest
Total Expenses
Pre-tax Earnings
Income Tax Provision
Net Earnings
2007 2008 2009
18.10% 18.10% 18.24% 18.59% 8.52% 16.31% 15.95% 15.52% 14.98% 14.26% 15.40% 15.22% 15.08% 14.99% 14.99%
69.56% 68.97% 66.43% 65.80% 65.48% 67.25% 66.79% 66.35% 66.33% 66.44% 66.63% 66.51% 66.45% 66.47% 66.50%
30.44% 31.03% 33.57% 34.20% 34.52% 32.75% 33.21% 33.65% 33.67% 33.56% 33.37% 33.49% 33.55% 33.53% 33.50%
17.71% 18.09% 20.74% 20.84% 20.75% 19.63% 20.01% 20.39% 20.33% 20.22% 20.12% 20.21% 20.25% 20.23% 20.21%
0.49% 0.42% 0.34% 0.33% 0.31% 0.38% 0.35% 0.34% 0.34% 0.35% 0.35% 0.35% 0.35% 0.35% 0.35%
2.45% 2.40% 2.36% 2.27% 2.48% 2.39% 2.38% 2.37% 2.38% 2.40% 2.38% 2.38% 2.38% 2.38% 2.39%
0.70% 0.58% 0.48% 0.37% 0.33% 0.49% 0.45% 0.42% 0.41% 0.42% 0.44% 0.43% 0.43% 0.43% 0.43%
21.35% 21.48% 23.91% 23.81% 23.87% 22.88% 23.19% 23.53% 23.46% 23.39% 23.29% 23.37% 23.41% 23.38% 23.37%
9.08% 9.55% 9.65% 10.40% 10.65% 9.87% 10.02% 10.12% 10.21% 10.17% 10.08% 10.12% 10.14% 10.14% 10.13%
3.45% 3.64% 3.71% 4.00% 4.03% 3.77% 3.83% 3.87% 3.90% 3.88% 3.85% 3.87% 3.87% 3.87% 3.87%
5.63% 5.91% 5.94% 6.39% 6.62% 6.10% 6.19% 6.25% 6.31% 6.29% 6.23% 6.25% 6.27% 6.27% 6.26%
94
Balance Sheet Forecast
Lowe’s balance sheet seemed to provide plenty of forecast able numbers.
As with the income statement we first created a common size balance sheet, and
then looked for trends in the percentage numbers. Total assets were forecasted
by finding the average percentage change over the past five years, which came
out to 14.59%. To determine if these forecasts seemed accurate, we looked at
the asset turnover and accounts receivable turnover ratios. The accounts
receivable turnover ratio didn’t help us with the forecasts because of Lowe’s
reporting $0 accounts receivable over the past couple years. We determined
that our numbers were accurate when we looked at the asset turnover ratio
because the forecasted numbers that the asset turnover ratio produced were
different by only 7.98% on average.
We forecasted current assets by calculating the average percentage of
current assets to total assets. Once current assets were forecasted, we used the
average current ratio over the past five years to forecast current liabilities. This
helped us forecast total liabilities by finding the average percentage of current
liabilities to total liabilities. To forecast owners’ equity we first forecasted Lowe’s
dividends for the next ten years. We forecasted dividends by calculating the
average difference between each of the past five year’s dividends and then
adding that number to each year after 2007. Once we forecasted dividends we
calculated future owners’ equity by taking the 2007 owners’ equity and adding
the forecasted 2008 net earnings and then subtracting the forecasted 2008
dividends. We then did the same thing for each year up to 2017. To make sure
our owners’ equity numbers were accurate we looked at the return on equity and
found that our numbers were only 9.45% off on average.
Once our forecasted owners’ equity numbers were found to be close to
return on equity we adjusted our total liabilities, and all numbers that would be
95
affected by that adjustment, in order to ensure that assets equaled liabilities plus
owners’ equity. All other forecasted numbers on the balance sheet were
calculated using the average percentages forecasted on the common size
balance sheet.
Lowe's Balance Sheet
(In Millions)
2003
Assets
Current Assets:
Cash and cash equivalents
Short-term investments
Accounts Receivable
Merchandise Inventory
Deffered Income Taxes
Other Current Assets
Total Current Assets
Actual Financial Statements
2004
2005
2006
Forecast Financial Statements
2011
2012
2013
2007
2008
2009
2010
2014
2015
2016
2017
1032
1029
1008
1092
1312
0
8269
149
0
9537
178
0
11062
218
0
12456
255
0
14167
282
1636
1784
1987
2277
2635
0
16233
314
0
18580
365
0
21222
420
0
24186
480
0
27614
544
10423
11766
13262
15022
20847
23886
27554
31470
17178
19840
22567
25696
29343
33543
35971
40848
46736
53427
61019
69650
31820
36320
41551
47352
54111
61792
70572
80565
92013
105073
853
273
172
3968
58
244
5568
913
711
146
4584
62
106
6522
642
171
9
5982
95
75
6974
423
453
0
6635
155
122
7788
364
432
0
7144
161
213
8314
10352
29
160
16109
11819
169
241
18751
13911
146
178
21209
16354
294
203
24639
18971
165
317
27767
Liabilities and Stockholder's Equity
Current Liabilities:
Short-term borrowings
Current maturities of long-term debt
Accounts Payable
Employee Retirement Plan
Accrued Salaries and Wages
Self Insurance Liabilities
Deffered Revenue
Other current liabilities
Total Current Liabilities
50
29
1943
88
306
0
0
1162
3578
0
77
2212
0
335
0
0
1576
4200
0
630
2687
0
386
0
0
2016
5719
0
32
2832
0
424
571
709
1264
5832
23
88
3524
0
372
650
731
1151
6539
3864
0
545
741
877
4416
0
609
848
978
5082
0
687
969
1132
5750
0
767
1105
1283
6641
0
866
1262
1470
7532
0
1021
1442
1676
8609
0
1158
1646
1916
9835
0
1316
1880
2186
11228
0
1500
2147
2498
12834
1
1714
2451
2852
7019
7631
8333
8995
9818
10722
11681
12682
13766
14918
Long-term debt
Deffered Income taxes
Other Long-term Liabilities
Total Non-Current Liabilities
Total Liabilities
3736
478
15
4229
7807
3678
594
63
4335
8535
3060
736
159
3955
9674
3499
735
277
4511
10343
4325
735
443
5503
12042
6232
13251
6776
14407
7399
15732
7986
16981
8717
18536
9520
20242
10371
22053
11260
23942
12222
25989
13245
28163
Property (less depreciation)
Long-term investments
Other Assets
Total Assets
Stockholder's Equity
Preferred Stock- $5 par value, none iss
Common Stock- $.50 par value
Shares Issued and outstanding
Capital in excess of par value
Retained Earnings
Accumulated and other comprehensive
Total Stockholder's Equity
Total Liabilities and Stockholder's
0
0
0
0
0
391
2023
5887
1
8302
16109
394
2247
7574
1
10216
18751
387
1514
9634
0
11535
21209
784
1320
12191
1
14296
24639
762
102
14860
1
15725
27767
14342
16989
19967
23003
26189
29275
33760
38711
44211
50374
18569
31820
21913
36320
25819
41551
30371
47352
35575
54111
41550
61792
48519
70572
56623
80565
66024
92013
76910
105073
Actual Financial Statements
2004
2005
2006
2007
2008
2009
2010
Forecast Financial Statements
2011
2012
2013
2014
2015
2016
2017
1.31%
1.56%
0.00%
25.73%
0.58%
0.77%
29.94%
3.24%
2.83%
2.43%
2.31%
2.42%
2.65%
2.53%
2.47%
2.47%
2.51%
0.00%
25.99%
0.47%
0.00%
26.26%
0.49%
0.00%
26.62%
0.52%
0.00%
26.31%
0.54%
0.00%
26.18%
0.52%
0.00%
26.27%
0.51%
0.00%
26.33%
0.52%
0.00%
26.34%
0.52%
0.00%
26.29%
0.52%
0.00%
26.28%
0.52%
32.76%
32.39%
31.92%
31.72%
31.75%
32.11%
31.98%
31.89%
31.89%
31.92%
68.32%
65.52%
65.77%
66.31%
66.46%
0.59%
1.14%
100.00% 100.00% 100.00% 100.00% 100.00%
66.48%
66.11%
66.22%
66.32%
66.32%
66.29%
Common Size Balance Sheet
2003
Assets
Current Assets:
Cash and cash equivalents
Short-term investments
Accounts Receivable
Merchandise Inventory
Deffered Income Taxes
Other Current Assets
Total Current Assets
Property (less depreciation)
Long-term investments
Other Assets
Total Assets
5.30%
1.69%
1.07%
24.63%
0.36%
1.51%
34.56%
4.87%
3.79%
0.78%
24.45%
0.33%
0.57%
34.78%
3.03%
0.81%
0.04%
28.21%
0.45%
0.35%
32.88%
1.72%
1.84%
0.00%
26.93%
0.63%
0.50%
31.61%
64.26%
63.03%
0.18%
0.90%
0.99%
1.29%
100.00% 100.00%
65.59%
0.69%
0.84%
100.00%
66.37%
1.19%
0.82%
100.00%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Liabilities and Stockholder's Equity
Current Liabilities:
Short-term borrowings
Current maturities of long-term debt
Accounts Payable
Employee Retirement Plan
Accrued Salaries and Wages
Self Insurance Liabilities
Deffered Revenue
Other current liabilities
Total Current Liabilities
0.31%
0.18%
12.06%
0.55%
1.90%
0.00%
0.00%
7.21%
22.21%
0.00%
0.41%
11.80%
0.00%
1.79%
0.00%
0.00%
8.40%
22.40%
0.00%
2.97%
12.67%
0.00%
1.82%
0.00%
0.00%
9.51%
26.96%
0.00%
0.13%
11.49%
0.00%
1.72%
2.32%
2.88%
5.13%
23.67%
0.08%
0.32%
12.69%
0.00%
1.34%
2.34%
2.63%
4.15%
23.55%
12.14%
0.00%
1.71%
2.33%
2.76%
12.16%
0.00%
1.68%
2.34%
2.69%
12.23%
0.00%
1.65%
2.33%
2.72%
12.14%
0.00%
1.62%
2.33%
2.71%
12.27%
0.00%
1.60%
2.33%
2.72%
12.19%
0.00%
1.65%
2.33%
2.71%
12.20%
0.00%
1.64%
2.33%
2.71%
12.21%
0.00%
1.63%
2.33%
2.71%
12.20%
0.00%
1.63%
2.33%
2.71%
12.21%
0.00%
1.63%
2.33%
2.71%
23.60%
23.34%
22.99%
22.86%
22.87%
23.13%
23.04%
22.98%
22.98%
23.00%
Long-term debt
Deffered Income taxes
Other Long-term Liabilities
Total Non-Current Liabilities
Total Liabilities
23.19%
2.97%
0.09%
26.25%
48.46%
19.61%
3.17%
0.34%
23.12%
45.52%
14.43%
3.47%
0.75%
18.65%
45.61%
14.20%
2.98%
1.12%
18.31%
41.98%
15.58%
2.65%
1.60%
19.82%
43.37%
21.23%
41.65%
20.22%
39.67%
19.65%
37.86%
19.85%
35.86%
20.15%
34.26%
20.22%
32.76%
20.02%
31.25%
19.98%
29.72%
20.04%
28.24%
20.08%
26.80%
0.00%
0.00%
0.00%
0.00%
0.00%
2.43%
2.10%
12.56%
11.98%
36.54%
40.39%
0.01%
0.01%
51.54%
54.48%
100.00% 100.00%
1.82%
7.14%
45.42%
0.00%
54.39%
100.00%
3.18%
5.36%
49.48%
0.00%
58.02%
100.00%
48.40%
47.38%
47.84%
48.05%
48.05%
47.94%
Stockholder's Equity
Preferred Stock- $5 par value, none iss
Common Stock- $.50 par value
Shares Issued and outstanding
Capital in excess of par value
Retained Earnings
Accumulated and other comprehensive
Total Stockholder's Equity
Total Liabilities and Stockholder's
2.74%
0.37%
53.52%
45.07%
46.78%
48.05%
48.58%
0.00%
56.63%
58.35%
60.33%
62.14%
64.14%
100.00% 100.00% 100.00% 100.00% 100.00%
65.74%
67.24%
68.75%
70.28%
71.76%
73.20%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
96
Statement of Cash Flow Forecast
When forecasting Lowe’s statement of cash flows we considered the
CFFO/NI and historical growth rates. We created a common size statement of
cash flows and looked for any trends. For operating cash flows we decided to
follow our methodology used to forecast the income statement and balance
sheet and use historical growth rates. After finding the average growth rate for
operating cash flows we compared them with the CFFO/NI ratio and found that
they were very close by an average of 5.62%. This affirmed that the numbers
we found using the historical growth rates should be accurate. The other
numbers were forecasted using historical growth rates as well.
