Table of Contents

INTRODUCTION ................................................................................... 1
STRATEGIC ANALYSIS ........................................................................... 1
Home Improvement Industry .................................................................. 1
Industry Analysis: Porters Five Forces ....................................................... 1
Company Strategy .............................................................................. 3
Home Depot SWOT Analysis .................................................................... 4
ACCOUNTING ANALYSIS......................................................................... 5
Accounting Policies ............................................................................. 5
Potential Red Flags and Biases................................................................. 8
FINANCIAL ANALYSIS .......................................................................... 10
Condensed Balance Sheet Assumptions and Analysis ...................................... 10
Ratio Analysis ................................................................................. 11
Prediction of Bankruptcy..................................................................... 15
Cross-Sectional Analysis ...................................................................... 16
FORECASTING .................................................................................. 17
Income Statement Assumptions ............................................................. 17
Forecasted Income Statements .............................................................. 20
Balance Sheet Assumptions .................................................................. 20
Forecasted Balance Sheets................................................................... 22
VALUATION ..................................................................................... 22
Cost of Equity Assumptions .................................................................. 22
Plain Vanilla Abnormal Earnings Valuation Results ........................................ 22
Sensitivity Analysis ........................................................................... 23
Abnormal Earnings Valuation with ROE Mean Reversion .................................. 24
RECOMMENDATION ............................................................................ 24
APPENDIX ....................................................................................... 26
Appendix 1 Consolidated and Condensed Balance Sheets ................................ 26
Appendix 2 Consolidated Income Statements ............................................. 27
Appendix 3 Consolidated Cash Flow Statements ......................................... 28
Appendix 4 Altmans Z-Score Calculation ................................................. 29
Appendix 5 - Plain Vanilla AEV .............................................................. 30
Appendix 6 Optimistic Scenario Forecast and AEV ....................................... 30
Appendix 7- Pessimistic Scenario Forecast and Valuation ................................ 32
Appendix 8 AEV with ROE Mean Reversion ............................................... 34
INTRODUCTION
The Home Depot (Home Depot) is one of the most well-known companies in the home
improvement industry. Founded in 1978, the company grew rapidly to become the worlds
largest home improvement retailer. With more than 2200 stores across North America, Home
Depot has become the most popular one-stop shop for both do-it-yourself home improvement
consumers as well as construction professionals. Each retail store carries a variety of branded as
well as generic home improvement products, building materials, and garden products. The stores
also offer home improvement and installation services. Home Depot has been extremely
successful to date and during the last financial year alone, the retail giant brought in profits
exceeding 6 billion US dollars.

STRATEGIC ANALYSIS
Home Improvement Industry
Home Depot belongs to the home improvement industry; the industry's value chain is divided
into three major parts: Manufacturing, Distribution, and Installments. The manufacturing arm
produces building materials and building products. Building materials are elements that are
vital to the structure of the building such as lumber, concrete, doors and windows. Building
products are modular items not critical to the structural integrity of the building; they include
items like hardware, heating ventilation and air conditioning (HVAC), systems and flooring.

The distribution chain is dominated by retailers that include: Home Depot, Lowes, Walmart and
Sears. Smaller hardware stores, garden centers, plumbing, and electrical supplies stores provide
competition in their specialized end of the market. These retailers have three major sets of
consumers: Do It For Me (DIFM) where they provides installation services for customers, Do It
Yourself, and Professionals.

Industry Analysis: Porters Five Forces

Internal Rivalry: High
The home improvement industry is an extremely competitive industry. The industry is
dominated by two major firms that focus exclusively on selling home improvement products
while multipurpose retailers like Walmart and Sears often sell home improvement products as
well. There is little differentiation among the offering of major players in the industry which
puts massive pressure on prices. The extreme price pressure often motivates retailers to offer
promotional deals to gain more market share. These deals involve deep discounting where
prices are often slashed well below standard prices in order to increase customer visits during
recessions. The low switching costs that the industry was famous for appears to be

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disappearing with the introduction of private label cards which allows retailers to offer
customers discounts based on spending. Customers will be encouraged to spend more with
their current retailers than their competitors to accumulate points that will lead to a discount
on their future purchase. The big players also have to compete with specialized and
independent hardware stores. The locality also plays an important factor in this industry as
consumers are more likely to visit stores that are conveniently located. Little diversif ication and
concentrations makes the rivalry in this industry intense.

Threat of New Entrants: Low

There is also a lack of product differentiation among the major players in the industry which
leads to intense competition. This competition will be a deterrent to potential entrants that
might not have the capital to compete with the major players. The competitive pressure in the
industry has also severely reduced profit margins, when margins are low few entrepreneurs will
want to enter the industry. Relationships between suppliers and retailers could also act as a
deterrent to new entrants. Retailers will enjoy tremendous benefits from manufacturers they
have been dealing with over time; they are more likely to receive better credit terms and
discounts which increases their ability to reduce prices. Large incumbents enjoy the economics
of scale and scope; they can get discounts by buying in bulk and they can offer consumers a
better value proposition through offering consumers a wide variety of goods that new entrants
will not be able to provide. New entrants could often enter the market only if the specialize in
producing a single category of products. The overall threat from new entrants is relatively small
as they face many barriers to entry.

Threat of Substitutes: Low

The use of professional services of builders, painters and other tradespeople can act as a
possible substitute to the home improvement offering. Consumers might opt for these services
because they might not have the time or the know-how in selecting specialized item to buy or
how to install certain items. These professionals have the know-how and can save consumers
the stress and thus poses a threat to home improvement retailers. However, these
professionals buy most of their specialized items from retailers that constraints the threat these
professionals pose. The threat of substitutes appears to be weak or inexistent in this market.

Bargaining Power of Buyers: Medium

The home improvement industry comprises of a large number of consumers that have little
financial strength. The size of customers and the presence of several alternative could mean
that buyer power in the industry is quite high. There seems to be no financial penalty for
switching between competitors, however, the introduction of private label cards has imposed
an artificial switching cost. These private cards are linked with loyalty programs; a customer
might opt out of switching due to repayments of credit card debts with existing company and

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the fear of higher borrowing costs from switching to a new business. Personal debt levels mean
buyers across the board are price sensitive as more of income is used to servicing debt. There is
no threat of backward integration due to the small financial strength of buyers. The sheer size
of consumers makes it difficult for them to organize in groups which means they can't influence
the price to fall any further.

Customers enjoy intense competition and low switching cos ts. However, the size of customers
and their inability to organize groups reduces their bargaining power. Thus, the bargaining
power of consumers in this industry is medium.

Bargaining Power of Suppliers: Low

Suppliers are divided into two categories: manufacturers and employees. Manufacturers in this
industry are well diversified; they vary in size ranging from large firms like Black and Decker to
small independent companies. Manufacturers attempt to persuade retailers to carry their
brand of products. The high number of suppliers reduces the bargaining power of vendors
means there is intense competition among suppliers which reduces their bargaining power.
Manufacturers are often forced to absorb a rise in the costs of labour and raw materials
because retailers are unwilling to accept an increase in price by manufacturers as they do not
want to pass the cost to consumers. Retailers with the help of some suppliers produce private-
label products with the aim of competing with branded products. This will improve the
bargaining power of retailers. Manufacturers can forward integration through setting up
proprietary stores and utilizing the internet to sell their products online to reduce dependence
on retailers.

Retail associates are known to have a high turnover due to the intense competition for talent in
the industry that gives employees bargaining power when negotiating wages. It could take a
new employee a long time to gain the customer service skills which is vital for success in this
industry.

The power of suppliers in this industry is low as the manufacturers absorb any increases in costs
of goods sold and also face competition from the retailer's brand. Although employees do have
significant bargaining power.

Company Strategy
Home Depot follows a cost leadership strategy and emphasizes productivity and efficiency
especially within its supply chain. The company uses advanced forecasting and replenishing
technology that allows it to maintain optimal levels of inventory and meet product demand
without tying up an excessive amount of investment in inventory. It also keeps other expenses

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low by leveraging the economies of scale and scope that come with its size. The company then
passes these costs savings on to its customers in the form of affordable prices.

While companies pursuing a cost leadership strategy often sell a limited number of products to
its customers, Home Depot is different as it carries a large product offering at each of its stores.
By minimizing costs on its operational side, Home Depot is able to continue offering low prices
to customers without compromising product variety or quality. The everyday low prices as well
as the one stop-shop experience available at Home Depot stores then help the company attract
customers and protect market share.

Home Depot SWOT Analysis

Strengths
Home Depot has many strengths and one of these strengths is its strong brand name. Because
the company is so well-known, it is the go to store for many consumers who are purchasing
home improvement products for the first time. In addition to easily attracting new customers,
Home Depot also retains customers effectively as it offers consumers a wide variety of products
at affordable prices as well as excellent customer service. The company also has a strong
sourcing program that allows it to access suppliers from around the world. This program, as
well as its position as a retail giant, gives Home Depot high bargaining power over most
suppliers and keeps its costs of good sold low.

