VALUE LINE PUBLISHING, OCTOBER 2002

Case Analysis Report

I.

INTRODUCTION

The Retail Buildings Supply Industry in the US is estimated to be $175 billion in 2001 and is
expected to reach as high as $194 billion in five years by 2006. It was divided into three: hardware stores,
lumberyards and larger-format home centers. Low interest rates and robust housing-construction market
provided an ongoing strength to the industry. Two of the major key players under the Retail Building
Supply Industry are Home Depot and Lowes as of 2001. The two captured more than a third of the total
industry sales wherein Home Depot holds 22.9% of the market share of the industry while 10.8% is held
by Lowes. Both companies were seen as tough competitors and the penetration of the two companies
made a great impact to other players of the industry.
In the midst of 2002, Value Line publishing, an investment survey firm assigned analyst Carrie
Galeotafiore to present a five-year financial forecast of Home Depot and of Lowes. According to her, the
expected growth of Home Depot and Lowes was said to be coming from different sources. Both
companies are seeking new but similar ways to boost both their top and bottom lines such as improving
customer service, attracting professional customers and creating a more favorable merchandise mix.
Although both are major players on the same industry, the two companies cater different markets.
The Home Depot traditionally focused on large metropolitan areas whereas Lowes focused on rural
areas. Home Depot had acquired several small companies for expansion and implemented ways to
attract professional customers effectively including stocking merchandise in larger quantities, training
employees and carrying professional brands. The company also developed a Home Depot Supply or
Pro-stores to reach out small-professional market. The company also broadened its international
presence by acquiring businesses in Canada and Mexico. Furthermore, Home Depot was also expanding
into installation services by creating the at home business. On the other hand, Lowes has also acquired
small companies and made ways to improve its professional market. While Home Depot expanded to
international markets, Lowes did not yet have an international presence. Despite the differences, both
companies maintained online stores. Lowes has its own website named Accent and Style that targeted
professional customers while Home Depot developed new type of retail stores that offer products and
services in a compact format. Because the two had already entered the same metropolitan markets,
some worries it may intensify price competition.
However, Home Depots CEO planned to make the company more competitive. His goal is to
make store operations efficient, cut costs and increase stock prices. He also focuses on improving
customer service as it has been the weak point of the company and hopefully helps in increasing sales.
These changes in Home Depot were supported by Galeotafiore. In her report, Galeotafiore based her
forecasts on historical performance, trends and ongoing changes in the industry and the economy and
companys strategy.

II.

STATEMENT OF THE PROBLEM

To be able to publish the quarterly report on retail building-supply industry for Value Line
Publishing, Carrie Galeotafiore has the following questions to answer:
1. Since Home Depot and Lowes are the two major players in the retail building-supply industry, who
has the better management strategy?
2. What are the factors that Galeotafiore considered in the assumptions of the financial forecast of
Home Depot?
3. What must be the financial forecast for Lowes?

1
Magbitang, Redilyn B.
Papa, Richelle Angeline O.

Talucod, Regine Marie D.

Taedo, Pauline D.

III.

INDUSTRY ANALYSIS

SWOT Analysis

STRENGTHS

WEAKNESSES

- Consolidating industry
- Large market size
- Ability to sell online
- New and unique retail
formats

- Higher occupancy and

operating costs due to
expansion
- Limited flexibility in
pricing
- Similar inventory offer

OPPORTUNITIES
- Acquidistion from a
variety of Sources
- Professional Market
Penetration
- International
Expansion

THREATS
- Growing Price
Competition
- Economic Recession

Porters Five Forces Analysis

Porter's Five Forces Analysis

Threats to
New
Entrants

Bargaining
Power of
Buyers

4
2
0

Bargaining
Power of
Suppliers

Threats of
Substitute
s

Rivalry
Among
Competit
ors

LEGEND
0 - No threat to the industry
1 - Insignificant threat to the
industry
2 - Low threat to the industry
3 - Moderate threat to the industry
4 - Significant threat to the
industry
5 - High threat to the industry

2
Magbitang, Redilyn B.
Papa, Richelle Angeline O.

Talucod, Regine Marie D.

Taedo, Pauline D.