97
Lowe's Statement of Cash Flow
(in Millions)
2003
Cash flows from operating activities:
Net Earnings
Earnings from discontinued operations, net of tax
Earnings from continuing operations
Depreciation and Amortization
Deferred Income tax
Loss on disposition/writedown of fixed and other assets
Share-based payment expense
Tax effect of stock options exercised
Changes in operating assets and liabilities:
Accounts receivable-net
Merchandise Inventory-net
Other operating assets
Accounts payable
employee retirement plan
Other operating liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of short-term investments
Proceeds from sale/maturity of short-term investments
Purchases of long-term investments
proceeds from sale/maturity of long-term investments
Increase in other long-term assets
Fixed assets acquired
Proceeds from the sale of fixed and other long-term assets
Net cash used in investing activities
Actual Financial Statements
2004
2005
2006
Forecast Financial Statements
2011
2012
2013
2007
2008
2009
2010
2014
2015
2016
2017
3329
3919
4569
5305
6045
6904
7988
9211
10598
12171
3329
3919
4569
5305
6045
6904
7988
9211
10598
12171
1471
-12
1459
1822
0
1822
2167
0
2167
2765
0
2765
3105
0
3105
659
221
18
926
102
55
70
33
1051
-37
31
76
59
1237
-6
23
62
29
807
143
31
51
31
-9
-357
-9
202
23
-571
-10
421
125
1358
156
483
-9
-785
-38
137
-509
-135
692
421
3033
286
3034
472
3073
642
3842
33
4502
4486
6160
7359
7673
8637
10002
12102
13865
15620
17820
-128
-33
-2336
44
-2477
-2759
2828
-381
193
-95
-2345
72
-2487
-1180
1799
-156
28
-12
-2927
86
-2362
-1829
1802
-354
55
-30
-3379
61
-3674
-284
572
-558
415
-16
-3916
72
-3715
-3326
-3518
-3751
-4065
-4153
-4252
-4461
-4674
-4883
-5068
-50
-50
-24
Cash flows from financing activities:
Net increase from short-term borrowings
Long-Term debt borrowing
Proceeds from issuance of long-term debt
Repayment of long-term debt
Proceeds from issuance of common stock under employee stock purchase plan
Proceeds from issuance of common stock from stock options exercised
Cash dividend payments
Repurchase of common stock
Excess tax benefits of share-based payments
Net cash used in financing activities
0
-63
50
65
-66
0
0
-29
52
97
-87
0
0
-82
61
90
-116
-1000
1013
-633
65
225
-171
-774
-64
-17
-1047
-275
989
-33
76
100
-276
-1737
12
-846
-410
-646
-803
-733
-778
-793
-922
-989
-1033
-1032
Net decrease in cash and cash equivalents
Cash and cash equivalents beginning of year
Cash and cash equivalents, end of year
129
244
373
530
336
866
-336
866
530
-107
530
423
-59
423
364
511
539
473
462
470
491
487
477
477
480
Actual Financial Statements
2004
2005
2006
2007
2008
2009
2010
Forecast Financial Statements
2011
2012
2013
2014
2015
2016
2017
23
Common Size Statement of Cash Flow
2003
Cash flows from operating activities
Net Earnings
Earnings from discontinued operations, net of tax
Earning from continuing operations
Depreciation and Amortization
Deferred Income tax
Loss on disposition/writedown of fixed and other assets
Share-based payment expense
Tax effect of stock options exercised
Changes in operating assets and liabilities:
Accounts receivable-net
Merchandise Inventory-net
Other operating assets
Accounts payable
employee retirement plan
Other operating liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of short-term investments
Proceeds from sale/maturity of short-term investments
Purchases of long-term investments
proceeds from sale/maturity of long-term investments
Increase in other long-term assets
Fixed assets acquired
Proceeds from the sale of fixed and other long-term assets
Net cash used in investing activities
100.82% 100.00% 100.00% 100.00% 100.00%
-0.82%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
21.73%
7.29%
0.59%
0.96%
26.60%
4.71%
1.02%
1.68%
1.02%
30.13%
3.32%
1.79%
2.28%
1.07%
27.36%
-0.96%
0.81%
1.98%
1.54%
-0.30%
-11.77%
-0.30%
6.66%
0.76%
-18.82%
-0.33%
13.88%
4.07%
44.19%
5.08%
15.72%
-0.23%
-20.43%
-0.99%
3.57%
-11.31%
-3.00%
15.37%
13.88%
38.74%
9.43%
15.36%
39.95% 123.01%
16.71%
29.33%
0.73%
31.03%
5.17%
0.97%
1.33%
94.31%
-1.78%
100.00%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
27.48%
-0.13%
0.51%
1.38%
34.76%
57.19%
61.07%
44.66%
110.94%
49.96%
49.78%
7.64%
-113.71% -76.16% -49.05% -15.40%
15.32%
6.60%
9.64%
15.02%
-7.76%
-1.19%
-1.50% -11.17%
3.82%
0.51%
0.82%
0.43%
94.29% 123.92%
91.97% 105.41%
-2.90%
-3.64%
-1.66%
-1.94%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
42.88%
44.87%
51.50%
50.53%
47.39%
46.42%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Cash flows from financing activities:
Net increase from short-term borrowings
Long-Term debt borrowing
Proceeds from issuance of long-term debt
Repayment of long-term debt
Proceeds from issuance of common stock under employee stock purchase plan
Proceeds from issuance of common stock from stock options exercised
Cash dividend payments
Repurchase of common stock
Excess tax benefits of share-based payments
Net cash used in financing activities
-368.36% -116.90%
230.18%
3.90%
-23.64%
-8.98%
-81.82% -11.82%
62.18%
32.62%
281.45% 205.32%
-1.42%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Net decrease in cash and cash equivalents
Cash and cash equivalents beginning of year
Cash and cash equivalents, end of year
34.58%
61.20% -63.40% -25.30% -16.21%
65.42%
38.80% 163.40% 125.30% 116.21%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
78.13%
294.12%
98.44% 170.59%
-78.13% -305.88%
-101.56% -570.59%
103.13% 511.76%
-2.72%
7.83%
-5.83%
-8.60%
11.08%
95.51%
98
Conclusion
Our forecast of Lowe’s is conservative and should mirror the actual
numbers closely. We believe that our numbers might be a little low initially in
some areas, but will resemble the actual numbers after a few years. If sales
grew at a rate of 18% like they have for the past five years we believe the
forecasted number for 2015 would be unrealistic. Lowe’s almost doubles its
sales and assets every five years, which our forecast predicts. One weakness in
our forecast might be that with Home Depot’s steadily growing sales rate our
numbers could be incorrect as far as Lowe’s net sales. It’s hard to predict what
will happen as Home Depot’s sales continue to increase even though its assets
aren’t increasing as fast as Lowe’s.
99
Weighted Average Cost of Capital
To look at a company financially the WACC is a very common value to
consider. This takes into account the weight of the equity and debt in a firm and
compares them to the rates of the market. Companies look at the value of the
WACC before tax because it will always give you a bigger value than after tax for
forecasting. To find Lowe’s weighted average cost of capital we had to find their
cost of equity, cost of debt, and the weight of debt and equity to the value of the
firm.
Cost of Equity
The CAPM model: Ke= Rf + Beta(Rf-Rm) is used to compute the cost of
equity. The Risk Free Rate (Rf) came from the St. Louis FRED. The regression
results gathered above are using the 3 month, 1 year, 2 year, 5 year, 7 year,
and 10 year. For each year we used 72 months, 60 months, 48 months, 36
months, and 24 months to find the highest adjusted R^2 which can explain the
best. The reason we used different time periods for the regressions is so we
could find the period of time that has the best explaining power. The adjusted
R^2 is the explaining power of the regressions, which is why we chose the one
with the highest adjusted R^2. The regression model that has the best
explaining power will give us the most accurate beta to use in our CAPM
equation to get the cost of equity. The 72 month regressions had the highest
adjusted R^2 which is not a surprise as you lose statistical power as you
decrease the observations. From these regression results we can gather the
beta which is 1+-.01 for the 72 month results. With a one beta Lowe’s has a low
systematic risk and moves really close to the market. This beta from our
regression table is a little bit lower than the published data of 1.31. The reason
ours is lower is that we account for more observations and for most companies
100
in the long run they will get a beta closer to one. For the market risk premium
(Rm-Rf) the value is 8% which is an average return for large corporations on
the S&P 500 in the last year. The 1 year treasury rates gave the highest
adjusted R^2 before the rounding to 11%. The risk free rate is 4.14% which is
found from the St. Louis website. Given these values the Ke equation looks like
Ke= .0414 + 1.01(.08). This gives you a cost of equity of 12.22%.
10 Year Rate
Observation
72
60
48
36
24
Beta
0.99
1.14
1.23
1.46
1.29
T Stat
3.11
2.49
1.92
1.79
1.02
Adjusted R^2
0.11
0.08
0.05
0.06
0
7 Year Rate
Observations
72
60
48
36
24
Beta
1
1.14
1.23
1.46
1.29
T Stat
3.11
2.5
1.93
1.79
1.02
Adj. R^2
0.11
0.08
0.06
0.06
0
5 Year Rate
Observations
72
60
48
36
24
Beta
1
1.15
1.23
1.46
1.29
T Stat
3.12
2.51
1.93
1.79
1.02
Adjusted R^2
0.11
0.08
0.06
0.06
0
2 Year Rate
Observations
Beta
T Stat
Adjusted R^2
72
1.01
3.14
0.11
60
1.15
2.53
0.08
48
1.23
1.94
0.06
36
1.46
1.8
0.06
24
1.29
1.02
0
101
1 Year Rate
Observations
3 Month Rate
72
60
48
36
24
Beta
1.01
1.16
1.24
1.47
1.28
T Stat
3.16
2.54
1.95
1.8
1.01
Adjusted R^2
0.11
0.08
0.06
0.06
0
Observations
Beta
T Stat
Adjusted R^2
72
1.01
3.15
0.11
60
1.06
2.54
0.08
48
1.24
1.95
0.06
36
1.47
1.8
0.06
24
1.28
1
0
Cost of Debt
After finding the items of debt on the balance sheet for Lowe’s you find
the weight of each item to the total liabilities. Then the value weighted rate is
just the weight times the stated rate of the items. The stated rate of the short
term items was 5.4%, and 7.24% for the long term debt according to the 10-K.
The percentages for the rate were assumed that all were the same considering
the interest rate can not vary by much and were not stated in the 10-K. Then
just add the value weighted rates to get the 5.07% of Kd.