Weaknesses
Because Home Depots products are considered consumer discretionary goods, the companys
sales are very dependent on the performance of the home improvement industry as well as the
economy in general. As a result, sales figures are often quite variable as they increase with
economic booms and decrease during recessions. Another weakness would be the lack of
differentiation between Home Depot and its competitors. While Home Depot is the exclusive
retailer for a few brands like Husky, Everbilt, and Diablo, most of the companys products are
also available at other home improvement retailers like Lowes. This lack of differentiation leads
to price competition between the retailers and as a result, profitability suffers. Finally, Home
Depot is currently facing some lawsuits from a data breach that occurred during 2014 and these
lawsuits take up a lot of company resources that could have been used productively
otherwise.

Opportunities
Two areas of opportunities exist for Home Depot. First, online shopping has increased
significantly in popularity over the last few years. For instance, the volume of US B2C e-
commerce sales has grown from 424 billion back in 2010 to over 700 billion in 20 14. Therefore,
Home Depot should take advantage of this additional sales channel and increase the amount of

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products available for purchase on its website. Second, Home Depot should consider
international expansion. For instance, there is a large demand for home improvement products
in Europe. According to the European Home Improvement Monitor, more than 245 billion euros
were spent on these products in the first six months of 2013 alone. By entering new markets
such as Europe, Home Depot will be able to increase its revenues by expanding its customer
base.

Threats
Home Depots largest threat is its competitors. Since little differentiation exists between the
products offered by various home improvement retailers, there is heavy competition and The
Home Depot is forced to offer consumers low prices in order to keep its market share. Other
threats include the possibility of an interest rate hike. Many analysts speculate that this may
occur in the near future and it could potentially lead to a downturn in the housing markets as
mortgage rates would also increase, making it more difficult for consumers to take on or
maintain their mortgages. As a result, there would be a decrease in construction projects which
would ultimately be damaging to Home Depots sales.

ACCOUNTING ANALYSIS
Accounting Policies
Merchandise Inventories
Home Depot is a retailer of home improvement and decorating products and merchandise
inventories is the second biggest asset on the companys balance sheet about $11 billion. The
accounting method used to record about 75% of the companys inventories is the lower of cost
(first-in, first-out) or market, as determined by the retail inventory method. The inventory retail
value is adjusted regularly to reflect market conditions, hence, the inventory valued using the
retail method approximates the lower of cost or market. The remaining approximately 26% of
inventories includes operations in Canada and Mexico, and distribution centers which record
Merchandise Inventories at the lower of cost or market, as determined by a cost method. The
company assess the inventory valued using a cost method at the end of each quarter to ensure
it is carried at the lower of cost or market. The company states that the valuation allowance for
inventories valued under a cost method was not material to the financial statements and does
not disclose an amount.

Independent physical inventory counts are taken on a regular basis in each store and
distribution center to compare it with the amount on the consolidated financial statements.
The company estimates and accrues for potential losses due to shrink (theft, loss, inaccurate
records for the receipt of inventory or deterioration of goods) on a store-by-store basis based

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on recent shrink results and current trends in the business. The company states that actual
shrink results did not differ materially from estimated for 2014, 2013 and 2012, but did not
disclose an amount.

Lowes records inventory using the same the same lower of cost and market method, however,
Lowes, unlike Home Depot, also discloses what components are used in calculating cost.
Overall, Home Depot could have provided more information regarding inventory write-downs
and reversals, etc.

Revenue Recognition
Revenue is recognized net of estimated returns and sales tax at the time the customer takes
possession of products or receives services. The allowance for sales returns is estimated based
on historical return levels. Amount received for merchandise and service not yet received by
the customer is recorded as Deferred Revenue. Deferred revenue is also recorded for sale of
gift cards and this revenue is recognized when gift cards are redeemed.

Sales balance on income statement also includes services revenue generated through
installation, home maintenance and professional service programs. The customer selects and
purchases material for a project and the Company provides or arranges professional
installation. Under certain programs, when the Company provides or arranges the installation
of a project and the subcontractor provides material as part of the installation, both the
material and labour are included in services revenue. The Company recognizes this revenue
when the service for the customer is complete. Services revenue was $3.8 billion, $3.5 billion
and $3.2 billion for fiscal 2014, 2013 and 2012, respectively.

Long-Lived Assets
Home Depot evaluates its Long-Lived Assets each quarter for any indications of potential
impairments in their value, which include the decision to relocate or close a store or other
location before the end of its previously estimated useful life and/or when changes in other
circumstances indicate the carrying amount of an asset may not be recoverable. In addition, the
test conducted by Home Depot to test the potential impairment of a specific asset includes
comparing the future undiscounted expected cash flows of the asset to its current carrying
value on the Balance Sheet. Specifically, the analysis of the undiscounted expected cash flows
of an asset includes Managements assumptions of cash inflows and outflows directly resulting
from the use of the specific asset in operations. Furthermore, considerations include
assumptions about the Gross Profit Margin on Net Sales, Payroll and Related Items, Occupancy
Costs, Insurance Allocations, and Other Costs needed to operate an individual store.
Consequently, if the carrying value is greater than the undiscounted expected cash flows, an
impairment charge is recognized on the financial statements based on the difference between
the carrying value and the estimated fair market value. In the instance that an impairment loss

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needs to be recognized, it is recorded as a component of Selling, General & Administrative
Expenses on the Income Statement. Also, when a leased location is closed, the net present
value of future lease obligations less sublease income is recognized in Selling, General &
Administrative Expenses. In addition, the variables that are used to assess the viability of
recovering the value of a Long-Lived Asset are consistent with the assumptions used for Lowes.

There are significant amounts of assumptions that are built into assessing whether an asset
should be impaired. The analysis of expected cash flows for a specific asset includes projections
several years into the future, with assumptions regarding key variables including future sales
growth, operating margin growth rates, economic conditions, market competition, and
inflation. Furthermore, Home Depot has identified that the threshold for an impairment charge
is a 10% decrease in the undiscounted expected cash flows or sublease income. Furthermore,
when comparing this threshold to Lowes, there is a slight divergence. In the case of Lowes,
and impairment charge is recognized if there is a 10% decrease in projected Sales that are used
to estimate undiscounted expected cash flows. This assumption does not take into account
the other sources of losses that could arise, such as increasing in operating costs, which the
Home Depot model does. As such, the Home Depot method for impairment is a more
comprehensive and inclusive model.

Goodwill & Other Intangible Assets

It is also important to look at the accounting policies elected to deal with Goodwill & Other
Intangible Assets, but this is not specifically disclosed in the Lowes financial statements. Home
Depot does not amortize Goodwill, but assess the recoverability in the third quarter of each
fiscal year. Furthermore, a qualitative analysis is conducted to assess i f the carrying amount
exceeds the fair value of the assets, and if so, a quantitative assessment is conducted to put a
numerical value on it. In conclusion, there is a quantitative analysis that is conducted at least
once every three years.

Self-Insurance
Home Depot operates in the Home Improvement Products & Services Retail, and as such, one
major component of the business model, is their employees. These line items represent a
substantial portion of Balance Sheet, and as such, Home Depot has established liabilities for
certain types of losses from general (and product) liabilities, workers compensation, employee
group medical and automobile claims. The retention for each claims include $25mn (general
liabilities), $1mn (workers compensation), and $1mn (automobile liabilities). Furthermore,
these liabilities are calculated (and presented) at the estimated ultimate cost of for the claims
incurred at the date of the Balance Sheet. These estimated liabilities are not discounted and are
established based upon analysis of historical data and actuarial estimates. Furthermore, these
liabilities are reviewed by Management and third-party actuaries on a regular basis to ensure

7
accuracy. In comparing these assumptions to the ones used in the financial statements of
Lowes, it is evident that the assumptions are in-line with industry practices. Furthermore, the
threshold that would cause a material impact on the operations of Home Depot is not disclosed
in the financial statements.

Share Repurchase
Home Depot has been buying back company shares under the share repurchase program since
2002 has spent over $34.55 billion in purchasing shares. The company entered into several
Accelerated Share Purchase Agreements (ASR) during 2012-2014 and has spent another $11.95
billion. The financing for these agreements is being done through debt issuance and operating
cash flows. Home Depot is buying back shares as they are a mature company and dont have
many opportunities for expansions or acquisitions. Home Depot is taking advantage of debt
financing due to reduced interest rates as well as higher operating cash flows due to improving
house market. The repurchased shares are being recorded as treasury stock with no voting
rights and are not part of outstanding shares. Repurchasing shares can help Home Depot
maintain a controlling interest within the company to prevent hostile takeovers. Also, by
reducing outstanding shares, the Earnings per Share and Price-to-Earnings ratios will also
improve. The remaining shareholders will also have more earnings allocated to their shares.

Potential Red Flags and Biases

Choice of GAAP
Home Depot uses U.S. GAAP for reporting purposes and is listed on the New York Stock
Exchange. U.S. GAAP is more rules-based and therefore, reduces the degree of judgment in
applying accounting standards compared to IFRS which is more principles-based. This can help
in reducing manipulations of balances. However, rules -based standards can also be too rigid
and may prevent financial reports from displaying the true economic condition of the firm due
to the strict application of rules.

Litigation & Data Breach

Between April and September of fiscal 2014, Home Depot had its payment data systems
breached, which potentially impacted customers who used payment cards at self-checkout
systems in the Company's U.S. and Canadian stores. The investigation is ongoing. This is red flag
because the potential costs and liability related to the litigation will be material and significant
according to the company, however, due to the lack of probability and reasonable estimation of
the amount currently, Home Depot has no provisions recorded yet. This could distort financial
statement comparison in future years and also impact stock price and earnings.