Threats of New Entrants - LOW

The industry was dominated by two major key players which are Home Depot and Lowes
acquiring a third of total industry sales. Due to this, independent hardware retailers were persisting to
remain competitive wherein some hardware stores shifted their locations to high rent shopping centers.
Although founding stores with low capital to set up is not impossible to overcome, it is the fact that being
competitive and difficulty in establishing company identity lead to decreasing number of independent
retailers. This is why it is safe to assume that threats to new entrants for the said industry are low. An
industry congested by major competitors and small players are really hard to enter unless you will invest a
large capital requirement enough to finance large number of inventories, rapid expansion and aggressive
promotional activities.
Threats of Substitutes - LOW
Since retail industrys inclination is to offer a wide range of products and services, there is a low
threat for substitutes. It is because retail industry sells what manufacturing industry produces and part of
this production are the substitutes which can be their inventory as well. Customers are also loyal in
products and services which both Home Depot and Lowes offer and can be easily accessed due to
increasing number of stores and expansion to different market segments like professional and
international markets . Installation services which can be a substitute is already penetrated by the two
major players wherein Home Depot has its at home business and expected to grow at an annual rate of
30%.
Bargaining Power of Buyers - HIGH
It is assumed that there is a high bargaining power of buyers for retail building supply-retail
industry because of a tight competition between companies. This is also increased by retailers having the
same products and services which can be applied to Home Depot and Lowes. The tendency is that
customers loyalty can be switched depending who offers the least cost and best quality at the same time
since there are lots of options available.
Bargaining Power of Suppliers - LOW
There is a low bargaining power of suppliers since retailing industry is composed of many readily
available suppliers and companies engaged to this can choose their own supplier whichever offers least
cost and best quality since based on the information given, companies in this industry are also welleducated of the products and services they offer. Retailers are also price sensitive because their
inventories are undifferentiated. Usually, they purchase product in high volume and these purchases
covers large share on the sales of the suppliers.
Rivalry among Competitors - HIGH
Retail building-supply industry has been an overcrowded market mainly because of the escalating
competition between the two major companies, the Home Depot and Lowes. Both are producing much
effort to be able to capture larger market share resulting to slow market growth. There is also substantial
amount of consolidation and most retailers offer no differences in products and services. These trigger
increasing price competition and therefore decreasing customer loyalty because it is easy to switch
suppliers depending on the costs and quality. Expansion is used by both companies to generate margin
improvement wherein they entered professional and international markets. Home Depot focused on large
metropolitan areas while Lowes is on rural areas but already expanding into metropolitan markets. Each
has its competitive advantage over the other wherein Home Depot offers added services like Service
Program Improvement that has already enjoyed labor productivity benefits and received positive feedback
from customers while Lowes highlights are superior relative EPS momentum, robust comp sales,
expanding operating margin, improving capital efficiency, and impressive new-store productivity.

3
Magbitang, Redilyn B.
Papa, Richelle Angeline O.

Talucod, Regine Marie D.

Taedo, Pauline D.

IV. ALTERNATIVE COURSES OF ACTION

1. Home Depot vs Lowes: who has the better management strategy?
In 2001, comparing the return on capital of the two companies based on Exhibit 7, Home Depot
reported a Return on Capital of 15.2% while Lowes reported an ROC of only 10.1%. Relative to their
respective Weighted Average Cost of Capital (WACC) calculated in Exhibit 3, Home depot accounted for
12.3% while Lowes has 11.6%. This shows that Home Depot is performing well because it has lower cost
compare to its return while Lowes ROC on the other hand is below in its WACC which signifies that the
company incur more cost compare to its return.
Using Exhibit 7 as basis in calculating Lowes ratios which is shown in Appendix 2 and by
comparing the operating performance of the two companies, it shows that Home Depot has outperformed
Lowes on an operating basis in 2001. However, in terms of stock-market performance, Lowes had
considerably perform better than Home Depot. The reason is shareholders appear to have lost
confidence that Home Depot can maintain its profit-and-growth trajectory given the magnitude of its retail
space and its ability to find new markets.
In summary, Home Depot remained to have better management strategy as management
performance is best measured by the impact on future cash flow. The strategies of Home Depot with
regards to investing in more profitable investments were better since value is represented by the spread
of 2.9% while Lowes just lost value amounting to 1.5% of their investments.

2. Factors that Galeotafiore considered in the assumptions of the financial forecast of Home Depot
In her report, Galeotafiore based her forecasts on historical performance, trends and ongoing
changes in the industry and the economy and companys strategy of Home Depot. Galeotafiores forecast
was based on her confidence in the successful roll-out of the strategy to attract the professional market.
Her forecast is reasonable if the analyst believes that Home Depot and Lowes will be successful in
capturing large share gains from the lumberyards and other professional retailers while maintaining
margins with an improved product mix. Some would be the factors considered by Galeotafiore in:
Using Exhibit 8, Existing-store sales growth has not been greater than 4% and 8.3% The assumption
requires a successful deployment of the companys strategy to capture more of the professional market.

Will the competitive pressure of the industry allow Home Depot to expand gross margin and
reduce operating expenses? Bob Nardelli claimed that product reviews and operating-efficiency
investment would provide for such gains, but what impact will the competitive environment
have on margins?

How should depreciation be allocated? Should it grow with sales or assets?

Gale Galeotafiore allocated depreciation in terms of sales as

What suggests that asset productivity will decline? Galeotafiores forecast of declining
inventory turnover is particularly relevant to the forecast. Should we expect inventory to grow
faster than sales?

4
Magbitang, Redilyn B.
Papa, Richelle Angeline O.

Talucod, Regine Marie D.

Taedo, Pauline D.

Many of the line items are relatively small. The class should make the point that the analyst
should invest little time in forecasting receivable turnover, for example, because it generates
little impact on the magnitude of the numbers. Those assumptions that generate important
differences are called value drivers.

3. What must be the financial forecast for Lowes?

IV. RECOMMENDATION

5
Magbitang, Redilyn B.
Papa, Richelle Angeline O.

Talucod, Regine Marie D.

Taedo, Pauline D.