Weight
Current maturities of
long-term debt
Rate
Value Weighted
Rate
Accounts Payable
88
3524
0.0073077
0.2926424
0.054
0.054
0.0395%
1.5803%
Other Current Liabilities
1151 0.09558212
0.054
0.5161%
Long Term Debt
Other Long-term
Liabilities
4325
0.3591596 0.0724
2.6634%
443 0.03678791 0.0724
0.26634%
Total Liabilities
12042
Kd=5.07%
102
Now plug in the numbers from above to figure out the WACC. The
formula for WACC before tax is (Vd/Vf)*Kd + (Ve/Vf)*Ke. So the WACC before
tax is (12,042/27,767)*.0507 + (15,725/27.767)*.1222. Lowe’s WACC bt comes
out to 9.12%. For WACC after tax you use the same equation except multiply
the Kd by 1 minus the tax rate. The corporate tax rate that Lowe’s uses is 35%.
The WACC after tax comes out to 8.35%.
Intrinsic Valuations
Discounted Dividends Model
The Discounted Dividends Model is a valuation that says the value of a
firm’s equity is the present value of all future dividends paid to shareholders. The
DDM is not a very reliable valuation because it depends heavily on forecasted
future dividends and growth rates. When using this model in reality, it is very
hard to set a standard forecasted measure on such a volatile number as
dividends for any firm. To use this model, the equation involves discounting the
future dividends back to the present value to value the firm. The following
valuation uses this model in respect to Lowe’s.
g
Sensitivity Analysis
Ke
0.08
0.09
0.1
0.11
0.1222
0
12.01
10.85
9.93
9.17
8.41
0.03
15.35
13.15
11.57
10.38
9.28
0.06
28.71
20.02
15.66
13.04
10.97
0.075
95.49
33.77
21.40
16.08
12.63
Over Valued
< $21.79
Fairly Valued within 20%
Under Valued > $31.38
Observed Price (as of November 1, 2007) $26.15
103
We found that Lowe’s dividends increase annually at an average of around
$.052. Therefore, we grew our dividends by this amount each year for ten years.
Then, we discounted these dividends to their present value, and found the sum
to give us the total PV of all future dividends. Next, we used the perpetuity
equation by using the 11th year dividend payout of $0.95, and divide it by the
Cost of Equity of 12.22% minus a growth rate of zero (shown below).
Po=Σ[dt/(Ke-g)t]
We can then add our total PV of annual dividends and the terminal PV perpetuity
to get to an estimated share price of $8.72 as of February 1, 2007. Although, to
value Lowe’s for November 2007, we must get the future value by using the
equation FV=1.41*(1+Ke) ^ (9/12). This will grow our share price by 9 months
to get a November share price of $9.51. This price is much smaller than the
November 1, 2007 observed share price of $26.15.
This model illustrates that investors obviously do not buy Lowe’s stock for
dividend expectations. The sensitivity analysis shows that even with a greater
growth rate of 7.5%, the share price cannot get within 20% of the observed
share price. The only way Lowe’s could come within reach of the observed share
price would be to cut cost of equity to 9% and grow their dividends at 6%, or
cut cost of equity to 10% and grow dividends at 7.5%. Neither of these options
seems realistic due to Lowe’s never having showed cutting cost of equity or
increasing dividends at this rate in this past. In conclusion, Lowe’s is extremely
over valued using the discounted dividends model; although, this valuation
model is very inaccurate due to uncertainty in respect to forecasted dividends
and growth rates.
104
Discounted Free Cash Flows
The discounted free cash flow model of valuation is different from each of
the other models presented; it is different in that it uses the WACC before tax as
the discount rate rather than the cost of equity (Ke). As you can see from our
model the Lowe’s Company WACC is 9.15%. To begin this model you must first
calculate the future cash flows which are done by, subtracting cash flows from
investing activities from cash flows from operations. You then take your
calculated FCF and multiply that by a present value factor (1/ (1+WACC)t), which
accounts for each forecasted year. Once you have successfully forecasted each
year a terminal value of perpetuity is then estimated and discounted back just as
the future cash flows. You then are able to determine the value of the firm by
adding the present value of free cash flows and present value of terminal
perpetuity. The value of the firm is then subtracted from the total liabilities found
on Lowe’s balance sheet. This successfully gives us an estimated market value of
equity; the calculated equity is then divided by the number of shares outstanding
completing our valuation of the firm.
Once the value of the company has been calculated a sensitivity analysis
(shown below) can be run to show how a change in the WACC before tax and/or
a change in the growth rate can manipulate the stock price of the firm. The
sensitivity analysis below shows Lowe’s to be most fairly valued when the WACC
is 18% and has a growth rate of 5%. In this case, the share price of $23.75 is
the closest estimate to the November 1, 2007 share price of $26.15.
What the model has been able to show through the valuation model and
sensitivity analysis is that Lowe’s Company Inc.’s share price with a WACC of
9.15% and a growth rate of 1% is strongly overvalued at $72.08. As you can see
by the trend in the analysis that the prices continue to rise as the growth rates
105
increase. By looking at this analysis Lowe’s is not considered a fairly valued
company until it reaches a WACC of 15%. However, once the 15% mark is
reached the manipulated prices still fluctuate around the observed share price of
$26.15.
WACC
0.085
0.0912
0.1222
0.15
0.18
0.01
81.37
72.46
43.52
29.23
19.6
0.02
91.4
80.49
46.67
30.82
20.44
G
0.03
105.07
91.15
50.5
32.68
21.4
0.04
124.83
105.97
55.27
34.87
22.49
0.05
155.87
127.98
61.35
37.5
23.75
Under Valued >31.38
Fairly Value within 20%
Over Valued <21.79
106
Residual Income Model
The residual income model is one of the best models to look at for valuing
a company. It links the income statement and balance sheet to help value the
company. The residual income is found by using the forecasted earnings and
subtracting the normal (benchmark) earnings. By using the forecasted earnings
the numbers are more accurate that are used in the model compared to the
other valuation models. Below is the sensitivity analysis derived from the
valuations of the model and an explanation of how the values were found.
Sensitivity
Ke
Analysis
0.1
0.11
0.1222
0.13
0.14
-0.1
30.73
28.12
25.3
23.67
21.78
growth
-0.2
28.63
26.34
23.83
22.38
20.67
-0.3
27.57
25.42
23.06
21.68
20.06
-0.4
26.94
24.87
22.58
21.25
19.68
Overvalued<$20.92
Undervalued >$31.38
Fairly Valued within 20%
Observed Price $26.15 (as of November 1, 2007)
To find the price per share in the sensitivity analysis was in most ways
similar to the other models. To get the book value equity you use the previous
year’s book value equity, add the earnings for this year and then subtract the
dividends. The next value we had to find is the normal (benchmark) earnings.
To find this we took the earnings and multiplied it by the cost of equity that we
calculated. The residual income is then the earnings subtracted by the
benchmark earnings. We have to take the residual income figures and discount
them back to time zero for our calculations. To get the present value factor you
use the equation, 1/(1+Ke)^n. In this equation Ke is the cost of equity and n is
the period in which the residual income figure is in. To discount these back we
107
multiplied the residual income by the present value factor of that year. This is a
chart showing the present value of the residual incomes.
0
1
2
3
4
5
6
7
8
9
10
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
PV
1254 1310 1338 1355 1311 1280 1299 1305 1303 1295
of RI
Overtime the residual income is supposed to get close to zero or decrease
in value as the company is getting level with the market, this is why we used
negative growth rates in the model. If we used positive rates then the residual
income would be increasing also, which should not happen. Lowe’s residual
income does not change much as it stays pretty close to 1300. Over the life
span of Lowe’s the residual income will eventually be close to zero, but according
to our forecasts, not in the next 10 years. With a high residual income like
Lowe’s has means doing better than the benchmark consistently which shows
they are holding their value and not spending more money than they are
making. This shows how forecasting can not always be accurate as the future is
always unpredictable.
Looking at the residual income sensitivity analysis for the residual income
model, Lowe’s Company shows that it is a fairly valued company. Lowe’s is
overvalued only when the growth rate is really high and the cost of equity is also
high. Throughout most of the analysis chart the numbers are around the $26.15
observed share price on November 1, 2007. The breaking points for being fairly
valued were $20.92 and $31.38 (over 20% above or below $20.15) and as we
said earlier most of the chart, except for the extreme conditions for high growth
rate and cost of equity, Lowe’s is fairly valued.
108
Long Run Residual Income
The long run residual income is done by using the MVE equation. This
uses the ROE, Ke, and average growth of ROE. This is another way to look at a
firm and see how it is valued compared to the observed share price. The
equation looks like:
MVE= BVEo ( 1 + (ROE-Ke) / (Ke- g)
To get the ROE we divided the earnings of this year and divided it by the
BVE of last year. The ROE is 21% in year 1 and slowly declines to a little over
18%, which is why we used 18% as our ROE. To get the growth rate, we just
got the average growth or decline of the ROE, which for Lowe’s is -1.52%. The
Ke we used the 12.22% we calculated from the CAPM model and BVEo we just
used the time zero book value of equity. Plugging these numbers into the MVE
equation and dividing by the number of shares outstanding of 1525 we got the
value of $13.90. After getting the time consistent price up to November 1, 2007
we got a value of $15.15. Using three different sensitivity analysis charts since
there are three different values instead of two, we show that Lowe’s is
overvalued. We just kept one of the values constant while changing the other
two in the analysis.
ROE
0.1
Ke
0.11
0.1222
0.13
(Holding g constant at -1.52%)
0.17
17.81
16.49
15.15
14.41
0.18
18.77
17.39
15.97
15.19
0.19
19.73
18.28
16.79
15.97
0.2
20.69
19.17
17.61
16.75
Overvalued < $20.92
Undervalued > $31.38
Fairly Valued
109
g
0.17
0.18
0.19
0.2
(Holding Ke constant at 12.22%)
ROE
-0.01
15.31
16.16
17.01
17.86
-0.0152
15.15
15.97
16.79
17.61
-0.03
14.77
15.51
16.25
16.99
-0.04
14.56
15.25
15.94
16.64
-0.03
17.89
16.73
15.51
14.83
-0.04
17.40
16.35
15.25
14.63
Overvalued < $20.92
Undervalued > $31.38
Fairly Valued
g
0.1
0.11
Ke
0.1222
0.13
(Holding ROE constant at 18%)
-0.01
19.13
17.66
16.16
15.34
-0.0152
18.77
17.39
15.97
15.19
Overvalued < $20.92
Undervalued > $31.38
Fairly Valued
According to all three of the long run residual income models Lowe’s is
overvalued. The Ke has the biggest impact on these models compared to ROE
and BE, the Ke would have to be considerably lower than the calculated 12.22%
to bring the price up to fair value. This situation is very unlikely and will
definitely not happen in the near future. Overall, according to this valuation,
Lowe’s is an overvalued company.
110
Abnormal Earnings Growth Model
The abnormal earnings growth model represents how a DRIP income
affects the intrinsic market price of a share. Drip, or Dividend Reinvestment and
Repurchase Plan, can be computed by the dividends in the previous year
multiplied by the cost of equity. In order to find the AEG for Lowe’s the
forecasted earnings and the forecasted annual dividends must be used. The AEG
model is related to the price to earnings comparable method because they are
based upon the some theory. This model is unique in that it discounts values
back to year one instead of year zero. This valuation model is directly linked to
the residual income valuation; therefore the model can be proven using check
figures.