In 2014, the Company recorded $63 million of expenses related to the as well as $30 million of
expected insurance proceeds for costs the Company believes are reimbursable under its

8
insurance coverage net expenses of $33 million recorded in SG&A expenses in the income
statement for 2014. Expenses include costs to investigate the Data Breach, provide identity
protection services to impacted customers and pay legal and other professional services. At
February 1, 2015, the company had accrued liabilities of $12 million and insurance receivable of
$20 million on its books.

Home Depot expects the payment card networks will make claims against the company. The
final amount of these claims will probably consist of amounts for incremental counterfeit fraud
losses and non-ordinary course operating expenses (such as card reissuance costs). In order for
Home Depot to have liability for such claims, it would have to be determined that at the time of
the data breach, the portion of the companys network that handles payment card data was
noncompliant with applicable data security standards, and the alleged noncompliance caused
at least some portion of the compromise of payment card data that occurred during the Data
Breach. An independent third-party assessor found the portion of the companys network that
handles payment card data to be compliant with applicable data security standards in the fall of
2013, and the process of obtaining such certification for 2014 was ongoing at the time of the
Data Breach. However, in March 2015 the forensic investigator working on behalf of the
payment card networks alleged that the company was not in compliance with some of those
standards at the time of the Data Breach. As a result, Home Depot expects it is probable that
the payment card networks will sue and the company will have to decide whether to litigate or
settle those claims. At this time, Home Depot believes that settlement negotiations will happen
and it is probable that the company will incur a loss in connection with those claims. Also,
lawsuits have been filed in courts in the U.S. and Canada, and other claims may be made
against the company on behalf of customers, shareholders or others. In addition, several state
and federal agencies, including State Attorneys General, are investigating the Data Breach and
the company may incur fines or other obligations. The company is not able to estimate the
range of costs because the investigations are in the early stages, and the company has not
recorded an accrual for litigation, claims and governmental investigations related to these
matters in fiscal 2014. An estimate for losses will be recorded at the time it is both probable
that a loss has been incurred and the amount of the loss is reasonably estimable. The Company
believes that the final amount paid on payment card network claims could be material to the
Company's consolidated financial condition, results of operations, or cash flows in future
periods.

In addition, the company expects to incur significant legal and other professional services
expenses related to the Data Breach in future periods and will record them as services are
received. The company has also taken another $100 million insurance policy on top of its
current one to cover these potential costs.

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Overall, the Home Depot Data Breach is a significant event that affected millions of customers
in two countries. The potential expenses arising from the lawsuits, legal and consulting fees,
insurance, fines and remediation of current weaknesses will be significant. Therefore, this is a
red flag as it will impact the companys financial statements, profitability, stock price and future
forecasts.

Deferred Revenues (Gift Cards)

As stated under revenue recognition accounting policy, gift card sales are recorded as deferred
revenue and realized as revenue upon redemption. Gift card breakage income is recognized for
the value of gift cards for which the Company believes the probability of redemption by the
customer is very low and is based upon historical redemption patterns. The Company recorded
$32 million, $30 million and $33 million of gift card breakage income during 2014, 2013 and
2012, respectively. This income is realized as a reduction in SG&A expenses. Even though, the
amount is not material, this could be a potential red flag as this allowance can be manipulated
to reduce expenses which will have an impact on profits. It is a red flag also because it an
estimate and does not represent the exact value of gift cards not redeemed.

Home Depot does not disclose the amount of deferred revenue from unredeemed gift cards or
the method used in estimating gift card breakage income, unlike Lowes which does.

Disclosure
Overall, Home Depot meets the minimum requirements for disclosure as per U.S. GAAP but
does not go above and beyond those requirements. There are many qualitative and
quantitative disclosures as discussed in the accounting policies and red flags that Home Depot
could have provided. Its main competitor Lowes, on the other hand, does provide more
disclosures; therefore, there is no reason to believe that Home Depots lack of detailed
disclosure is for competitive purposes.

FINANCIAL ANALYSIS
Condensed Balance Sheet Assumptions and Analysis

CONDENSED BALANCE SHEET

(amounts in millions)

Fiscal Year Ended: 01-Feb-15 02-Feb-14 03-Feb-13 29-Jan-12 30-Jan-11

Net Operating Working Capital 4,361 4,563 5,231 5,174 4,399

Net Long-Term Assets 22,158 22,683 23,342 23,512 24,239
Net Assets 26,519 27,246 28,573 28,686 28,638

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Net Debt 17,197 14,724 10,796 10,788 9,749
Shareholders' Equity 9,322 12,522 17,777 17,898 18,889
Net Capital 26,519 27,246 28,573 28,686 28,638

Cash and Cash Equivalents

The cash and cash equivalents balance is decreasing. Most of the cash flow from operations is
being used in repurchasing stock, so theres no need to separate into operating and financial
cash. By separating into financial cash, Net Debt will be distorted.

Net Operating Working Capital

Net OWC is calculated by deducting net operating liabilities from net operating assets. Net
OWC is positive but decreasing since 2012, and is the lowest in the past five years.

Net Long-Term Assets

Net long-term assets are calculated by adding together Goodwill, Property and Equipment and
long-term Other Assets and deducting Long-term liabilities and Deferred income taxes. Net LT
assets have been decreasing for the past five years primarily due to decrease in Net Property
and Equipment.

Adding Net long-term assets and Net operating working capital gives Net Assets which is similar
to Total Assets on a regular balance sheet. Net assets are decreasing due to decrease in net
OWC and LT assets.

Net Debt
Net Debt is calculated by adding short-term debt, and current and long-term portions of debt.
Net debt is increasing since Home Depot is borrowing money to finance its share repurchase
program by taking advantage of historically low interest rate.

Shareholders' Equity
Shareholders equity is decreasing since the company is buying back shares as a result of their
share repurchase program since 2002. The company renewed their commitment and signed a
new share repurchase program in 2014; therefore, shareholders equity will be decreasing
further.

Net Capital is obtained by adding together Net Debt and Shareholders Equity and is equal to
Net Assets.

Ratio Analysis

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RATIOS

As of: 01-Feb-15 02-Feb-14 03-Feb-13 29-Jan-12 30-Jan-11

ROE 68.06% 43.00% 25.51% 21.70% 17.67%

Operating ROA 25.11% 21.40% 17.07% 14.86% 12.91%

Net Borrowing Cost 1.82% 3.02% 3.17% 3.52% 3.68%
SPREAD 23.29% 18.38% 13.90% 11.34% 9.23%

Net Financial Leverage 1.84 1.18 0.61 0.60 0.52

ROE = Operating ROA + Net Financial 68.06% 43.00% 25.51% 21.70% 17.67%
Leverage*SPREAD

Operating Asset T/O 3.14 2.89 2.62 2.45 2.37

Operating Profit Margin 8.01% 7.40% 6.52% 6.06% 5.44%

Line Items:

Cost of Sales/Sales 65.19% 65.25% 65.43% 65.53% 65.73%

SG&A/Sales 20.24% 21.06% 22.08% 22.77% 23.31%

Individual Asset Turnovers:

Receivables T/O 56.05 56.37 53.59 56.54 62.67
Inv T/O 4.89 4.65 4.57 4.47 4.21
Payables T/O 9.36 8.95 9.16 9.45 9.55
Fixed Asset T/O 3.66 3.38 3.11 2.88 2.71

Days Rec 6.51 6.47 6.81 6.46 5.82

Days Inv 74.58 78.48 79.92 81.69 86.77
Days Pay 39.00 40.79 39.83 38.63 38.22
Cash Cycle 42.09 44.17 46.90 49.51 54.38

Risk Ratios:

Liquidity Ratios:

Current Ratio 1.36 1.42 1.34 1.55 1.33

Quick Ratio 0.28 0.31 0.34 0.34 0.16
CFO/CL Ratio 0.73 0.71 0.61 0.71 0.45

Solvency Ratios:

D/E Ratio 1.84 1.18 0.61 0.60 0.52

Net D/E (same as Net Financial Leverage) 1.84 1.18 0.61 0.60 0.52
Liabilities/Assets 0.77 0.69 0.57 0.56 0.53

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 Coverage Ratios:

Interest Coverage (EBIT/Interest Expense) 21.24 13.11 14.25 11.23 10.32

Interest Coverage using cash flows 25.08 16.32 18.73 15.90 12.52
Capex Coverage (assume Capex =negative of Cash 0.15 0.20 0.21 0.17 0.22
from Investing)

Profitability Ratios:
Operating Return on Assets
Operating ROA is obtained by dividing Net operating profit after tax with Net assets. Operating
ROA is increasing because Net earnings are increasing and Net assets are decreasing.

Net Borrowing Cost

Net borrowing cost is decreasing since Net interest expense after tax is decreasing and net debt
(denominator) is increasing. Interest for fiscal 2014 decreased despite increase in net debt
because of a pre-tax gain of $323 million related to the sale of a portion of equity ownership in
a subsidiary - HD Supply. This partially offset the additional interest expense from $2 billion of
long-term debt issued in June 2014.

