1. 1 Financial Statement Analysis Forecasting Home Depot’s fourth quarter of 2005 financial statements super freakfreak

2. 2 Overview of business/industry World’s largest home improvement retailer and 2 nd largest retailer in the U.S. Sell assortment of building materials, home improvement and lawn and garden products as well as other services. Target individual homeowners, small contractors, and moving into commercial and industrial customers.

3. 3 Industry Outlook (S&P NetAdvantage) Our fundamental outlook for the home improvement retail sub- industry is positive. In 2005, the S&P Home Improvement Retail Index posted a 1.7% gain, versus a 3.8% increase for the S&P 1500… We expect home improvement retailers to report strong fourth- quarter results… The rebuilding efforts from Hurricane Katrina bode well for home improvement retailers …In addition, should the housing market face a significant slowdown in 2006, we believe remodeling will remain a large focus for consumers… The total home improvement products market in the U.S. is expected to grow to $291.3 billion in 2005 from $271.1 billion in 2004, and is projected to grow to $369.9 billion in 2010.

4. 4 Business Strategy Key Success Factors Warehouse retailing concept - Low overhead - High turnover - Purchase quantity discounts Focus on D-I-Y, D-I-F-M, and Professional markets. Large merchandise assortment. Aggressive advertising program (integration into reality show…). Strong recent housing market. Several brands (e.g., Expo and HD Supply Company). Offer expanded services.

5. 5 Business Strategy Key Risks Competition (Lowe’s)! Lowe's bright, airy stores are decorated in a blue-and-white theme more reminiscent of Betty Crocker than Home Depot's earthen brown and orange colors. "Fifty percent of our shoppers are female," says Carson Anderson, a Lowe's spokesman. Lowe's focuses on the female, he says, because 70% of the buying decisions are made by women. Reaching end of growth opportunities. Strategy conflict (cost leader with high level of service). Capital constraints. Burst of the housing market bubble (interest rates have been increasing, consumers spending on home improvements are declining…). Sensitive to consumer debt levels, job security concerns (unemployment), seasonality, weather. Cannibalizing their own stores.

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7. 7 Comparing HD, LOW, industry

8. 8 Comparing HD, LOW, industry (cont.)

9. 9 What are your forecasted Sales, Net Income and EPS? Collect forecasts Collect forecasts Home Depot Q4 2005

10. 10 What’s my forecast? First, let’s get some relevant information from Q3 2005 10Q (November 15, 2005) The Home Depot Announces Record Third Quarter 2005 Results Lifts fiscal 2005 sales and earnings per share growth guidance Fiscal 2005 sales growth guidance 10-12 percent, earnings per share growth guidance 17-18 percent - Record Third Quarter Sales of $20.7 billion - Record Third Quarter Operating Margin of 11.9 percent - Record Third Quarter Net Earnings of $1.5 billion - Record Average Ticket of $58.92 Sales for the period increased $2.0 billion, or 10.5 percent, to $20.7 billion. Growth in comparable store sales was 3.6 percent.

11. 11 What did you learn from “The Home Depot Investor and Analyst Conference” held on January 13, 2005 ? http://ir.homedepot.com/releases.cfm http://ir.homedepot.com/releases.cfm ATLANTA, Jan 19, 2006 : (Carol Tome, CFO) - Sales growth of 10% to 12% (80.4 to 81.9 billion) - comps of 3.3% -Gross margin “above” 33.4% (ytd through Oct) -total expenses between 21.6% and 22.6% (depr+sga) -EPS at “high end” of 2.64-2.67 for year -inventory to grow 11% -SCF: 8.2B CFO, 1B Debt Issuance, 4B capX, 2.6BM&A, 3B stk repurchase,.9B dividend, leaving.9B in cash at end of year (vs 2.2 in 2004)

12. 12 Seasonal Sales Effects HD Quarterly Sales Per Store

13. 13 Home Depot Step 1: Forecasting sales growth A Naïve forecast: Sales = (avg weekly sales per store (10Q, Q3) x13 weeks x #stores) Sales = $765,000 x 13 x (2043+1972)/2 = $19,965 mil However, there are other relevant factors: -Sales are seasonal! -HD is growing, so need to factor in new stores. -Separate between (1) same-store or comp sales growth, (2) new store sales growth (Same stores are those that were in operation for the entire quarter in both qtrs!) -What else? (cold weather, disruptive renovations, 14 week quarters)

14. 14 computing annual comparable store sales growth close 3 new mid old Comparable store sales growth is the growth in sales from stores that have been open for two full years (and are currently still open).

15. 15 Computing Quarterly Comparable Store Sales Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 fiscal 2004 fiscal 2005 2.1 4.0 3.6 3.3 ??

16. 16 past seasonal comp growth

17. 17 Use Seasonal variation on simple %’s model: Sales Growth % = (1+growth % in stores)(1+ comp growth) -1 how many new stores were opened between 2004 Q4 and 2005 Q4? seasonal growth in average # stores: 2043/1890 -1 = 8.1% growth. I used forecasted Q4 comps of 3.3% (webcast) (1+.081)(1+.033) – 1 = 11.67% seasonal growth 16812 Q4 2004 sales X (1.1167) = $18,773M Sales Estimate – option 2

18. 18 Sales Estimate – Option 3 (trust management forecast)

19. 19 Next, forecasting CGS and SG&A: Are they also seasonal?

20. 20 Gross Margin and SGA Estimate “33.4% or above”  GM=% (Q3 this year of 33.6) x 34.2%/33.3% = 34.5% go with 34% between 21.6 and 22.6 annual (depr is included in sga in eVal data). Using 18,773,000 Q4 sales and past SGA rates, implies 24.1%  SGA = (Q3 this year of 21.6) x (24.3/22.4) = 23.4%  go with 24%

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22. 22 So, my forecasted Sales and EPS are… Sales = $ 19,000,000 Net income = $1,216,679 shrs outstdg Q3 = 2124M, less 5M repo EPS = NI/2,122 = 0.57/per share 02/21/06 - 9:00 AM ET Home Depot Inc. 4th Quarter 2005 Earnings Conference Call

23. 23 What are the analysts predicting? http://biz.yahoo.com/z/a/h/hd.html http://www.earningswhispers.com/stocks.asp?symbol=HD http://biz.yahoo.com/z/a/h/hd.html http://www.earningswhispers.com/stocks.asp?symbol=HD

24. 24 HD Earnings Surprise History

25. 25 Common behavior of quarterly earnings Seasonal random walk E t = E t-4 +  t, where  t is zero, on average Seasonal autoregressive model E t = E t-4 +.34(E t-1 – E t-5 ) +  t E t+1 = E t-3 +.19(E t-1 – E t-5 ) +  t E t+2 = E t-2 +.06(E t-1 – E t-5 ) +  t E t+3 = E t-1 -.24(E t-1 – E t-5 ) +  t Positive surprise Negative surprise

26. 26 Abarbanell and Bernard, Journal of Finance 1992 Stevie Wonder – Sir DukeWonder