Sensitivity Analysis
G
Ke
-0.1
-0.2
-0.3
-0.4
0.1
48.49
46.16
44.99
44.29
0.11
40.69
38.90
37.98
37.42
0.122
33.32
32.09
31.29
30.95
0.13
29.53
28.42
27.83
27.46
0.14
25.47
24.59
24.11
23.80
Under Valued>$31.38
Fairly Valued within 20%
Over Valued<$20.92
AEG and R.I. Proof
AEG
Change in R.I
2009
242.48
242.48
2010
241.10
241.10
2011
258.54
258.54
2012
183.81
183.81
2013
223.55
223.55
2014
354.05
354.05
2015
371.06
371.06
2016
396.43
396.43
To begin the AEG valuation we first had to calculate the DRIP income by
multiplying the cost of equity by the dividends in the previous year. Then the
cumulative dividend income must be computed by summing the earnings and
111
2017
424.41
424.41
DRIP income for each forecasted year. Afterward our benchmark, or normal
earnings, is calculated by multiplying the previous year’s earnings by one plus
the company’s cost of equity. This “benchmark” value is then used in computing
the abnormal earnings growth by taking the cumulative dividend income and
subtracting the benchmark earnings for the year. Then the AEG values had to
be discounted back to year one by simply multiplying the values by the present
value factor. By taking the sum of the AEG values we calculated a total AEG of
1633.99.
Furthermore, a perpetuity value for AEG must be calculated for the years
out to infinity. To do this a forecasted AEG value of 515 is used because it
follows the pattern of the AEG values. Now it is necessary to use the perpetuity
equation to calculate the continuing terminal value of the perpetuity. This
equation is as follows:
AEG Perpetuity = forecasted AEG/ (Ke - growth)
AEG Perpetuity = 515/ (.1222-growth)
The value of the perpetuity must then be brought back to year one which
is done by multiplying the AEG perpetuity by the present value factor of year ten.
It is then necessary to sum the discounted AEG perpetuity, the summed AEG
values, and the forecasted earnings for 2008. This sum is used in finding the
intrinsic value of equity by dividing it by the cost of equity.
The sensitivity analysis must then be done in order to realize whether the
company is fairly valued. To determine the share values it is necessary to find
the times consistent price. This is calculated using this formula:
Times Consistent Price = Value of Equity x ((1+ Ke)^(9/12))/ Shares Outstanding
112
The Times Consistent Price provides the estimated value of the share at a given
cost of equity and growth rate. The results show Lowe’s to be slightly
overvalued at a cost of equity equal to 12.22% with a -10% growth rate.
However, by increasing the cost of equity to 13% or 14% Lowe’s is fairly valued
at all of the growth rates tested. The results of the sensitivity analysis show that
if Lowe’s could increase their cost of equity to 13% or 14% a fairly valued
company is possible using negative growth rates. The results also show that the
AEG valuation is less sensitive than other models to changes in the growth rate
and cost of equity.
As mentioned earlier the yearly AEG values must match the change in the
residual income. To illustrate this further, the value of AEG in year 2 must equal
RI in year 2 minus RI in year 1. However, this is not the only link between these
two models. The models should also share similar results on the sensitivity
analysis. The results for the two valuations for Lowe’s share similar results
because the estimated share prices are very close.
113
Credit Analysis
The Altman Z-score model is a measure that reflects the credit worthiness
of a public firm. “The model predicts bankruptcy when Z<1.81, and the range
between 1.81 and 2.67 is labeled the gray area” (Palepu). Therefore, a company
would be considered to have a low chance of bankruptcy and credit risk if Z>3.
The Altman Z-score is produced by using the formula:
1.2 (Working Capital/Total Assets) + 1.4 (Retained Earnings/ Total
Assets) +
3.3 (EBIT/Total Assets) + .6 (Market Value of Equity/Total Liabilities)
+ 1.0
(Sales/ Total Assets)
The following shows the Altman Z-score in respect to Lowe’s:
Altman Z-score
Z-Score
2002
2003
2004
2005
2006
5.43
6.33
8.33
8.85
5.47
The Altman Z-score shows that Lowe’s is currently operating at 5.47. This
is a decrease compared to the previous three years of 6.33 to 8.85, but they are
still in good standing with respect to bankers. The main cause being the
decrease in Market Value of Equity/Total Liabilities, which explains the measure
of market leverage. This number fell due to a stock split in 2006 decreasing the
closing price per share.
114
Analysis of Valuations
There are many ways to value a firm by producing different models to
come up with a share price. These methods are pertinent for an investor to be
financially sound with their decision of a company’s position and future. By
coming up with a share price of our own (using the valuation methods), we are
able to observe whether a firm is overvalued, undervalued, or fairly valued. The
method of comparables and intrinsic valuations are the two models we will use
to produce a manipulated share price. The first of the two, the method of
comparables, uses a set of ratios that help weigh share price compared to the
industry average. Although this method is great at giving a quick glance at share
price compared to the industry, it is not always the most reliable valuation. The
second valuation model is the intrinsic valuations. These are more accurate in
evaluating the firm due to the use of extensive forecasts and prior years’ figures.
Method of Comparables
The method of comparables values a firm by finding a share price by
comparing the company’s ratios in relation to the industry average. This method
uses multiple ratios to determine a value of a firm which include: Trailing &
Forecasted Price to Earnings (P/E), Price to Book (P/B), Dividend Yield (D/P),
Price Earnings Growth (P.E.G.), Price over EBITDA (P/EBITDA), Price over Free
Cash Flow per Share (P/FCF), and Enterprise Value over EBITDA (EV/EBITDA).
When valuing Lowe’s, we found an industry average by using the competitors
Home Depot, Sherwin Williams, and Tractor Supply Co. Although, we had to
exclude Tractor Supply Co. from the industry average for dividend yield because
they do not pay out dividends, and from P/EBITDA and P/FCF due to being an
outlier from the industry ratios. The following is the application of these ratios
with respect to Lowe’s and its competitors.
115
Trailing Price to Earnings
The trailing price to earnings ratio is derived by dividing the current price
per share by the current earnings per share.
Lowe's
P/E (Trailing)
Industry Average
Lowe's Share Price
12.84 (26.15/2.036)
14.21
28.94
Home Depot
11.89
Sherwin Williams
13.48
Tractor Supply Co.
17.27
Current share price- $26.15
We found the trailing P/E ratio for Lowe’s and all of its competitors using
this ratio. Next, we took an industry average by summing each of the
competitors trailing P/E ratios and dividing by 3. Last, to find Lowe’s share price
we multiplied the industry average of 14.21 by Lowe’s current earnings per share
of 2.036. This gives us the share price of $28.94, which is closely related to the
November 1st share price of $26.15. Lowe’s, in conclusion, is fairly valued since
the observed share price is only undervalued by $2.79.
116
Forward Price to Earnings
This valuation ratio is different than the trailing P/E because it uses
forecasted earnings instead of current EPS. Therefore, we derive the forward P/E
by dividing current price per share by forecasted earnings per share.
Lowe's
P/E (Forward)
Industry Average
Lowe's Share Price
11.98 (26.15/2.183)
12.72
27.77
Home Depot
11.58
Sherwin Williams
12.12
Tractor Supply Co.
14.47
Current share price- $26.15
We found the forward P/E ratio for Lowe’s using the current price per
share (26.15) divided by our forecasted earnings per share (2.183). This
formula applies to our competitors as well; although, we used forecasted
earnings from yahoo finance for simplicity purposes. Next, as with the trailing
P/E ratio, we took an average the three competitors forward P/E to come up with
an industry average. We then multiplied this industry average with Lowe’s
forecasted EPS to get to a share price of $27.77. Again, this share price is fairly
valued with the observed share price of $26.15. It is slightly undervalued, but
$1.62 is a very minimal amount that would not infer that Lowe’s stock price is
severely understated.
117
Price to Book
The price to book method of comparables incorporates the price per share
and the book value of equity per share of a company.
Lowe's
P/B
Industry Average
Lowe's Share Price
2.39 (26.15/10.92)
3.5867
39.1664
Home Depot
2.76
Sherwin Williams
5.29
Tractor Supply Co.
2.71
Current share price- $26.15
First, the P/B ratios for the industry are found by dividing the price per
share (PPS) by the book value per share (BPS) for each company. Price per
share can be found on the latest financial reports while the BPS is found by
dividing the total stockholder’s equity by the number of shares outstanding. Once
the industry values are calculated it is necessary to find the industry average P/B
ratio. In the home improvement industry the average P/B ratio is 3.5867. This
number is then multiplied by Lowe’s BPS of 10.92 to find the estimated share
price. With a share price of $39.17 this method portrays Lowe’s as being
undervalued since their actual PPS is $26.15.
118
Dividend Yield
The dividend yield method is a ratio takes a look at dividends in relation to
share price. To compute this ratio, we use dividends per share divided by price
per share.
Lowe's
D/P
Industry Average
Lowe's Share Price
.0099 (.26/26.15)
0.025
10.52
Home Depot
0.02933
Sherwin Williams
0.02010
Tractor Supply Co.
N/A
Current share price- $26.15
We computed this for Lowe’s, and the other competing firms. Although,
we excluded Tractor Supply Co. because they do not pay out dividends.
Therefore, the industry average is derived by adding Home Depot and Sherwin
Williams D/P and dividing by 2. We then computed Lowe’s share price by taking
Lowe’s dividends per share (.26), and divide this by the industry average (.025).
This gave us a share price of $10.52; which explains that Lowe’s (using the
dividend yield method) is extremely overvalued compared to its observed share
price of $26.15. It seems that the industry average is quite consistent due to
Home Depot and Sherwin Williams D/P being similar, but dividend yields are so
noisy in the marketplace it is hard to draw a clear conclusion to the value of a
firm. Even if Lowe’s grew its dividends per share to .52 (double the original
DPS), using the same industry average, its share price would still be a low value
of $20.80. This price would still explain the observed share price to be
overstated, and it would be very uncharacteristic for Lowe’s to increase dividends
by this much. In conclusion, this method does not do a great job in explaining
the value of a firm due to such noise in the market with respect to dividends.
119
Price Earnings Growth
PEG Ratio
Industry Average
LOW PPS
LOW
0.83
0.96
$30.36
HD
0.98
SHW
0.93
TSCO
0.97
Current share price- $26.15
The PEG ratio is a step up from the P/E ratio because the PEG also
accounts for the earnings growth of the companies. To calculate the PEG ratio
we took the companies P/E ratio that we calculated above as 12.82 and divided
by the estimated earnings growth rate of 15.5% to get 0.83 for Lowe’s. To get
the share price for Lowe’s we took the average of the PEG ratios of their
competitors, which were found on Yahoo Finance, and multiplied that by the
estimated earnings growth rate, and then multiplied that by our EPS to get
$30.36. According to the PEG ratio Lowe’s is slightly undervalued which means
that the price of Lowe’s stock per share is lower than the PEG ratio projects it to
be at on November 1, 2007. This matches the PEG ratio of Lowe’s because
Lowe’s has the lowest PEG of the competition and that should translate into an
undervalued company.
120
P/EBITDA
P/EBITDA
LOW
6.31592
HD
5.05025
SHW
7.11503
TSCO
Industry Average
6.083
LOW PPS
25.18
7.62620
Current share price- $26.15
This ratio is found by taking the price of the companies share multiplying
by the number of shares outstanding and dividing it by EBITDA, which is
earnings before interest, taxes, depreciation, and amortization. The reason we
multiplied by the shares outstanding was to get a more accurate ratio due to the
fact that Lowe’s and Home Depot acquire more earnings than Sherwin William’s
and Tractor Supply. To get Lowe’s EBITDA we took the net earnings and added
interest expense, tax expense, and depreciation expense to get $6314. Lowe’s
has no amortization so it was not included.
P/EBITDA=($26.15*1525)/$6314=6.31592
To get Lowe’s share price we multiplied Lowe’s EBITDA by the industry
average and then divided by the number of shares outstanding to get $25.18.