SPREAD
Spread is the difference between Operating ROA and Net borrowing cost. Spread has been
increasing for the past five years because operating ROA is increasing and net borrowing cost is
decreasing.

Net Financial Leverage

Leverage is calculated by dividing net debt with shareholders equity. Leverage is increasing
because net debt is increasing and shareholders equity is decreasing. Debt is increasing
because Home Depot is taking advantage of low interest rates.

Return on Equity
ROE is increasing because operating ROA as well as leverage are increasing. Home Depots sales
and net income are increasing. They are also increasing debt financing and reducing equity
through share repurchases.

Operating Profit Margin

Operating profit margin is increasing and is a contributing factor in increasing operating ROA
and NOPAT due to increasing margins. Margins are increasing because COGS/Sales and
SG&A/Sales are decreasing.

Line Items:

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Cost of Sales/Sales
The ratio is decreasing since cost of sales is increasing slower than sales. This will contribute to
increasing margins and is in line with the Home Depots cost cutting strategy.

Selling, General & Administrative Costs/Sales

The ratio is decreasing and keeps up with the companys strategy of improving economies of
scale.

Turnover Ratios:
Operating Asset Turnover
Operating asset turnover is improving year-by-year due to increasing sales and reducing net
assets, meaning asset use is becoming more efficient.

Receivables Turnover
Receivables turnover is relatively steady and it takes the company about 6-7 days to collect
cash. This also shows that sales are improving from improving economic conditions and not
channel stuffing.

Inventory Turnover
Inventory turnover is improving since inventory is being sold faster. The company took 74 days
to sell inventory during 2014 than 78 days in 2013. Inventory turnover is getting better due to
Home Depots increasing implementation of technology such as cellphones for employees to
help them immediately answer customer queries such as inventory availability, price, etc. Also,
the improvement of website to allow customer to buy more products online is also leading
increasing and faster sales.

Payables Turnover

Payables turnover is also relatively steady in the past 5 years where the company takes about
38-40 days to payoff payables.

Fixed Asset Turnover

Fixed asset turnover has been improving because sales are increasing, and net property and
equipment is decreasing in the last five years.

Cash Cycle
Cash cycle is getting better mostly due to improving inventory turnover.

Liquidity Ratios:
Current Ratio
There are fluctuations in the past five years but company has become less liquid from last year.

14
Quick Ratio
The quick ratio has been decreasing since 2012 due to increase in liabilities but the changes are
not significant. The main driver of decrease during 2014 is short-term debt of $290 million.

CFO/CL Ratio
The ratio is improving since 2012 due to increase in cash flow from operations but is not
enough to cover current liabilities.

Solvency Ratios:
D/E Ratio
Increasing since company is incurring more debt by issuing senior notes and reducing equity
through buybacks.

Liabilities/Assets
The ratio is increasing because companys overall liabilities are increasing for the past five years
whereas total assets are relatively steady with small fluctuations. Total assets cannot cover
total liabilities. The main driver for increasing liabilities is long-term debt.

Coverage Ratios:
Interest Coverage (EBIT/Interest Expense)
Interest coverage is improving from higher earnings. Interest expense decreased by $206
million from last year and has been fluctuating in the past five years.

Interest Coverage using cash flows

Improving due to higher cash flows from operations.

Capex Coverage (assume Capex =negative of Cash from Investing)

Assuming capital expenditures are negative of cash from investing, cash flow from operations
covers CAPEX. Coverage is increasing from last three years due to higher CFO and increases
significantly from last year due to drop in investment expenditures.

Payout Ratio
Company is paying between 38% - 42% of net earnings as dividends since 2011. Therefore,
retaining about 60% of profits for use in the firm.

Prediction of Bankruptcy
Altmans Z-Score

01-Feb-15 02-Feb-14 03-Feb-13 29-Jan-12 30-Jan-11

15
Altman's Z-score 7.57 6.53 6.39 5.46 4.88

Home Depots Altmans Z-score has been above 3 for the last 5 years which means that the
company falls into the safe category according to Altmans Z-score model. This means that the
company is very unlikely to go bankrupt. Also, notice that this score is actually increasing as the
years pass. Since Altmans Z-score model says that any company with a Z-score above 3 is
considered safe, an increasing Z-score is a good sign as it indicates that the company is getting
safer and safer. As a result, investors who hold Home Depots bonds should feel confident that
they will receive all the payments associated with their Home Depot bonds. For detailed
calculation of Z-score, refer to appendix.

Cross-Sectional Analysis

Key Stats Comparison

Company Name Share Price Shares Market Total Enterprise

Outstanding Capitalization Value
The Home Depot Inc. 134.74 1,267.9 170,834.3 188,656.3
Lowes Company Inc. 77.34 917.0 70,920.8 82,134.8
Industry Average 36.78 402.3 11,577.8 12,782.6
LTM Tangible Book Price/Book Beta LTM Diluted EPS
Value/share Value Excl. Extra Items

The Home Depot Inc. 3.90 34.55x 0.97 5.33

Lowes Company Inc. 9.14 8.46x 0.95 3.15
Industry Average 11.24 3.27x 1.54

Ratios Comparison

Company Name ROA % (Net) ROE % (Net) EBITDA Gross Margin %

Margin %
The Home Depot Inc. 16.5% 78.0% 15.2% 34.9%
Lowes Company Inc. 10.0% 31.2% 11.9% 34.8%
Inventory Net PPE Total Accounts
Turnover Turnover Asset Receivable
Turnover Turnover
The Home Depot Inc. .4.6x 3.8x 2.0x 48.8x
Lowes Company Inc. 3.8x 2.9x 1.7x NA
Quick Ratio Current Ratio Cash Ratio

The Home Depot Inc. 0.3x 1.2x 0.6x

Lowes Company Inc. 0.1x 1.0x 0.4x
Total Debt to Interest
Equity Coverage
The Home Depot Inc. 273.8% 12.7x

16
 Lowes Company Inc. 150.4% 9.8x
Note: the ratios of the two firms are based on LTM 12 months Nov-01-2015 stats cited from the
Capital IQ for consistency and comparability.

The two industry giants, Home Depot and Lowe's, are expected to generate about 83.3% of
total industry revenue in 2015, making the Home Improvement industry highly concentrated.
When their key stats are compared to the industry average, we see that both Home Depot and
Lowes have significantly larger enterprise value figures. In other words, they have larger firm
sizes and will be able to take advantage of economies of scale. Between the two major
competitors, Home Depot tends to outperform in every aspect. It has higher profitability ratios,
liquidity ratios, and turnover ratios. However, they have a very similar gross margin ratio which
means that the profitability of their products are quite comparable. It also implies that Home
Depot must have other advantages. Also, Home Depot has a significantly higher ROE ratio of
78% compared to Lowes 11.9% and the ROA ratio of Home Depot is higher than Lowes by
6.5%. In addition, Home Depot has a considerably higher P/B ratio of 34.55x compared to
Lowes 8.46x and the EPS of Home Depot is $5.33 compared to that of Lowes of $3.15. (The
Home Depot has a P/B ratio that is 4x Lowes and an EPS that is 1.7x Lowes.)

Although Home Depot and Lowes have similar betas of 0.97 and 0.95, they have significantly
different capital structures. Home Depot has a substantial amount of debt and its D/E ratio is
273.8% whereas Lowes D/E ratio is 150.4%. Theoretically, a higher portion of debt increases a
firms idiosyncratic risk since debt is an obligation that firms must repay and the firms will go
bankrupt if they miss any of the payments. However, Home Depot also has higher interest
coverage ratios which implies that it has sufficient funds to pay for its debt related payments.
Finally, since the home improvement industry is a relatively mature industry and Home Depot is
a mature firm, the cash flows and the profitability of the firm are relatively stable and Home
Depot has accumulated a lot of cash on hand. For these reasons, investors are relatively
confident in Home Depots ability to make future interest and debt payments.

FORECASTING
Income Statement Assumptions
Revenue Growth Assumption
From the past data, it can be seen that there has been some variability in the revenue growth
rate. There was a jump in the growth rate between 2010 and 2011 but then the rate started
declining slightly after 2011. It is likely that Home Depot couldnt maintain the strong sales
growth rate seen in 2011 since the home improvement industry is quite mature and very
competitive. As a result, a realistic assumption for Home Depots sales growth rate going
forward would be a rate that is relatively low and decreasing over time. But, we can assume

17
that the sales growth rate will continue to be a positive figure as we see the company opening
new stores (6 new stores in 2015 alone) which helps increase sales as more consumers will be
able to easily access Home Depot stores. In addition, it is safe to assume that sales will have
positive growth as the U.S economy and home improvement market continues to strengthen,
increasing the amount of disposable income available for consumers to spend on home
improvement. Home Depot continues to add value to consumer through its online distribution
offering. The increase in efficiency of customer delivery has made improved consumer
retention and attraction which is important for topline growth in a competitive industry.
Therefore, we assume that the sales growth rate for 2015 is 5% and then declines by 0.5% each
year.

