COMPANIES ARE CREATING VALUE FOR THEIR SHAREHOLDERS IN A MORE AND MORE ORIGINAL WAYS. THEY BET ON VARIOUS THINGS: INNOVATIVE BUSINESS MODELS, ECONOMIES OF SCALE, COMPETITIVE ADVANTAGES ETC. APPROACHES DIFFER AND SOME MAY EVEN LOOK STRANGE FOR THOSE THAT DO NOT REALLY HAVE A STRONG FINANCIAL BACKGROUND – CASE OF HOME DEPOT INC.

Company Home Depot Inc. is a US retail giant, selling equipment for home, garden and workshop. Their products and services are sold throughout the network of 2.200+ stores in USA, Canada, Mexico and online. The company is the biggest retailer worldwide in its segment. In financial year 2017 the company generated 101,0 billion USD net sales and 16,5 billion USD EBITDA. More than all non-financial legal entities in a smaller country such as Slovenia, EU.

Why is increasing the financial debt beneficial?

The company operates in a smart way. Part of the success story is linked also to the financial structure and its restructuring. In last years the company is increasing the level of financial debt and decreasing the level of equity. In this way Home Depot Inc. is increasing its Return on equity (ROE). Meaning, the shareholders’ equity is being managed in a more and more efficient way. Let’s look more in details how this is possible.

Development of invested capital and return on equity (ROE) of Home Depot Inc.

Source: Home Depot Inc. Consilue analysis.

Invested capital as at the end of FY 2017 amounts to 28,5 billion USD. Financial debt equals 27 billion USD and shareholder’s equity 1,5 billion USD. One can quickly notice that the indebtedness measured as D/E ratio is »very high«, 1611%. Nevertheless, the ratio as such is not really problematic. The key is to consider the market (not book value) indebtedness ratio. In the case of Home Depot Inc. future returns on invested capital are expected significantly above the weighted average cost of capital (WACC). The market value of equity therefore significantly (more than 100x) exceeds its book value, making the healthy debt levels significantly higher.

The more value the company creates, the higher the optimal levels of debt. As the debt levels built, the ease of creating value for shareholders increase. And the system works as a spiral. The more debt there is, the higher the value for shareholders.

Financial debt and debt management

Financing mix with a leverage as in the case of Home Depot Inc also brings challenges. A mistake in managing financing can have serious consequences. Financial debt can quickly show its other face. Proper supervision of risks and stabilization of future cash flow is therefore of crucial importance. Management of Home Depot Inc. is well aware of this fact. They are eager to continuously strengthen the underlying competences. Especially those that influence the increase in gross margin and further development of competitive advantages.

Financial debt is being managed carefully. Risks related to new obligations and danger of eventual liquidity gaps are continuously addressed in a proper way. The majority of debt is of long-term nature. Its maturities match the maturities of underlying projects. The company does not seek to create »fast« profits at the expense of differences in maturities. The company is aware of risks and the fact that this is not really their business.

Table of financial debt as at the end of FY 2017 (m’ USD):

Source: Home Depot Inc. Consilue analysis.

The financial structure is despite the relatively leveraged financial mix, stable. What makes it sustainable is the value that is being created. Additionally, the lenders are also well aware of the fact that the ratio Net debt / EBITDA as at the end of FY 2017 amounts to »only« 1,4x. This fact additionally strengthens the position of the company. It messages that in case of tightening, the financial debt can still be relatively quickly repaid with operational cash flow.

The success story described above still has space to develop further. The debt levels are not yet optimal, meaning that in the area of debt management there is still space for improvements and value creation. Yield to maturity for 10-year bonds is below 5,0%, meaning that eventual increase of debt levels is further improving the weighted average cost of capital.

The developments described are strongly appreciated by the investors. The value of the Home Depot Inc. stock in last 7 years strongly outperformed competitive peer companies. The growth was truly significant, from 30 USD/share to 200 USD/share. Furthermore, the company was also paying out dividends. Compounded annual growth rate (CAGR) of the Home Depot Inc. stock in the period that matches FY 2011 – FY 2017 amounts to 28,5%, compared to the 9,6% growth of S&P Retail index.

Chart: Stock price development

Source: Bloomberg. Consilue analysis.

As we see, the financial debt is taking the nature of equity. D.E.B.T. is the magic word or key to a success of Home Depot Inc. The more the indebtedness increases, the more the value increases. On the given case we see how event the financing structure can become the source of value creation for shareholders and even a strategic competitive advantage of a company.

Is value creation in your company addressed in a sufficiently advanced way? Do you know the specifics and best practices that would fit your company best? Does your strategy hide innovative financial & business approaches or you think it is just another block of paper in your drawer? Which strategic decision may hit your competitors next?

The post D.E.B.T. – a success story of a US giant Home Depot Inc. appeared first on Consilue.

Competitive strategy refers to a way of creating competitive advantage over competitors. It represents a greater value for the customer, created either by lower prices or by providing greater benefits and services that justify higher prices.

Generally speaking, there are four possible ways to differentiate a business – to become a cost leader (meaning that you become the lowest-cost producer in the industry) and to become a differentiation leader (meaning that you compete in areas other than price valued by customers), both in a narrow or broad scope of business’ activities.