This estimated share price is very close to the observed share price of $26.15
and is therefore fairly valued.
Price/Free Cash Flows
LOW
HD
SHW
TSCO (outlier)
P/FCF
Industry Average
0.03323
0.087
0.00684
0.16767
4.817
Observed share price- $26.15
LOW PPS
68.67
121
The price/free cash flow ratio is found by dividing the price per share of
each company by the free cash flow of each company. Free cash flow is the
cash flow from operating activities +/- cash flow from investing activities. For
Lowe’s we used the November 1, 2007 price of $26.15 and divided it by the
CFFO+-CFFI, which came out to 4502-3715=787, giving us a P/FCF ratio of
0.03323. The free cash flows and share prices were found on Yahoo Finance to
find the ratios of Lowe’s competitors in the industry. To get the share price of
Lowe’s we took the industry average of the P/FCF ratios, once again excluding
Tractor Supply because of their ratio being extremely different from the rest of
the industry, and multiplied it by Lowe’s free cash flow. Tractor Supply’s free
cash flow is smaller than the other three competitors in the industry because of
their size compared to the others; since they are smaller they have less cash
flowing through their company. Lowe’s share price came out to $68.87 being
undervalued.
EV/EBITDA
LOW
HD
SHW
TSCO
EV/EBITDA
Industry Average
4.34
7.354
5.844
8.250
7.968
Observed share price- $26.15
LOW PPS
22.79
The EV/EBITDA ratio is found by taking the enterprise value of a company
and dividing it by the earnings before income, tax, interest, depreciation, and
amortization. The enterprise value of a company is the market value of equity +
total liabilities – cash and cash equivalents. The EV for Lowe’s equals:
15,725 + 12,042 – 364 = 27,403
122
We then divide this number by the EBITDA number we got in the above
P/EBITDA ratio of 6314, and we get a EV/EBITDA ratio of 4.34. The way we get
the share price for Lowe’s is similar to the other valuations. We took the
industry average of Lowe’s competitors found on Yahoo Finance and multiplied
that by Lowe’s EBITDA OF 6314. After this we subtracted Lowe’s liabilities and
added its cash and cash equivalents. Divide this number by the number of
shares outstanding for Lowe’s, 1525, and we got a share price of 22.79. This
value differs from most of the other valuation ratios as it is within 20% of the
observed share price and is fairly valued.
Conclusion
Overall, Lowe’s seems to be a fairly valued firm with respect to the
method of comparables model. Below are the ratios for this model that give
estimated price per share compared with industry averages, and their rank from
most to least reliable with consideration to each deviation from the observed
share price.
Price
St. Dev. From observed share price
Overvalued/Undervalued
P/EBITDA
Forward
P/E
Trailing P/E
25.18
0.686
Fairly Valued
27.77
1.146
Fairly Valued
28.95
1.980
Fairly Valued
EV/EBITDA
22.79
2.376
Fairly Valued
P.E.G.
30.36
2.977
Fairly Valued
P/B
39.17
9.207
Undervalued
D/P
10.52
11.052
Overvalued
P/FCF
68.67
30.066
Undervalued
123
As mentioned before, Lowe’s is a fairly valued using this method of
comparables. We determine our stock price to be in a fair range if it is within
20% of the observed share price. In our observations, we have determined that
D/P and P/FCF are not relevant in valuing Lowe’s. As mentioned before, the
dividend yield does not do a great job in valuing Lowe’s because dividends are
very noisy in the market place, as held true for the home improvement retail
industry. Also, the P/FCF did not do Lowe’s any justice with their estimated stock
price because Home Depot and Lowe’s are much larger firms when dealing with
cash flows. Therefore, the industry averages become substandard. All things
considered, Lowe’s seems to be fairly valued using the method of comparables,
but we must look further to the intrinsic values for Lowe’s to come to a more
reliable conclusion.
124
Appendix
Liquidity Ratios
Current Ratio
2002
2003
2004
2005
2006
Lowe's
1.56
1.55
1.22
1.34
1.27
Home Depot
1.48
1.4
1.35
1.2
1.39
Sherwin Williams
1.39
3.19
1.17
1.22
1.18
Tractor Supply
1.73
1.9
1.9
1.83
2.58
Quick Asset Ratio
2002
2003
2004
2005
2006
Lowe's
0.36
0.42
0.14
0.15
0.12
Home Depot
0.41
0.41
0.35
0.25
0.3
Sherwin Williams
0.61
0.73
0.51
0.54
0.65
0.092
0.12
0.13
0.07
0.14
Tractor Supply
Accounts Receivable Turnover
20 02
2003
20 04
2005
1 5 1 .81
2 1 1.2 2
N /A
N /A
N /A
H om e Depot
5 4 .33
59 .0 8
4 8 .76
34 .0 2
2 8 .18
S h e r w in - W illia m s
1 0 .52
9 .9 4
8 .44
8 .8 9
9 .02
T r a c t o r S u p p ly
1 1 .85
N /A
N /A
N /A
N /A
L o w e's
20 06
Days sales outstanding
Lowe's
2002
2003
2004
2005
2006
2.4
1.73
N/A
N/A
N/A
Home Depot
6.72
6.18
7.49
10.73
12.95
Sherwin-Williams
34.7
36.72
43.25
41.06
40.47
Tractor Supply
30.8
N/A
N/A
N/A
N/A
2002
2003
2004
2005
2006
Lowe's
4.58
4.64
4.05
4.29
4.3
Home Depot
4.82
4.87
4.83
4.75
4.76
SherwinWilliams
4.55
4.63
4.42
5.03
5.33
3
3.16
3.15
3.1
2.73
Inventory Turnover
Tractor Supply
Days supply of inventory
2002
2003
2004
2005
2006
Lowe's
79.69
78.66
90.12
85.08
84.88
Home Depot
75.73
74.95
75.57
76.84
76.68
Sherwin Williams
80.22
78.83
82.58
72.56
68.48
121.67
115.51
115.87
117.74
133.7
Tractor Supply
125
Working capital turnover
2002
2003
2004
2005
2006
30.00% 31.03% 33.57% 34.20% 34.52%
Lowe's
Home
Depot
31.0% 32.0% 33.0% 34.0% 33.0%
Sherwin
Williams 45.10% 45.40% 44.19% 42.84% 43.72%
Tractor
Supply
28.28% 30.48% 30.17% 30.93% 31.71%
Profitability Ratios
Operating Profit Margin
2002
2003
2004
2005
2006
Lowe's
9.08% 9.55% 9.65% 10.40% 10.65%
Home
Depot
10.01% 10.56% 10.84% 11.49% 10.65%
Sherwin
Williams 9.59% 9.67% 9.49% 9.13% 10.68%
Tractor
Supply
5.33% 6.50% 5.84% 6.60% 6.25%
Net Profit Margin
Lowe's
Home
Depot
Sherwin
Williams
Tractor
Supply
2002
5.66%
2003
5.93%
2004
5.94%
2005
6.39%
2006
6.62%
6.29%
6.64%
6.84%
7.16%
6.34%
2.46%
6.14%
6.43%
6.44%
7.38%
3.15%
3.78%
3.68%
4.14%
3.84%
126
Asset Turnover
2002 2003 2004 2005 2006
Lowe's
1.62
1.64
1.72
1.76
1.69
Home Depot
1.94
1.88
1.88
1.84
1.74
Sherwin Williams
1.51
1.47
1.43
1.65
1.56
Tractor Supply
2.64
2.74
2.56
2.54
2.35
Return on Assets
2002
Lowe's
Home
Depot
Sherwin
Williams
Tractor
Supply
2003
2004
2005
2006
10.20% 11.40% 11.55% 13.03% 12.60%
12.81% 14.34% 14.52% 15.01% 12.97%
4.22%
9.02% 10.68% 10.84% 13.18%
9.57% 12.14% 11.90% 12.63% 11.17%
Return on Equity
2002
2003
2004
2005
2006
Lowe's
21.10% 22.03% 21.21% 23.97% 21.72%
Home Depot
Sherwin
Williams
Tractor
Supply
22.14% 21.74% 22.32% 24.17% 21.41%
10.35% 24.75% 26.96% 28.12% 33.29%
19.16% 24.44% 22.02% 23.12% 19.05%
127
Working Capital Ratios
Debt to Equity
2002
2003
2004
2005
2006
Lowe's
0.94
0.84
0.84
0.72
0.77
Home Depot
Sherwin
williams
0.52
0.54
0.61
0.65
1.09
1.56
1.52
1.59
1.52
1.51
Tractor Supply
1.01
0.85
0.83
0.71
0.68
Times Interest Earned
2002 2003 2004
14.03
17.36
21.00
157.58 110.42 113.23
13.28
14.50
15.52
13.7
27.78
70.52
Lowe's
Home Depot
Sherwin Williams
Tractor Supply
2005
29.46
65.48
14.23
83.61
2006
33.45
24.68
13.42
55.07
Debt Service Margin
2002
2003
2004
2005
2006
Lowe's
51.41
104.62
39.91
6.10
140.69
Home Depot
Sherwin
williams
N/A
935.00
13.03
601.82
14.93
37.26
51.40
63.91
77.75
Tractor Supply
N/A
187.96
227.33
112.45
83.07
37.26
128
Regression Analysis
3 month Regression Analysis
72 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.353167771
0.124727474
0.112223581
0.093857661
72
ANOVA
df
Regression
Residual
Total
SS
1
70
71
Coefficients
Intercept
X Variable 1
MS
0.087873177
0.61664824
0.704521417
Standard Error
7.28651E-05
1.011857834
t Stat
0.011121853
0.320376803
Observations
F
0.087873177
0.008809261
0.002342427
P-value
0.006551522
3.158336765
Beta
72
60
48
36
24
Significance F
9.97509112
0.994791315
0.002342427
T Stat
1.01
1.06
1.24
1.47
1.28
3.15
2.54
1.95
1.8
1
Lower 95%
Upper 95%
-0.022108972
0.372886458
0.022254702
1.650829211
Lower 95.0%
-0.022108972
0.372886458
Upper 95.0%
0.022254702
1.650829211
Adjusted R^2
0.11
0.08
0.06
0.06
0
60 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.316012636
0.099863986
0.0843444
0.091819359
60
ANOVA
df
Regression
Residual
Total
SS
1
58
59
Coefficients
Intercept
X Variable 1
-0.008519342
1.157430946
0.054249691
0.488986092
0.543235782
Standard Error
0.012308635
0.456279244
MS
0.054249691
0.008430795
t Stat
-0.692143556
2.53667236
F
6.434706663
P-value
0.491608937
0.013904483
Significance F
0.013904483
Lower 95%
Upper 95%
-0.033157752
0.244088814
0.016119067
2.070773079
Lower 95.0%
-0.033157752
0.244088814
Upper 95.0%
0.016119067
2.070773079
129
48 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.27578058
0.076054928
0.055969166
0.093473316
48
ANOVA
df
Regression
Residual
Total
SS
1
46
47
Coefficients
Intercept
X Variable 1
0.03308372
0.401913995
0.434997716
Standard Error
-0.015269925
1.240926335
0.013947623
0.637714778
MS
F
0.03308372
0.008737261
t Stat
3.786509408
P-value
-1.094804828