Operating Expense Assumption

The operating expense ratio for The Home Depot has been steadily declining over the last few
years even though the sales growth rate has increased. We see that it dropped from 91.5% back
in 2010 to approximately 87.5% in 2014. This indicates that The Home Depot has been effective
in controlling their costs and that they havent been increasing sales through aggressively
lowering prices. This is not surprising as cost efficiency is one of the companys key strategies.
The main expenses within this operating expense figure include cost of goods sold (COGS),
sales, general, and administrative expenses (SG&A), as well as research and development (R&D)
expenses.

From our ratio analysis, we can see that The Home Depots COGS ratio has been steady around
65.5% over the past 5 years. In 2010, it was equal to 65.73% and by 2014, it was still 65.19%.
The stability of the COGS ratio makes us believe that it will remain relatively constant for the
foreseeable future. The Home Depots position as a retail giant has likely played a large role in
helping the company keep this ratio steady and maintain their healthy gross margin of
approximately 34.5%. Because the company is such a large retailer, its suppliers have very little
bargaining power and therefore cannot raise their prices. As a result, The Home Depot is able to
continue purchasing goods from their suppliers at a similar price from year to year.

For the SG&A/Sales ratio, it has been declining over the last few years and this decline is likely
the reason for the overall decline in The Home Depots operating expense ratio over the past
few years. However, this ratio will likely increase in the future because while the sales expense
component of the SG&A ratio is likely to be stable or declining slightly due to the companys
cost cutting strategy, the general and administrative expenses component will increase
significantly as The Home Depot is currently facing lawsuits and will need to pay ongoing
litigation fees.

As for R&D expenses, this component is not a significant part of operating expenses as The
Home Depot is mainly a retailer and doesnt really do much R&D in regards to product

18
innovation. However, the company does invest in R&D with regards to its technology and
systems. But, since the company isnt planning on starting any large scale technological projects
within the next few years, the R&D expense will likely stay around the same level.

Therefore, since both the COGS ratio and R&D ratio are assumed to remain stable while SG&A
ratio increases due to litigation fees, we will assume that the overall operating expense ratio
will increase by 0.6% to 88% for the next few years. This is because the rise in SG&A expense
will overpower the constant COGS ratio and R&D ratio. However, after the litigation concludes,
we can assume that the operational expense ratio will start decreasing again as Home Depot is
generally very cost efficient and has been expanding its online presence. With a higher
investment in online distribution capabilities such as the Buy Online Pickup In-Store, future
staffing needs will be reduced and inventory management will improve. Consequently, the
SG&A ratios will decline. As the legal case will likely wrap up by the end of 2017, we will
therefore assume that Home Depots operating expense ratio will decline to 87.5% in 2018 and
continue to fall by 0.5% each year.

Net Interest Expense Assumption

Home Depots borrowing costs were volatile between 2011 and 2014. The biggest decline in
borrowing costs was between 2013 and 2014 where rates fell from 6.47% to 3.35%. Home
Depot is taking advantage of the low-interest environment by refinancing current debt and
borrowing at longer maturities so the company is protected from future interest rate increases.
Since it is best to use the most recent interest rates for forecasting assumptions as they
represent the current interest rate environment, we will use an interest rate expense of 3.35%
for our forecast.

Tax Rate Assumption

The tax rate slightly varied between 2010 and 2012, however, after 2012 the tax rate stayed
constant at 36.4%. There is no evidence to suggest that the current tax rate will vary
significantly in the future hence we will apply a tax rate of 36.4% in our forecasts.

Income Statement Assumptions Table

ANALYSIS of KEY Actual Assumptions

RATIOS
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Revenue Growth 3.53% 6.19% 5.43% 5.54% 5% 4.50% 4.00% 3.50% 3.00%
Op Expenses/Sales 91.49% 90.54% 89.52% 88.37% 87.41% 88% 88% 88% 87.50% 87.00%
Interest Expense 6.08% 5.67% 6.47% 3.35% 3.35% 3.35% 3.35% 3.35% 3.35%
(l a gged debt)

Ta x Ra te 36.70% 36.01% 37.20% 36.40% 36.40% 36.40% 36.40% 36.40% 36.40% 36.40%

19
*Note: We have referred to fiscal year ending on Jan. 30, 2011 a s 2010, fi s cal year ending on Jan 29, 2011 a s 2010 a nd s o
on to ma ke the forecasts easier to understand.

Forecasted Income Statements

CONDENSED
INCOME Actual Condensed Income Statements Forecasting Period
STATEMENT
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Revenues 67,997 70,395 74,754 78,812 83,176 87335 91265 94915 98238 101185
Opera ting 62,209 63,734 66,921 69,646 72,707 76855 80313 83526 85958 88031
Expenses
Interest Expense 515 593 612 699 493 576 726 851 969 874
Income pre-tax 5,273 6,068 7,221 8,467 9,976 9,904 10,226 10,539 11,311 12,280
Ta x 1,935 2,185 2,686 3,082 3,631 3605 3722 3836 4117 4470
Net Income 3,338 3,883 4,535 5,385 6,345 6299 6503 6703 7193 7810

Balance Sheet Assumptions

Net Operating Working Capital (Net OWC) Assumption

Home Depots net owc ratio has been declining since 2012. Since this ratio indicates how much
operating working capital is needed to support sales, a decline in this ratio is a good thing as it
means that Home Depot is being more efficient with its working capital. The decline may also
be partially attributed to the decrease in the sales growth rate. As the sales growth rate
declines, the net owc ratio often falls slightly as well because a lower level of owc is needed to
support sales. We see that the decline in Home Depots past net owc ratios has ranged from
0.5% to 1%. Since Home Depots focuses heavily on operational efficiency and its sales growth
rate is forecasted to continue declining, it is safe to assume that net owc/sales will also
continue to fall as well. However, since it is difficult to keep improving operating working
capital efficiency, we will assume that this ratio only declines by 0.15% a year which is more
conservative than the rate at which this ratio had been declining at in the past.

Net Long Term Assets (Net LTA) Assumption

The net long term assets ratio for Home Depot has been steadily decreasing at a significant rate
for the last few years. Since this ratio is also an inverse asset turnover ratio, a decreasing net
long term assets ratio is a positive sign as it indicates that the company needs less fixed assets
to support a given level of sales. However, since Home Depot has opened new stores in 2015,
its net long term assets ratio for 2016 will increase (since we are using lagged long term assets).
This is especially likely since sales growth rate is forecasted to decline. But, after this increase in
fixed assets, Home Depot will likely be able to support their sales with the new level of fixed

20
 assets. Therefore, we will assume that the net long term assets ratio increases to 26% for 2016
and then stays constant for the rest of our forecast period.

Liabilities Assumption Payout Approach

We will use the payout approach to forecast Home Depots level of equity. We will then
determine net debt by subtracting shareholders equity from net capital. Home Depot has a
history of regular dividend payments; they have paid a dividend for 112 consecutive quarters
with the aim of increasing shareholders value. The board recently announced they were going
to target a dividend payout ratio of approximately 50%. For this reason, we will assume a
dividend payout ratio of 50%. The board has also indicated that they have agreed to a share
repurchase plan where they will repurchase $18 billion of shares by the end of 2017. For our
forecast, we will spread this $18 billion worth of share repurchases evenly over the three years
and assume that Home Depot will repurchase $6.0 billion of shares each year from 2015 to
2017. We will also modify the regular shareholder equity formula to reflect this plan. We will
therefore calculate the future book value of equity for 2015 to 2017 with the following formula:
SEt = SEt-1 + retention ratio*forecast net income t - $6.0 billion. After 2017, we can revert back to
using the formula SE t = SEt-1 + retention ratio*forecast net income to calculate book value of
equity.

Balance Sheet Assumptions Table

ANALYSIS of Actual Assumptions

KEY RATIOS
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

OWC/Sales 6.25% 6.92% 6.64% 5.49% 4.99% 4.84% 4.69% 4.54% 4.39%
(l a gged OWC)

LTA/Sales 34.43% 31.45% 29.62% 27.27% 25.37% 26.00% 26.00% 26.00% 26.00%
(l a gged LTA)

Debt/Net 34.04% 37.61% 37.78% 54.04% 64.85%

As s ets
65.96% 62.39% 62.22% 45.96% 35.15%
Equi ty/Net
As s ets
50.00% 50.00% 50.00% 50.00% 50.00%
Pa yout Ra tio
50.00% 50.00% 50.00% 50.00% 50.00%
Retention Ratio
6000 6000 6000 0 0
Sha re Buyback

21
Forecasted Balance Sheets

CONDENSED
BALANCE Actual Condensed Balance Sheets Forecasting Period
SHEETS
2010 2011 2012 2013 2014 2015 2016 2017 2018
Net OWC 4,399 5,174 5,231 4,563 4,361 4420 4455 4463 4445
Net LT As s ets 24,239 23,512 23,342 22,683 22,158 23729 24678 25542 26308
Net As s ets 28,638 28,686 28,573 27,246 26,519 28149 29133 30005 30753

Net Debt 9,749 10,788 10,796 14,724 17,197 21678 25410 28931 26082
Equi ty 18,889 17,898 17,777 12,522 9,322 6471 3723 1075 4671
Net Ca pi tal 28,638 28,686 28,573 27,246 26,519 28149 29133 30005 30753

ROE 20.56% 25.34% 30.29% 50.67% 67.57% 100.49% 180.02% 669.46%

VALUATION
Cost of Equity Assumptions
We are going to assume that the risk-free rate is equal to 2.30% since the 10 year U.S. Treasury
bond currently yields approximately 2.30%. Also, we will use 0.97 for Home Depots beta as
Yahoo Finance provided us with this figure. For the market risk premium, we will use 5% to be
conservative since the market risk premium is usually around 4% to 6%. With these
assumptions, we can now calculate Home Depots cost of equity by using the CAPM formula: Re
= Rf + beta*(Market Risk Premium). Home Depots cost of equity will therefore be equal to
7.15% in our forecast. Furthermore, we will assume the growth of abnormal earnings to be
equal to 2% since the long term GDP growth rate for the US is around 2.4% and the growth of a
US companys abnormal earnings should be lower than the countrys long term GDP growth
rate.