Choosing the right competitive strategy is crucial strategy development step for the corporate, business unit and products and/or services success.

Cost strategy

Cost strategy is built on no-frills. Cost leadership strives towards cutting costs to a minimum possible levels in order to provide customers with lower prices and thus boost their savings. Cost strategy prerequisites normally relate to high technical capabilities and access to capital for the company to invest in technology and assure economies of scale.

In most of the cases cost strategy for first-movers lead to significant increase in market share and capacity utilization, that further drives down costs.

Building a strategy on minimizing costs requires a company to achieve:

• High productivity
• High capacity utilization
• Use of bargaining power to negotiate the lowest prices for production inputs
• Lean production methods (e.g. JIT)
• Effective production process
• Effective distribution channels

Leading cost leadership brands have obtained a major success by introducing revolutionary business models built on a single base – the lowest possible prices for a given perceived value.

Differentiation strategy

Differentiation strategy is built on a belief that one needs a clear and unique positioning. Differentiation leadership focuses in providing perks that add value for consumers, while higher prices are a sort of “make up” for their higher costs.

Building a strategy on a differentiation requires a company to continuously invest in and develop:

• Superior product quality (features, benefits, durability, reliability)
• Branding (strong brand recognition, desire and loyalty)
• Industry-wide distribution across all major channels (i.e. the product or brand is an essential item to be stocked by retailers)
• Marketing capabilities (advertising, sponsorship etc.)

Differentiation strategy could be further divided into:

• Purification (decrease in price; decrease in perceived value) – examples: EasyJet, Tata, Logan etc.
• Hybrid (decrease in price; increase in perceived value) – examples: IKEA (SCM optimisation), Loreal (new brands as a response to crisis) etc.
• Sophistication (increase in price; increase in perceived value) – examples: Mercedes (status), VW (reliability); Toyota (TQM)

Despite the fact that these brands pointed out above achieve significant economies of scale, they do not rely on a cost leadership strategy to compete. Strong marketing capabilities enable them to sell products for a premium and at the same time persuade customers to become brand loyal.

Focus OF THE strategy

Cost strategy as well as differentiation strategy could be narrow or broad. Small and medium sized companies are often forced to become focused, namely a niche player, since they are unable to compete against better-resourced broad market companies’ offerings. Only true understanding of the market dynamics and customers’ unique needs in combination with unique low cost or well-specified products and/or services eventually result in strong brand loyalty.

How to successfully differentiate your products and/or services in the market? Are your products and/or services uniquely positioned in the market? If not – follow the steps written below:

Step 1: Examine  existing positioning of the company and its products and/or services in customers’ minds

Step 2: Choose the competitive strategy (cost strategy vs. differentiation strategy) you think you should be following

Step 3: Analyze the competition and determine the industry standard

Step 4: Study market dynamics and search for market gaps

Step 5: Choose your most appropriate competitive strategy and look for potential practical solutions

Interested in our support? Contact us!

OTHER RECOMMENDED TOPICS TO COMPETITIVE strategy

You are kindly invited to read also about:

• leading views on industry analysis (Porter’s five forces model)
• selected strategic management tool (Balanced scorecard)

The post Competitive strategies – cost strategy vs. differentiation strategy appeared first on Consilue.

The client is a small company, operating in the plastic industry, specializing in the next generation packaging solutions. The company works for prominent clients from cosmetic, chemical, food & beverage, pharma and medical industry worldwide. The company is about to expand its presence in the Latin America. As planned, strengthening the presence in the emerging markets would most likely result in the projected two digit growth rates and EBITDA margins.

The client has developed strategic partnership relationship with its indirect competition all over the globe. Intense cooperation resulted in cost synergies and sharing of a supplier-side know-how. The indirect competitor’s owner has experienced a serious financial problems and thus a decision to divest the business has been accepted.

Addressing the pain:

Firstly, the client has decided for a general overview of the indirect competitor’s past operations. Based on the preliminary findings, the client has decided to continue only with the acquisition process of the most valuable asset – the existing customer database.

Later on the advisor has prepared the client a revision of the competitor’s past projects and their profitability analysis. The findings served as a base for the determination of key variables and preparation of the financial projections, calculation of synergies and customer database valuation.

In order to be able to achieve the full potential as planned in the financial projections, the client has been advised to employ competitor’s key sales personnel.

Results:

The acquisition of the customer database and complementary activities are expected to result in significant revenue and cost synergies and geographic risk dispersion.

Client’s testimonial:

It is very important to be aware of the fact that valuing the customer database from the perspective of “as is” projections and from the perspective of our business (reflecting our business model) varies. It messages significant synergies. Furthermore, taking over customer database with key employees is “a must” – it is a good oportunity to gain new capabilities.

Advisor’s thought:

The client is about to gain short term and long term boost in its operations through new emerging market penetrations and risk diversification. Last but not least, fulfilling the sales capabilities gap will enhance the company’s position and its ability to compete with significantly larger global players.

The post Case study: Acquisition of client database appeared first on Consilue.