1.945895529
0.279301633
0.05779178
Significance F
0.05779178
Lower 95%
Upper 95%
-0.043345033
-0.042726915
0.012805183
2.524579584
Lower 95.0%
-0.043345033
-0.042726915
Upper 95.0%
0.012805183
2.524579584
36 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.294775194
0.086892415
0.060036309
0.104499611
36
ANOVA
df
Regression
Residual
Total
SS
1
34
35
Coefficients
Intercept
X Variable 1
0.035331997
0.371285738
0.406617735
Standard Error
-0.018558004
1.468312114
0.018007245
0.816298438
MS
F
0.035331997
0.010920169
t Stat
3.235480844
P-value
-1.030585396
1.798744241
0.310011098
0.080941952
Significance F
0.080941952
Lower 95%
Upper 95%
-0.055153128
-0.190605895
0.018037121
3.127230124
Lower 95.0%
-0.055153128
-0.190605895
Upper 95.0%
0.018037121
3.127230124
24 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.209803103
0.044017342
0.000563585
0.124533974
24
ANOVA
df
Regression
Residual
Total
SS
1
22
23
Coefficients
Intercept
X Variable 1
-0.028166313
1.277173599
0.015709855
0.341191636
0.356901491
Standard Error
0.026790825
1.268970982
MS
0.015709855
0.015508711
t Stat
-1.051341757
1.006463991
F
1.012969765
P-value
0.304513403
0.325134718
Significance F
0.325134718
Lower 95%
Upper 95%
-0.083727084
-1.354511132
0.027394457
3.90885833
Lower 95.0%
-0.083727084
-1.354511132
Upper 95.0%
0.027394457
3.90885833
130
1 Year Regression Analysis
72 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.353175525
0.124732952
0.112229137
0.093857368
72
ANOVA
df
Regression
Residual
Total
SS
1
70
71
Coefficients
Intercept
X Variable 1
MS
0.087877036
0.616644381
0.704521417
Standard Error
0.000310063
1.010359483
0.011114237
0.319894366
Observations
72
60
48
36
24
F
0.087877036
0.008809205
t Stat
P-value
0.027897835
3.158415997
Beta
Significance F
9.975591611
1.01
1.16
1.24
1.47
1.28
0.977823019
0.002341871
T Stat
3.16
2.54
1.95
1.8
1.01
0.002341871
Lower 95%
Upper 95%
-0.021856582
0.372350296
0.022476709
1.64836867
Lower 95.0%
-0.021856582
0.372350296
Lower 95%
Upper 95%
Lower 95.0%
-0.032855892
0.244284956
0.016313461
2.068685404
Upper 95.0%
0.022476709
1.64836867
Adjusted R^2
0.11
0.08
0.06
0.06
0
60 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.316135987
0.099941963
0.084423721
0.091815382
60
ANOVA
df
Regression
Residual
Total
SS
1
58
59
Coefficients
Intercept
X Variable 1
-0.008271216
1.15648518
0.05429205
0.488943732
0.543235782
Standard Error
0.012281792
0.455708779
MS
0.05429205
0.008430064
t Stat
-0.673453507
2.537772437
F
6.440288944
P-value
0.503333713
0.013865307
Significance F
0.013865307
-0.032855892
0.244284956
Upper 95.0%
0.016313461
2.068685404
131
48 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.275714858
0.076018683
0.055932133
0.093475149
48
ANOVA
df
SS
Regression
Residual
Total
1
46
47
Coefficients
Intercept
X Variable 1
0.033067954
0.401929762
0.434997716
Standard Error
-0.014980041
1.239203115
0.013911061
0.636993505
MS
F
0.033067954
0.008737604
t Stat
3.78455642
P-value
-1.076843832
1.945393641
0.28716525
0.057853878
Significance F
0.057853878
Lower 95%
Upper 95%
-0.042981554
-0.042998288
0.013021473
2.521404519
Lower 95.0%
-0.042981554
-0.042998288
Upper 95.0%
0.013021473
2.521404519
36 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.294934104
0.086986126
0.060132777
0.104494249
36
ANOVA
df
SS
Regression
Residual
Total
1
34
35
Coefficients
Intercept
X Variable 1
-0.018305823
1.467626931
0.035370101
0.371247634
0.406617735
Standard Error
0.017970632
0.815436052
MS
F
0.035370101
0.010919048
t Stat
3.239302665
P-value
-1.018652125
1.799806285
0.31556223
0.080770701
Significance F
0.080770701
Lower 95%
Upper 95%
-0.054826541
-0.189538498
0.018214896
3.124792361
Lower 95.0%
-0.054826541
-0.189538498
Upper 95.0%
0.018214896
3.124792361
24 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.21115249
0.044585374
0.001157437
0.124496971
24
ANOVA
df
Regression
Residual
Total
SS
1
22
23
Coefficients
Intercept
X Variable 1
-0.0281116
1.284352851
0.015912587
0.340988905
0.356901491
Standard Error
0.026748949
1.267572324
MS
0.015912587
0.015499496
t Stat
-1.050942211
1.013238319
F
1.026651892
P-value
0.304692809
0.321961016
Significance F
0.321961016
Lower 95%
Upper 95%
-0.083585525
-1.34443124
0.027362325
3.913136942
Lower 95.0%
-0.083585525
-1.34443124
Upper 95.0%
0.027362325
3.913136942
132
2 Year Regression Analysis
72 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.352128429
0.123994431
0.111480066
0.093896956
72
ANOVA
df
SS
Regression
Residual
Total
1
70
71
Coefficients
Intercept
X Variable 1
MS
0.087356732
0.617164685
0.704521417
Standard Error
0.000561812
1.005365326
t Stat
0.011111698
0.319394348
Observations
F
0.087356732
0.008816638
0.00241807
P-value
0.050560454
3.147724223
Beta
72
60
48
36
24
Significance F
9.908167781
0.959819773
0.00241807
T Stat
1.01
1.15
1.23
1.46
1.29
3.14
2.53
1.94
1.8
1.02
Lower 95%
Upper 95%
-0.021599769
0.368353393
0.022723394
1.642377258
Lower 95.0%
-0.021599769
0.368353393
Upper 95.0%
0.022723394
1.642377258
Adjusted R^2
0.11
0.08
0.06
0.06
0
60 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.31535997
0.099451911
0.08392522
0.091840374
60
ANOVA
df
Regression
Residual
Total
SS
1
58
59
Coefficients
Intercept
X Variable 1
0.054025837
0.489209946
0.543235782
Standard Error
-0.008059096
1.153092493
0.012265481
0.455613975
MS
F
0.054025837
0.008434654
t Stat
6.405222443
P-value
-0.657055065
2.530854094
0.513744436
0.014113359
Significance F
0.014113359
Lower 95%
Upper 95%
-0.032611123
0.241082041
0.016492931
2.065102946
Lower 95.0%
-0.032611123
0.241082041
Upper 95.0%
0.016492931
2.065102946
48 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.274983581
0.07561597
0.055520665
0.093495517
48
ANOVA
df
Regression
Residual
Total
SS
1
46
47
Coefficients
Intercept
X Variable 1
-0.014796236
1.23467077
0.032892774
0.402104942
0.434997716
Standard Error
0.013893454
0.636490176
MS
0.032892774
0.008741412
t Stat
-1.064978881
1.939811197
F
3.762867479
P-value
0.292443831
0.058548447
Significance F
0.058548447
Lower 95%
Upper 95%
-0.042762309
-0.046517484
0.013169837
2.515859024
Lower 95.0%
-0.042762309
-0.046517484
Upper 95.0%
0.013169837
2.515859024
133
36 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.29423675
0.086575265
0.059709832
0.104517758
36
ANOVA
df
Regression
Residual
Total
SS
1
34
35
Coefficients
Intercept
X Variable 1
0.035203038
0.371414697
0.406617735
Standard Error
-0.018246007
1.462100576
0.017969063
0.814474063
MS
F
0.035203038
0.010923962
t Stat
3.222552336
P-value
-1.015412296
1.795146884
0.317081039
0.081524304
Significance F
0.081524304
Lower 95%
Upper 95%
-0.054763536
-0.193109857
0.018271522
3.117311009
Lower 95.0%
-0.054763536
-0.193109857
Upper 95.0%
0.018271522
3.117311009
24 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.211757772
0.044841354
0.001425052
0.124480291
24
ANOVA
df
Regression
Residual
Total
SS
1
22
23
Coefficients
Intercept
X Variable 1
-0.028242875
1.285846108
0.016003946
0.340897545
0.356901491
Standard Error
0.026778421
1.265249138
MS
0.016003946
0.015495343
t Stat
-1.054687872
1.016278984
F
1.032822973
P-value
0.303013858
0.320543549
Significance F
0.320543549
Lower 95%
Upper 95%
-0.08377792
-1.338119991
0.02729217
3.909812208
Lower 95.0%
-0.08377792
-1.338119991
Upper 95.0%
0.02729217
3.909812208
134
5 Year Regression Analysis
72 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.349641643
0.122249279
0.109709983
0.093990439
72
ANOVA
df
SS
Regression
Residual
Total
1
70
71
Coefficients
Intercept
X Variable 1
MS
0.086127235
0.618394182
0.704521417
Standard Error
0.001135965
0.997320221
F
0.086127235
0.008834203
t Stat
0.011108121
0.319409662
Significance F
9.749293613
0.002608007
P-value
0.102264389
3.122385885
0.918839208
0.002608007
Observations Beta
72
60
48
36
24
1
1.15
1.23
1.46
1.29
Lower 95%
Upper 95%
-0.021018483
0.360277745
0.023290414
1.634362698
T Stat
3.12
2.51
1.93
1.79
1.02
Lower 95.0%
-0.021018483
0.360277745
Upper 95.0%
0.023290414
1.634362698
Adjusted R^2
0.11
0.08
0.06
0.06
0
60 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.313031207
0.097988537
0.082436615
0.091914963
60
ANOVA
df
Regression
Residual
Total
SS
1
58
59
Coefficients
Intercept
X Variable 1
0.053230879
0.490004903
0.543235782
Standard Error
-0.007484714
1.146234849
0.012224449
0.456644261
MS
F
0.053230879
0.00844836
t Stat
6.300734929
P-value
-0.612274166
2.510126477
0.542749412
0.014880765
Significance F
0.014880765
Lower 95%
Upper 95%
-0.031954607
0.232162056
0.016985179
2.060307642
Lower 95.0%
-0.031954607
0.232162056
Upper 95.0%
0.016985179
2.060307642
48 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.274009427
0.075081166
0.054974235
0.093522559
48
ANOVA
df
Regression
Residual
Total
SS
1
46
47
Coefficients
Intercept
X Variable 1
-0.014386235
1.230286084
0.032660136
0.40233758
0.434997716
Standard Error
0.01385118
0.636668705
MS
0.032660136
0.008746469
t Stat
-1.038628796
1.932380332
F