Cost of Equity Assumptions

RF 2.30%
Beta 0.97
Market Premium 5%
Re 7.15%
g 2%

Plain Vanilla Abnormal Earnings Valuation Results

According to our plain vanilla abnormal earnings valuation, Home Depots shares are worth
$107.58 each. Since Home Depots shares are currently trading at approximately $134, our

22
valuation suggests that Home Depots shares are overvalued. Again, for a more detailed AEV
that shows the implicit assumptions for year 5 to year 10, please refer to the appendix.

Abnormal Earnings
Valuation
YEARS 0 1 2 3 4 5
B.V.E 9,322 6,471 3,723 1,075 4,671 8,576
NI 6,345 6,299 6,503 6,703 7,193 7,810

ROE 68% 100% 180% 669% 167%

NORMAL EARNINGS 667 463 266 77 334

AE 5,632 6,041 6,436 7,117 7,476
TV OF AE 148073
AE+TV 5,632 6,041 6,436 7,117 155,549

VALUE 140,601

SHARES OUTSTANDING 1307

VALUE PER SHARE $107.58

Sensitivity Analysis
A sensitivity analysis was also conducted in order to see how Home Depots value would change
if they performed better or worse than our initial assumptions. Please refer to the appendix for
the detailed sensitivity analysis forecasts and valuation.

Optimistic Scenario
In this scenario, we assume that Home Depot will perform better than our assumptions in the
base case. Specifically, we will see what happens to Home Depots stock value if it achieves
higher revenue growth rates and is more efficient at using its working capital and assets to
drive sales. Instead of a decline of 0.5% in revenue growth rate a year, we will assume that
Home Depot is actually able to grow its revenue and that the growth rate increases by 0.25% a
year. We will then assume that Home Depot is more efficient with its net owc and is able to
support the revenue growth while reducing its net owc by 0.20% a year. We will also assume
that Home Depots long term assets ratio stays steady at the 2015 levels instead of increasing
to 26%.

The results from this optimistic scenario was that Home Depots value per share rose to
$114.42. The increase in share value is not unexpected as this scenario assumes that Home
Depot is doing better than we assumed under the initial AEV case.

23
Pessimistic Scenario:
In this scenario, we see what happens to the value of Home Depot if sales growth rate further
declines and if they need to grow assets more aggressively to support sales. For instance, this
would be the case if Home Depot needed to open a lot more stores in order to keep their sales
growth rate from declining even further. We will also see what happens if interest rates
increase and Home Depot is forced to pay higher interest rate expenses. Therefore, we will
assume that revenue growth rate for 2015 is 5% and then declines by 0.75% each year. For the
LTA/sales ratio, we will assume that it grows by 0.50% a year. Finally, we will use 4% for interest
expense assumption instead of 3.35%.

The results from this pessimistic scenario was that the value per share fell to $103.73. Again, a
fall in share value compared to the initial case is expected as Home Depot has lower revenue
growth, higher interest expenses, and less efficiency with their fixed assets in this scenario.

Abnormal Earnings Valuation with ROE Mean Reversion

We also completed an abnormal earnings valuation for Home Depot with the ROE returning
back to the industry average. By doing so, we saw how much Home Depot would be worth if its
ROE converged to industry ROE levels by year 15. We obtained the average industry ROE for the
home improvement industry from CSI Market and the figure was 23.96%. The result from this
valuation was that Home Depots share price was equal to $376.99. This figure is very inflated
because Home Depot had a very high ROE at the end of our initial forecast period due to their
share repurchase plan. So, when we lowered ROE levels slowly so that it would converge to
23.96% by year 15, the result was that Home Depot was assumed to still have very high ROE
levels up until year 12. Therefore, Home Depots share price is inflated with this AEV. However,
we will still include this valuation for completeness and include the calculations in the appendix.

RECOMMENDATION
While Home Depot is currently trading at approximately $134 per share, our valuation suggests
that Home Depot is overvalued and should be trading at approximately $108. We believe Home
Depots current share price might reflect the mispriced U.S. equity market and that the
companys buyback progra m has inflated the companys stock. Therefore, we would
recommend investors to sell this stock.

Although the U.S. economy has witnessed a tremendous amount of growth since the recession
in 2009, the current values of the S&P 500 might reflect economic factors beyond the
strength/growth of the U.S. economy. Market turmoil in Europe and fear of tapering in the
emerging markets has meant that international investors are moving their capital towards the
safest and best performing market in the world - the U.S. These investors are not attracted to

24
the bond markets due to the historically low-interest rate environment. This has led to a
massive inflow of capital into the U.S. equity market. The capital inflow from abroad combined
with a domestic asset class rotation from bonds to equities has resulted in an overvalued equity
market. As the global economy recovers, capital flow out of the U.S. economy could adversely
affect Home Depot stock price.

In addition, Home Depot is engaged in a share repurchase program that has increased the stock
price because of an artificial rise in the demand for the stock. Buybacks have a positive impact
on shares by signaling the company is undervalued. However, we do not believe Home Depot is
undervalued; we believe they are engaging in buybacks due to the lack of expansion projects in
the market since home improvement is a saturated market. As a result, it might be difficult for
Home Depot to expand in this space unless it is through acquisitions. In the absence of
expansion opportunities, Home Depot might feel that the most tax efficient way to deliver
value to shareholders will be through repurchases.

25
APPENDIX
Appendix 1 Consolidated and Condensed Balance Sheets

THE HOME DEPOT, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(amounts in millions, except share and per share data)

ASSETS 01-Feb- 02-Feb- 03-Feb- 29-Jan- 30-Jan- Ca tegory

15 14 13 12 11
Current Assets:
Ca s h a nd Ca sh Equivalents $1,723 $1,929 $2,494 $1,987 $545 OWC
Receivables, net 1,484 1,398 1,395 1,245 1,085 OWC
Mercha ndise Inventories 11,079 11,057 10,710 10,325 10,625 OWC
Other Current As sets 1,016 895 773 963 1,224 OWC
Tota l Current Assets 15,302 15,279 15,372 14,520 13,479
Property a nd Equipment, at cost 38,513 39,064 38,491 38,975 38,385
Les s Accumulated Depreciation and Amortization 15,793 15,716 14,422 14,527 13,325
Net Property a nd Equipment 22,720 23,348 24,069 24,448 25,060 LT As s ets
Goodwill 1,353 1,289 1,170 1,120 1,187 LT As s ets
Other As sets 571 602 473 430 399 LT As s ets
Total Assets $39,946 $40,518 $41,084 $40,518 $40,125

LIABILITIES AND STOCKHOLDERS EQUITY

Current Liabilities:
Short-Term Debt $290 $- $- $- $- Debt
Accounts Paya ble 5,807 5,797 5,376 4,856 4,717 OWC
Accrued Sa laries and Related Expenses 1,391 1,428 1,414 1,372 1,290 OWC
Sa l es Taxes Pa yable 434 396 472 391 368 OWC
Deferred Revenue 1,468 1,337 1,270 1,147 1,177 OWC
Income Ta xes Pa yable 35 12 22 23 13 OWC
Current Installments of Long-Term Debt 38 33 1,321 30 1,042 Debt
Other Accrued Expenses 1,806 1,746 1,587 1,557 1,515 OWC
Tota l Current Li abilities 11,269 10,749 11,462 9,376 10,122
Long-Term Debt, excluding current installments 16,869 14,691 9,475 10,758 8,707 Debt
Other Long-Term Liabilities 1,844 2,042 2,051 2,146 2,135 LT Li a bilities
Deferred Income Taxes 642 514 319 340 272 LT Li a bilities
Tota l Li abilities 30,624 27,996 23,307 22,620 21,236
STOCKHOLDERS EQUITY
Common Stock, par va lue $0.05; a uthorized: 10 bi llion
s ha res; issued: 1.768 bi llion s hares at February 1,
2015 a nd 1.761 bi llion s hares at February 2, 2014;
outs tanding: 1.307 bi llion s hares at February 1, 2015

26
a nd 1.380 bi llion s hares a t February 2, 2014 88 88 88 87 86
Pa i d-In Ca pital 8,885 8,402 7,948 6,966 6,556
Reta ined Earnings 26,995 23,180 20,038 17,246 14,995
Accumul ated Other Comprehensive (Loss) Income -452 46 397 293 445
Trea sury Stock, a t cost, 461 mi llion shares a t February 1, -26,194 -19,194 -10,694 -6,694 -3,193
2015 a nd 381 mi llion s hares at Feb. 2, 2014
Tota l Stockholders Equity 9,322 12,522 17,777 17,898 18,889 Equi ty
Total Liabilities and Stockholders Equity $39,946 $40,518 $41,084 $40,518 $40,125

CONDENSED BALANCE SHEET

Al l 'Ca sh and Ca sh Equivalents' i s assumed to be from Operations since Home Depot is repurchasing stock for the
pa s t fi ve yea rs , hence, Ca s h Fl ow from Fi na nci ng Acti vi ti es i s nega ti ve.