3.734093749
P-value
0.304406234
0.059484085
Significance F
0.059484085
Lower 95%
Upper 95%
-0.042267215
-0.05126153
0.013494745
2.511833699
Lower 95.0%
-0.042267215
-0.05126153
Upper 95.0%
0.013494745
2.511833699
135
36 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.293540455
0.086165999
0.059288528
0.10454117
36
ANOVA
df
SS
Regression
Residual
Total
1
34
35
Coefficients
Intercept
X Variable 1
MS
0.035036623
0.371581112
0.406617735
Standard Error
-0.018114234
1.459096992
F
0.035036623
0.010928856
t Stat
0.017957699
0.814911406
Significance F
3.20588199
P-value
-1.008716859
1.790497693
0.320235659
0.082282187
0.082282187
Lower 95%
Upper 95%
-0.05460867
-0.197002228
0.018380202
3.115196213
Lower 95.0%
-0.05460867
-0.197002228
Upper 95.0%
0.018380202
3.115196213
24 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.211743423
0.044835277
0.001418699
0.124480687
24
ANOVA
df
SS
Regression
Residual
Total
1
22
23
Coefficients
Intercept
X Variable 1
-0.028281285
1.285714993
MS
0.016001777
0.340899714
0.356901491
F
0.016001777
0.015495442
Standard Error
t Stat
0.026790642
1.265209884
Significance F
1.032676429
P-value
-1.055640451
1.016206883
0.302587926
0.32057711
0.32057711
Lower 95%
Upper 95%
-0.083841676
-1.3381697
0.027279105
3.909599685
Lower 95.0%
-0.083841676
-1.3381697
Upper 95.0%
0.027279105
3.909599685
7 Year Regression Analysis
72 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.34875436
0.121629603
0.109081455
0.094023611
72
ANOVA
df
Regression
Residual
Total
SS
1
70
71
Coefficients
Intercept
X Variable 1
0.001383279
0.994609554
0.085690661
0.618830757
0.704521417
Standard Error
0.011106514
0.319464648
MS
0.085690661
0.008840439
t Stat
0.12454666
3.113363431
F
Significance F
9.693031854
P-value
0.901239429
0.002678939
Observations Beta
72
60
48
36
24
0.002678939
Lower 95%
Upper 95%
-0.020767965
0.357457411
0.023534523
1.631761696
-0.020767965
0.357457411
Upper 95.0%
0.023534523
1.631761696
Adj. R^2
T Stat
1
1.14
1.23
1.46
1.29
Lower 95.0%
3.11
2.5
1.93
1.79
1.02
0.11
0.08
0.06
0.06
0
136
60 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.312023198
0.097358476
0.081795691
0.091947059
60
ANOVA
df
Regression
Residual
Total
SS
1
58
59
Coefficients
Intercept
X Variable 1
0.052888608
0.490347175
0.543235782
Standard Error
-0.007219546
1.143172202
0.01220588
0.457054963
MS
F
0.052888608
0.008454262
t Stat
6.25585181
P-value
-0.591480984
2.501170088
0.556496599
0.01522388
Significance F
0.01522388
Lower 95%
Upper 95%
-0.031652269
0.228277299
0.017213177
2.058067105
Lower 95.0%
-0.031652269
0.228277299
Upper 95.0%
0.017213177
2.058067105
48 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.273477304
0.074789836
0.054676571
0.093537287
48
ANOVA
df
SS
Regression
Residual
Total
1
46
47
Coefficients
Intercept
X Variable 1
-0.014191055
1.227990179
0.032533408
0.402464308
0.434997716
Standard Error
0.013832342
0.636817347
MS
F
0.032533408
0.008749224
t Stat
3.718433479
P-value
-1.02593294
1.928324008
0.310288111
0.060000212
Significance F
0.060000212
Lower 95%
Upper 95%
-0.042034114
-0.053856636
0.013652004
2.509836995
Lower 95.0%
-0.042034114
-0.053856636
Upper 95.0%
0.013652004
2.509836995
36 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.293186868
0.085958539
0.059074967
0.104553036
36
ANOVA
df
Regression
Residual
Total
SS
1
34
35
Coefficients
Intercept
X Variable 1
-0.018011652
1.457833075
0.034952267
0.371665468
0.406617735
Standard Error
0.01794719
0.815279974
MS
F
0.034952267
0.010931337
t Stat
3.197437387
P-value
-1.003591771
1.788137966
0.322664831
0.082669132
Significance F
0.082669132
Lower 95%
Upper 95%
-0.054484731
-0.199015167
0.018461426
3.114681317
Lower 95.0%
-0.054484731
-0.199015167
Upper 95.0%
0.018461426
3.114681317
24 months
137
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.211637996
0.044790641
0.001372034
0.124483596
24
ANOVA
df
Regression
Residual
Total
SS
1
22
23
Coefficients
Intercept
X Variable 1
MS
0.015985847
0.340915645
0.356901491
Standard Error
-0.0282524
1.2853345
F
0.015985847
0.015496166
t Stat
0.026783605
1.265495101
Significance F
1.031600142
P-value
-1.054839346
1.015677184
0.3029461
0.320823744
0.320823744
Lower 95%
Upper 95%
-0.083798197
-1.339141694
0.027293396
3.909810695
Lower 95.0%
-0.083798197
-1.339141694
Upper 95.0%
0.027293396
3.909810695
10 Year Regression Analysis
72 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.348163885
0.121218091
0.108664064
0.094045633
72
ANOVA
df
Regression
Residual
Total
SS
1
70
71
Coefficients
Intercept
X Variable 1
MS
0.085400741
0.619120676
0.704521417
Standard Error
0.001592964
0.993142229
72
60
48
36
24
P-value
0.143448146
3.107364401
Beta
Significance F
9.655713519
t Stat
0.011104809
0.319609193
Observation
F
0.085400741
0.008844581
0.99
1.14
1.23
1.46
1.29
0.886348409
0.002727095
T Stat
3.11
2.49
1.92
1.79
1.02
0.002727095
Lower 95%
Upper 95%
-0.020554879
0.355701801
0.023740807
1.630582657
Lower 95.0%
-0.020554879
0.355701801
Upper 95.0%
0.023740807
1.630582657
Adjusted R^2
0.11
0.08
0.05
0.06
0
60 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.311085049
0.096773908
0.081201044
0.091976827
60
ANOVA
df
Regression
Residual
Total
SS
1
58
59
Coefficients
Intercept
X Variable 1
-0.006968732
1.140408339
0.052571049
0.490664733
0.543235782
Standard Error
0.012188727
0.45747302
MS
0.052571049
0.008459737
t Stat
-0.57173585
2.492842834
F
6.214265394
P-value
0.569710171
0.015549287
Significance F
0.015549287
Lower 95%
Upper 95%
-0.03136712
0.224676604
0.017429656
2.056140073
Lower 95.0%
-0.03136712
0.224676604
Upper 95.0%
0.017429656
2.056140073
138
48 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.272957694
0.074505903
0.054386466
0.093551639
48
ANOVA
df
Regression
Residual
Total
SS
1
46
47
Coefficients
Intercept
X Variable 1
0.032409897
0.402587818
0.434997716
Standard Error
-0.013985782
1.225709986
0.013812852
0.636942597
MS
F
0.032409897
0.008751909
t Stat
-1.012519474
1.924364913
3.703180317
Significance F
0.06050766
P-value
Lower 95%
Upper 95%
0.31658613
0.06050766
-0.041789611
-0.056388945
0.013818047
2.507808917
Lower 95.0%
-0.041789611
-0.056388945
Upper 95.0%
0.013818047
2.507808917
36 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.292791588
0.085726914
0.058836529
0.104566282
36
ANOVA
df
Regression
Residual
Total
SS
1
34
35
Coefficients
Intercept
X Variable 1
0.034858084
0.371759651
0.406617735
Standard Error
-0.017878383
1.456340916
0.017933111
0.815648357
MS
F
0.034858084
0.010934107
t Stat
3.188013646
P-value
-0.996948187
1.785500951
0.325832375
0.083103369
Significance F
0.083103369
Lower 95%
Upper 95%
-0.05432285
-0.201255969
0.018566084
3.113937801
Lower 95.0%
-0.05432285
-0.201255969
Upper 95.0%
0.018566084
3.113937801
24 months
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.21152419
0.044742483
0.001321687
0.124486734
24
ANOVA
df
Regression
Residual
Total
SS
1
22
23
Coefficients
Intercept
X Variable 1
-0.028193084
1.285139295
0.015968659
0.340932832
0.356901491
Standard Error
0.026767297
1.266015588
MS
0.015968659
0.015496947
t Stat
-1.053266024
1.015105428
F
1.030439029
P-value
0.30365041
0.321090108
Significance F
0.321090108
Lower 95%
Upper 95%
-0.08370506
-1.340416324
0.027318892
3.910694914
Lower 95.0%
-0.08370506
-1.340416324
Upper 95.0%
0.027318892
3.910694914
139
Cost of Equity
10 Year Rate
Observation
72
60
48
36
24
Beta
0.99
1.14
1.23
1.46
1.29
T Stat
3.11
2.49
1.92
1.79
1.02
Adjusted R^2
0.11
0.08
0.05
0.06
0
7 Year Rate
Observations
72
60
48
36
24
Beta
1
1.14
1.23
1.46
1.29
T Stat
3.11
2.5
1.93
1.79
1.02
Adj. R^2
0.11
0.08
0.06
0.06
0
5 Year Rate
Observations
72
60
48
36
24
Beta
1
1.15
1.23
1.46
1.29
T Stat
3.12
2.51
1.93
1.79
1.02
Adjusted R^2
0.11
0.08
0.06
0.06
0
2 Year Rate
1 Year Rate
Observations
Beta
T Stat
Adjusted R^2
72
1.01
3.14
0.11
60
1.15
2.53
0.08
48
1.23
1.94
0.06
36
1.46
1.8
0.06
24
1.29
1.02
0
Observations
72
60
48
36
24
Beta
1.01
1.16
1.24
1.47
1.28
T Stat
3.16
2.54
1.95
1.8
1.01
Adjusted R^2
0.11
0.08
0.06
0.06
0
140
3 Month Rate
Observations
Beta
T Stat
Adjusted R^2
72
1.01
3.15
0.11
60
1.06
2.54
0.08
48
1.24
1.95
0.06
36
1.47
1.8
0.06
24
1.28
1
0
Cost of Debt and WACC
Weight
Current maturities of
long-term debt
Rate
Value Weighted
Rate
Accounts Payable
88
3524
0.0073077
0.2926424
0.054
0.054
0.0395%
1.5803%
Other Current Liabilities
1151 0.09558212
0.054
0.5161%
Long Term Debt
Other Long-term
Liabilities
4325
0.3591596 0.0724
2.6634%
443 0.03678791 0.0724
0.26634%
Total Liabilities
12042
Kd=5.07%
WACCbt = 9.12%
WACCat= 8.35%
141
Discounted Dividends Model
DPS (Dividends Per Share)
PV Factor
PV of Dividends Year by Year
Total PV of Annual Dividends
Continuing (Terminal) Value Perpetuity
PV of Terminal Value Perpetuity
Estimated Price per Share
Time Consistent Price
Observed Share Price
Initial Cost of Equity
Perpetuity Growth Rate (g)
0
2007
1
2008
2
2009
3
2010
4
2011
5
2012
6
2013
7
2014
8
2015
9
2016
10
2017
0.26
0.31
0.36