Net OWC 4,361 4,563 5,231 5,174 4,399

Net LT As s ets 22,158 22,683 23,342 23,512 24,239
Net As s ets 26,519 27,246 28,573 28,686 28,638

Net Debt 17,197 14,724 10,796 10,788 9,749

Sh Equi ty 9,322 12,522 17,777 17,898 18,889
Net Ca pi tal 26,519 27,246 28,573 28,686 28,638

Appendix 2 Consolidated Income Statements

THE HOME DEPOT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS

(amounts in millions, except per share data) Fiscal Year Ended

01-Feb-15 02-Feb-14 03-Feb-13 29-Jan-12 30-Jan-11
NET SALES 83,176 78,812 74,754 70,395 67,997
Cos t of Sa les 54,222 51,422 48,912 46,133 44,693
GROSS PROFIT 28,954 27,390 25,842 24,262 23,304
Opera ting Expenses:

Sel ling, General and Administrative 16,834 16,597 16,508 16,028 15,849
Depreciation and Amortization 1,651 1,627 1,568 1,573 1,616
Tota l Operating Expenses 18,485 18,224 18,076 17,601 17,465
OPERATING INCOME 10,469 9,166 7,766 6,661 5,839
Interest a nd Other (Income) Expense:
Interest a nd Investment Income -337 -12 -20 -13 -15
Interest Expense 830 711 632 606 530
Other - - -67 - 51

27
 Interest and Other, net 493 699 545 593 566
EARNINGS BEFORE PROVISION FOR INCOME TAXES 9,976 8,467 7,221 6,068 5,273
Provi s ion for Income Taxes 3,631 3,082 2,686 2,185 1,935
NET EARNINGS 6,345 5,385 4,535 3,883 3,338

Wei ghted Average Common Shares 1,338 1,425 1,499 1,562 1,648
BASIC EARNINGS PER SHARE 4.74 3.78 3.03 2.49 2.03
Di l uted Weighted Average Common Shares 1,346 1,434 1,511 1,570 1,658
DILUTED EARNINGS PER SHARE 4.71 3.76 3.00 2.47 2.01

Ta x Ra te 36.4% 36.4% 37.2% 36.0% 36.7%

Net Interest Expense after Tax 314 445 342 379 358
NOPAT 6,659 5,830 4,877 4,262 3,696

Appendix 3 Consolidated Cash Flow Statements

THE HOME DEPOT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in millions, except per share data) Fiscal Year Ended

01-Feb- 02-Feb- 03-Feb- 29-Jan-12 30-Jan-11
15 14 13
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Earnings $6,345 $5,385 $4,535 $3,883 $3,338
Reconciliation of Net Earnings to Net Cash Provided by Operating Activities:
Depreciation and Amortization 1,786 1,757 1,684 1,682 1,718
Stock-Based Compensation Expense 225 228 218 215 214
Gain on Sales of Investments -323 - - - -
Goodwill Impairment - - 97 - -
Changes in Assets and Liabilities, net of the effects of acquisitions:
Receivables, net -81 -15 -143 -170 -102
Merchandise Inventories -124 -455 -350 256 -355
Other Current Assets -199 -5 93 159 12
Accounts Payable and Accrued Expenses 244 605 698 422 -133
Deferred Revenue 146 75 121 -29 10
Income Taxes Payable 168 119 87 14 -85
Deferred Income Taxes 159 -31 107 170 104
Other Long-Term Liabilities -152 13 -180 -2 -61

28
Other 48 -48 8 51 -75
Net Cash Provided by Operating Activities 8,242 7,628 6,975 6,651 4,585
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures, net of $217, $46 and $98 of non-cash capital
expenditures in fiscal 2014, 2013 and 2012, respectively -1,442 -1,389 -1,312 -1,221 -1,096
Proceeds from Sales of Investments 323 - - 101 -
Payments for Businesses Acquired, net -200 -206 -170 -65 -
Proceeds from Sales of Property and Equipment 48 88 50 56 84
Net Cash Used in Investing Activities -1,271 -1,507 -1,432 -1,129 -1,012
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Short-Term Borrowings, net 290 - - 0
Proceeds from Long-Term Borrowings, net of discount 1,981 5,222 - 1,994 998
Repayments of Long-Term Debt -39 -1,289 -32 -1028 -1,029
Repurchases of Common Stock -7,000 -8,546 -3,984 -3,470 -2,608
Proceeds from Sales of Common Stock 252 241 784 306 104
Cash Dividends Paid to Stockholders -2,530 -2,243 -1,743 -1,632 -1,569
Other Financing Activities -25 -37 -59 -218 -347
Net Cash Used in Financing Activities -7,071 -6,652 -5,034 -4,048 -4,451
Change in Cash and Cash Equivalents -100 -531 509 1,474 -878
Effect of Exchange Rate Changes on Cash and Cash Equivalents -106 -34 -2 -32 2
Cash and Cash Equivalents at Beginning of Year 1,929 2,494 1,987 545 1,421
Cash and Cash Equivalents at End of Year $1,723 $1,929 $2,494 $1,987 $545

SUPPLEMENTAL DISCLOSURE OF CASH PAYMENTS MADE FOR:

Interest, net of interest capitalized $782 $639 $617 $580 $579
Income Taxes $3,435 $2,839 $2,482 $1,865 $2,067

Appendix 4 Altmans Z-Score Calculation

Altman's Z-Score:
Working Capital/Total Assets 0.10 0.11 0.10 0.13 0.08
Retained Earnings/Total Assets 0.68 0.57 0.49 0.43 0.37
EBIT/Total Assets 0.26 0.23 0.19 0.16 0.15
Market Value of Equity/BV of Liabilities 4.80 3.88 4.45 3.35 2.85
Sales/Total Assets 2.08 1.95 1.82 1.74 1.69
Altman's Z-Score 7.57 6.53 6.39 5.46 4.88

Home Depot Inc., EV ca lculation

(Information needed to calculate Altman's Z-Score)
Source: www.stock-analysis-on.net
Feb 1, Feb 2, Feb 3, Jan 29, Jan 30,
2015 2014 2013 2012 2011

29
 No. shares of common stock outstanding 1,307,394, 1,381,350, 1,485,517, 1,523,263, 1,622,070,
094 137 485 533 458
Share price (USD $) 112.37 78.68 69.78 49.68 37.36
USD $ in millions
Common equity (market value) 146,912 108,685 103,659 75,676 60,601

Appendix 5 - Plain Vanilla AEV

Abnormal Earnings Valuation IMPLICIT FORECASTS

YEARS 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

B.V.E 9,322 6,471 3,723 1,075 4,671 8,576 12,696 17,039 21,615 26,434 31,506 36,842 42,453 48,351 54,547 61,054

NI 6,345 6,299 6,503 6,703 7,193 7,810 8239 8686 9152 9638 10144 10672 11222 11795 12392 13014

ROE 68% 100% 180% 669% 167% 96% 68% 54% 45% 38% 34% 30% 28% 26% 24%

NORMAL EARNINGS 667 463 266 77 334 613 908 1218 1545 1890 2253 2634 3035 3457 3900

AE 5,632 6,041 6,436 7,117 7,476 7,626 7,778 7,934 8,093 8,254 8,419 8,588 8,760 8,935 9,113

TV OF AE 148073

AE+TV 5,632 6,041 6,436 7,117 155,549

VALUE 140,601
SHARES
OUTSTANDING 1307

VALUE PERSHARE 107.58

TV at PV $104,837.20

TV proportion 75%

BV proportion 7%

Appendix 6 Optimistic Scenario Forecast and AEV

Optimistic Scenario Assumptions

ANALYSIS of Actual Assumptions

KEY RATIOS
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Revenue 3.53% 6.19% 5.43% 5.54% 5% 5.25% 5.50% 5.75% 6.00%
Growth
Op 91.49% 90.54% 89.52% 88.37% 87.41% 88% 88% 88% 87.50% 87.00%
Expenses/Sales
Interest 6.08% 5.67% 6.47% 3.35% 3.35% 3.35% 3.35% 3.35% 3.35%
Expense

30
(lagged debt)

Tax Rate 36.70% 36.01% 37.20% 36.40% 36.40% 36.40% 36.40% 36.40% 36.40% 36.40%
ANALYSIS of Assumptions
KEY RATIOS
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
OWC/Sales 6.25% 6.92% 6.64% 5.49% 4.99% 4.79% 4.59% 4.39% 4.19%
(lagged OWC)
LTA/Sales 34.43% 31.45% 29.62% 27.27% 25.37% 25.37% 25.37% 25.37% 25.37%
(lagged LTA)

Debt/Net 34.04% 37.61% 37.78% 54.04% 64.85%

Assets
Equity/Net 65.96% 62.39% 62.22% 45.96% 35.15%
Assets
Payout Ratio 50.00% 50.00% 50.00% 50.00% 50.00%
Retention 50.00% 50.00% 50.00% 50.00% 50.00%
Ratio
Share Buyback 6000 6000 6000 0 0

Optimistic Scenario Forecasts

CONDENSED INCOME
STATEMENTS Actual Forecasting Period
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
10870
Revenues 67,997 70,395 74,754 78,812 83,176 87335 91920 96975 102552 5

Operating Expenses 62,209 63,734 66,921 69,646 72,707 76855 80889 85338 89733 94573
Interest Expense 515 593 612 699 493 576 712 848 983 911
Income pre-tax 5,273 6,068 7,221 8,467 9,976 9,904 10,318 10,789 11,836 13,221
Tax 1,935 2,185 2,686 3,082 3,631 3605 3756 3927 4308 4812
Net Income 3,338 3,883 4,535 5,385 6,345 6299 6562 6862 7528 8408
CONDENSED BALANCE
SHEETS Actual Forecasting Period
2010 2011 2012 2013 2014 2015 2016 2017 2018
Net OWC 4,399 5,174 5,231 4,563 4,361 4406 4454 4506 4558
Net LT Assets 24,239 23,512 23,342 22,683 22,158 23321 24604 26019 27580
Net Assets 28,638 28,686 28,573 27,246 26,519 27727 29058 30524 32138

Net Debt 9,749 10,788 10,796 14,724 17,197 21256 25306 29341 27191
Equity 18,889 17,898 17,777 12,522 9,322 6471 3753 1184 4948
Net Capital 28,638 28,686 28,573 27,246 26,519 27727 29058 30524 32138

20.56 25.34 30.29 50.67 67.57 101.41 182.85 635.94

ROE % % % % % % % %

Optimistic Scenario Valuation

Abnormal
Earnings

31
Valuation IMPLICIT FORECASTS
YEA 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
RS
B.V.E 9,322 6,4 3,7 1,1 4,9 9,152 13,5 18,2 23,1 28,3 33,8 39,5 45,6 51,9 58,6 65,6
71 53 84 48 87 63 89 78 39 84 25 75 46 52
NI 6,345 6,2 6,5 6,8 7,5 8,408 8870 9351 9853 1037 1092 1149 1208 1269 1334 1401
99 62 62 28 7 2 0 2 9 2 2

ROE 68% 101 183 636 170% 97% 69% 54% 45% 38% 34% 31% 28% 26% 24%
% % %

NORMAL 667 463 268 85 354 654 971 1306 1658 2029 2419 2830 3262 3716 4193
EARNINGS
AE 5,6 6,1 6,5 7,4 8,055 8,21 8,38 8,54 8,71 8,89 9,07 9,25 9,43 9,62 9,81
32 00 94 43 6 0 8 9 3 1 2 7 6 9
TV OF AE 1595
28
AE+TV 5,6 6,1 6,5 7,4 167,5
32 00 94 43 83

VALUE 149,548
SHARES 1307
OUTSTAND
ING
VALUE PER 114.42
SHARE

TV at PV $112,947
.68
TV 76%
proportion
BV 6%
proportion

Appendix 7- Pessimistic Scenario Forecast and Valuation

Pessimistic Scenario Assumptions

ANALYSIS of Actual Assumptions

KEY RATIOS
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Revenue 3.53% 6.19% 5.43% 5.54% 5% 4.25% 3.50% 2.75% 2.00%
Growth
Op 91.49% 90.54% 89.52% 88.37% 87.41% 88% 88% 88% 87.50% 87.00%
Expenses/Sales
Interest 6.08% 5.67% 6.47% 3.35% 4.00% 4.00% 4.00% 4.00% 4.00%
Expense
(lagged debt)

Tax Rate 36.70% 36.01% 37.20% 36.40% 36.40% 36.40% 36.40% 36.40% 36.40% 36.40%

ANALYSIS of Actual Assumptions

KEY RATIOS
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
OWC/Sales 6.25% 6.92% 6.64% 5.49% 4.99% 4.84% 4.69% 4.54% 4.39%
(lagged OWC)
LTA/Sales 34.43% 31.45% 29.62% 27.27% 25.37% 25.87% 26.37% 26.87% 27.37%
(lagged LTA)

Debt/Net 34.04% 37.61% 37.78% 54.04% 64.85%

32
Assets
Equity/Net 65.96% 62.39% 62.22% 45.96% 35.15%
Assets
Payout Ratio 50.00% 50.00% 50.00% 50.00% 50.00%
Retention Ratio 50.00% 50.00% 50.00% 50.00% 50.00%
Share Buyback 6000 6000 6000 0 0

Pessimistic Scenario Forecasts

CONDENSED Actual Forecasting Period

INCOME
STATEMENTS
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Revenues 67,997 70,395 74,754 78,812 83,176 87335 91047 94233 96825 98761
Operating 62,209 63,734 66,921 69,646 72,707 76855 80121 82925 84721 85922
Expenses
Interest Expense 515 593 612 699 493 688 861 1025 1180 1080
Income pre-tax 5,273 6,068 7,221 8,467 9,976 9,792 10,064 10,283 10,923 11,759
Tax 1,935 2,185 2,686 3,082 3,631 3564 3663 3743 3976 4280
Net Income 3,338 3,883 4,535 5,385 6,345 6228 6401 6540 6947 7479

CONDENSED Actual Forecasting Period

BALANCE SHEETS
2010 2011 2012 2013 2014 2015 2016 2017 2018
Net OWC 4,399 5,174 5,231 4,563 4,361 4410 4423 4399 4339
Net LT Assets 24,239 23,512 23,342 22,683 22,158 23555 24851 26018 27032
Net Assets 28,638 28,686 28,573 27,246 26,519 27965 29273 30417 31371

Net Debt 9,749 10,788 10,796 14,724 17,197 21529 25637 29511 26992
Equity 18,889 17,898 17,777 12,522 9,322 6436 3636 906 4380
Net Capital 28,638 28,686 28,573 27,246 26,519 27965 29273 30417 31371

ROE 20.56% 25.34% 30.29% 50.67% 66.81% 99.46% 179.84% 766.52%

Pessimistic Scenario Valuation

Abnormal
Earnings IMPLICIT FORECASTS
Valuation
YEA 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
RS
B.V.E 9,322 6,4 3,6 906 4,3 8,119 12,0 16,2 20,6 25,2 30,0 35,1 40,5 46,2 52,1 58,3
36 36 80 64 23 05 20 77 87 61 09 43 74
NI 6,345 6,2 6,4 6,5 6,9 7,479 7890 8318 8764 9230 9715 1022 1074 1129 1186 1246
28 01 40 47 0 7 6 8 3

ROE 67 99 180 767 171% 97% 69% 54% 45% 39% 34% 31% 28% 26% 24%
% % % %

33
NORMAL 667 460 260 65 313 581 863 1160 1473 1803 2151 2516 2900 3304 3728
EARNINGS
AE 5,5 5,9 6,2 6,8 7,166 7,30 7,45 7,60 7,75 7,91 8,07 8,23 8,39 8,56 8,73
61 41 80 82 9 5 4 6 2 0 1 6 4 5
TV OF AE 1419
24
AE+TV 5,5 5,9 6,2 6,8 149,0
61 41 80 82 89

VALUE 135,569

SHARES 1307
OUTSTAND
ING
VALUE PER 103.73
SHARE

TV at PV $100,483
.30
TV 74%
proportion
BV 7%
proportion

Appendix 8 AEV with ROE Mean Reversion

Industry ROE (source: CSIMarket.com) 23.96%

ROE declines by this figure each year of implicit forecast 14%

Abnormal Earnings
Valuation IMPLICIT FORECASTS
YEA
RS 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
6,4 3,7 1,0 4,6 8,5 15,1 25,6 41,5 64,3 95,0 133,7 178,4 225,4 268,5 300,7
B.V.E 9,322 71 23 75 71 76 32 15 25 43 92 25 77 24 74 49
6,2 6,5 6,7 7,1 7,8 1311 2096 3182 4563 6149 7726 8950 9389 8630 6435
NI 6,345 99 03 03 93 10 1 5 0 7 8 7 4 3 1 0

100 180 669 167 153 139 124 110

ROE 68% % % % % % % % % 96% 81% 67% 53% 38% 24%

1276 1611 1920

NORMAL EARNINGS 667 463 266 77 334 613 1082 1831 2969 4601 6799 9561 1 8 3
5,6 6,0 6,4 7,1 7,4 12,4 19,8 29,9 42,6 56,8 70,46 79,94 81,13 70,18 45,14
AE 32 41 36 17 76 98 83 89 68 98 8 3 1 3 7
6314
TV OF AE 31
5,6 6,0 6,4 7,1 7,4 12,4 19,8 29,9 42,6 56,8 70,46 79,94 81,13 70,18 676,5
AE+TV 32 41 36 17 76 98 83 89 68 98 8 3 1 3 78

VALUE 492,725
SHARES
OUTSTANDING 1307

VALUE PER SHARE 376.99

$224,100
TV at PV .59

TV proportion 45%

BV proportion 2%

34
35