0.42
0.47
0.52
0.57
0.62
0.68
0.73
0.78
1.000 0.917 0.842
0.840 0.771 0.707
5.876
0.772
0.649
0.708
0.595
0.650
0.546
0.596
0.501
0.547
0.460
0.502
0.422
0.460
0.387
28.000
12.892
18.768
20.021
26.15
0.09
0.06
Sensitivity Analysis
Ke
Over Valued < $20.92
Fairly Valued within 20%
Under Valued > $31.38
g
0
0.03
0.06
0.08 12.01 15.35 28.71
0.09 10.85 13.15 20.02
0.1 9.93 11.57 15.66
0.11 9.17 10.38 13.04
0.1222 8.41 9.28 10.97
0.075
95.49
33.77
21.40
16.08
12.63
Observed Price (as of No
142
Free Cash Flows Model
Free Cash Flows
Cash from Operations
Cash Investments
Book Value of Debt and Preferred Stock
Annual Free Cash Flow
PV Factor
PV of Free Cash Flows
Total PV of Annual Free Cash Flows
Continuing (Terminal) Value of Perpetuity
Present Value of Continuing (Terminal) Value
Value of the Firm
Book Value of Liabilities
Estimated Market Value of Equity
Estimated Value per Share
Time Consistent Implied Share Price
Observed Share Price
WACC bt
Perpetuity Growth Rate (g)
WACC (bt)
9.12%
0
2007
1
2008
2
2009
3
2010
4
2011
5
2012
6
2013
7
2014
8
2015
9
2016
4,502
-3,715
12,042
4486
-3326
6160
-3518
7359
-3751
7673
-4065
8637
-4153
10002
-4252
12102
-4461
13865
-4674
15620
-4883
1160
0.9164
1063
2642
0.8398
2219
3608
0.7696
2777
3609
0.7053
2545
4484
0.6464
2898
5750
0.5923
3406
7641
0.5428
4148
9191
0.4975
4572
10737
0.4559
4895
0.085
0.0912
0.1222
0.15
0.18
0.01
81.37
72.46
43.52
29.23
19.6
Sensitivity Analysis
0.02
0.03
91.4
105.07
80.49
91.15
46.67
50.5
30.82
32.68
20.44
21.4
0.04
124.83
105.97
55.27
34.87
22.49
0.05
155.87
127.98
61.35
37.5
23.75
33,851
81,690
115,541
12,042
103,499
67.87
72.46
26.15
0.0912
0.01
WACC bt
Kd
5.07%
Ke
0.12222%
g
Overvalued > 31.38
Fair Valued within %20
Undervalued < 20.92
143
Residual Income Model
Fiscal Year ends February 2, 2007
WACC(BT)= 9.15%
9.12%
change in RI
Earnings
Dividends
Book Value Equity
0
2007
$ 3,105 $
$
397 $
$ 15,725 $
$
$
$
1
2008
3,329 $
485 $
18,569 $
Actual Earnings
"Normal" (Benchmark) Earnings
Residual Income (Annual)
PV Factor
PV of Annual Residual Income
Total PV of Annual Residual Income
$
$
3,329
1,922
1,407
0.891
1,254
13,051
PV of Terminal Value Perpetuity
Initial Book Value of Equity
$
$
6,607
15,725
Estimated Price per Share (end of 1987)
Time Consistent Price
Observed Share Price
Initial Cost of Equity
Perpetuity Growth Rate (g)
$
$
23.20
25.30
$
$
$
$
Kd
242.48
2
2009
3,919 $
574 $
21,913 $
3,919
2,269
1,650
0.794
1,310
241.10
3
2010
4,569 $
663 $
25,819 $
$
$
$
4,569
2,678
1,891
0.708
1,338
$
Sensitivity
ROE
ROE growth
$
Ke
5.07%
258.54
4
2011
5,305 $
752 $
30,371 $
$
$
$
5,305
3,155
2,149
0.631
1,355
$
Analysis
$
$
$
$
Ke
183.81
5
2012
6,045 $
841 $
35,575 $
6,045
3,711
2,333
0.562
1,311
223.55
6
2013
6,904 $
930 $
41,550 $
$
$
$
$
growth
6,904
4,347
2,557
0.501
1,280
$
$
$
$
354.05
7
2014
7,988
1,019
48,519
7,988
5,077
2,911
0.446
1,299
0.1
0.11
0.1222
0.13
0.14
-0.1
30.73
28.12
25.3
23.67
21.78
-0.2
28.63
26.34
23.83
22.38
20.67
-0.3
27.57
25.42
23.06
21.68
20.06
26.15
12.22%
-10%
21.17%
21.10%
-0.31%
20.85%
-1.21%
20.55%
-1.46%
19.90%
-3.13%
19.41%
-2.49%
19.23%
-0.93%
0.177224973
0.165816891
0.161053989
0.139528243
0.14218513
0.157026508
0.153069848
144
Long-Run Residual Income Model
Book Value of Equity
Long run ROE
Long Run Growth Rate in Equity
Cost of Equity
15725
18%
-4.00%
10.00%
Estimated Price Per Share
Time consistent Price per Share
$ 16.20
$ 17.40
Observed Share Price
$ 26.15
Ke
ROE
Ke
0.1
0.11
0.1222
0.13
0.17
17.81
16.49
15.15
14.41
0.18
18.77
17.39
15.97
15.19
ROE
0.19
19.73
18.28
16.79
15.97
0.2
20.69
19.17
17.61
16.75
0.17
0.18
0.19
0.2
g
-0.01 -0.0152 -0.03 -0.04
15.31
15.15 14.77 14.56
16.16
15.97 15.51 15.25
17.01
16.79 16.25 15.94
17.86
17.61 16.99 16.64
0.1
0.11
0.1222
0.13
g
-0.01 -0.0152 -0.03 -0.04
19.13
18.77 17.89 17.40
17.66
17.39 16.73 16.35
16.16
15.97 15.51 15.25
15.34
15.19 14.83 14.63
145
Abnormal Earnings Growth
Abnormal Earnings GrowthModel
Earnings
Dividends
Dividends invested at 12.2%Drip
Cum-Dividend Earnings
Normal Earnings
Abnormal Earning Growth
PV Factor
PV of AEG
Residual Income Check Figure
Core Earnings
Total PVof AEG
Continuing Termial Value
PV of Terminal Value
Total PVof AEG
Total Average EPS Perp (t+1)
Capitalization Rate
Intrinsic Value per Share
Times Consistent Price
Shares Outstanding
Observed Share Price (11/1/07)
0
2008
3329
485
1
2009
3919
574
59.31
3978.20
3735.71
242.48
0.8911
216.08
2
2010
4569
663
70.17
4638.87
4397.77
241.10
0.7941
191.45
3
4
5
6
7
8
9
2011 2012 2013 2014 2015
2016
2017
5305
6045 6904 7988 9211
10598
12171
752
841
930 1019 1107
1196
1285
81.03
91.89 102.75 113.61 124.46 135.32 146.18
5385.54 6136.53 7006.84 8101.83 9335.44 10733.00 12317.12
5127.00 5952.72 6783.30 7747.78 8964.39 10336.56 11892.71
258.54 183.81 223.55 354.05 371.06 396.43 424.41
0.7076 0.6305 0.5619 0.5007 0.4462 0.3976 0.3543
182.94 115.90 125.61 177.27 165.56 157.62 150.37
10
2018
13980
1390
157.04
14137.10
13658.23
478.87
0.3157
151.19
3328.92
1633.99
2317.731773
731.75
2365.73
5694.65
0.1222
46601.09
33.32
1525
26.15
Ke
0.1
0.11
0.122
0.13
0.14
Sensitivity Analysis
-0.1
-0.2
-0.3
48.49
46.16 44.99
40.69
38.90 37.98
33.32
32.09 31.29
29.53
28.42 27.83
25.47
24.59 24.11
-0.4
44.29
37.42
30.95
27.46
23.80
146
Z – Score Analysis
1.2
1.4
3.3
0.6
1
Working Capital/Total Assets
Retained Earnings/Total Assets
EBIT/Total Assets
Market Value of Equity/Book Value of Liabilities
Sales/Total Assets
2002
0.1235
0.3654
0.3380
3.423691559
1.6210
2003
0.1238
0.4039
0.3066
4.937768014
1.6446
2004
0.0592
0.4542
0.1303
9.119342568
1.7193
2005
0.0794
0.4948
0.1604
9.634187373
1.7551
2006
0.0639
0.5352
0.1194
4.269037535
1.6900
Working Capital/Total Assets
Retained Earnings/Total Assets
EBIT/Total Assets
Market Value of Equity/Book Value of Liabilities
Sales/Total Assets
Z-Score
2002
0.15
0.51
1.12
2.05
1.62
5.45
2003
0.15
0.57
1.01
2.96
1.64
6.33
2004
0.07
0.64
0.43
5.47
1.72
8.33
2005
0.10
0.69
0.53
5.78
1.76
8.85
2006
0.08
0.75
0.39
2.56
1.69
5.47
Z-Score
2002
5.43
Altman Z-score
2003
6.33
2004
8.33
2005
8.85
147
2006
5.47
Sales Diagnostic Ratios
2002
2004
2005
2006
Lowe's
Net Sales/Cash from sales
1
1
1
Net Sales/Net Accounts Receivab 151.81 211.29 4051.55
Net Sales/Unearned Revenues
N/A
N/A
137.6
Net Sales/Inventory
6.58
6.73
6.1
Net Sales/Warranty Liabilities
N/A N/A
424
1
N/A
114.7
6.52
209.92
1
N/A
128.92
6.57
148.97
Home Depot
Net Sales/Cash from sales
Net Sales/Net Accounts Receivab
Net Sales/Unearned Revenues
Net Sales/Inventory
Net Sales/Warranty Liabilities
2003
1
54.33
58.36
6.99
N/A
1
59.08
50.59
7.14
N/A
1.01
48.76
47.28
7.25
N/A
1.01
34.02
46.39
7.15
N/A
1.01
28.18
55.59
7.08
N/A
Sherwin Williams
Net Sales/Cash from sales
0.99
Net Sales/Net Accounts Receivab
10.5
Net Sales/Unearned Revenues
N/A
Net Sales/Inventory
8.3
Net Sales/Warranty Liabilities
334.29
1.01
9.94
N/A
8.47
326.65
1.03
8.44
N/A
7.91
337.82
1.01
8.89
N/A
8.89
312.6
1.01
9.03
N/A
9.46
309.59
Tractor Supply Company
Net Sales/Cash from sales
1
Net Sales/Net Accounts Receivab11862.7
Net Sales/Unearned Revenues
N/A
Net Sales/Inventory
4.18
Net Sales/Warranty Liabilities
N/A
1
N/A
N/A
4.54
N/A
1
N/A
N/A
4.51
N/A
1
N/A
N/A
4.49
N/A
1
N/A
N/A
3.99
N/A
148
Core Expense Manipulation Diagnostics
Lowe's
Asset Turnover
CFFO/OI
Changes in CFFO/change in OI
Changes in CFFO/Change in NOA
Total Accruals/Sales
Other Employment Expenses/SG&
2002
2003
2004
2005
2006
1.62
1.49
1.6
0.97
0.10
0.025
1.64
1.17
0
0
0.10
0.015
1.72
0.83
0.07
0.02
0.09
0.009
1.76
0.83
0.8
0.31
0.08
0.015
1.69
0.87
1.33
0.25
0.09
0.004
Home Depot
Asset Turnover
CFFO/OI
Changes in CFFO/Change in OI
Changes in CFFO/Change in NOA
Total Accruals/Sales
Other Employment Expenses/SG&
1.94
0.82
-1.28
-0.33
0.11
0.009
1.88
0.96
1.71
0.61
0.11
0.008
1.88
0.84
0.33
0.13
0.12
0.007
1.84
0.71
-0.29
-0.19
0.15
0.008
1.74
0.79
N/A
0.69
0.19
0.009
Tractor Supply
Asset Turnover
CFFO/OI
Changes in CFFO/change in OI
Changes in CFFO/Change in NOA
Total Accruals/Sales
Other Employment Expenses/SG&
2.64
0.71
0.8
0.51
0.10
0.01
2.74
0.65
0.55
0.63
0.09
0.005
2.56
0.76
2.16
0.21
0.09
0.004
2.54
0.73
0.63
0.49
0.10
0.004
2.35
0.59
-1
-0.28
0.11
0.004
Sherwin Williams
Asset Turnover
CFFO/OI
Changes in CFFO/change in OI
Changes in CFFO/Change in NOA
Total Accruals/Sales
Other Employment Expenses/SG&
1.51
1.01
0.69
0.78
0.32
0.007
1.47
0.97
0.04
-0.07
0.33
0.008
1.43
0.86
-0.24
-0.2
0.39
0.008
1.65
0.98
2.02
N/A
0.35
0.007
1.56
0.93
0.51
1.19
0.34
0.006
149
References
1.
Lowe’s 10-K
2.
www.finance.yahoo.com
3.
www.edgarscan.com
4.
www.forbes.com
5.
www.investor.reuters.com
6.
stats.oecd.org/glossary
7.
www.photopla.net/wwp0503/exit.php
8.
www.scottrade.com
9.
stocks.us.reuters.com
10. Business Analysis and Evaluation (Palepu and Healy)
11. Home Depot 10-K
12. Sherwin Williams 10-K
13. Tractor Supply Company 10-K
14. Financial Statement Handout
150
151
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