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.

TECHNOLOGY BRINGS REVOLUTIONARY CHANGES INTO THE BUSINESSES. IT ENABLES NEW DIMENSIONS OF COST OPTIMIZATION ON ONE SIDE, AND EXTREMELY FAST AND CHEAP EXPANSION ON THE OTHER SIDE. THIS CENTURY IS FOR SMART INVESTORS DEFINITELY A GOLDEN ERA. FROM THE PERSPECTIVE OF VALUE CREATION, MEGA INVESTMENT OPPORTUNITIES ARE SHOWING ON THE INVESTOR RADARS – CASE OF MASTERCARD INC.

Mastercard Inc. is a specialized technology company offering e-payment solutions to banks, governments and others. In other words, clients are offered super-fast network for processing end-users’ transactions. The company philosophy is to simplify and upgrade the payment process. Efforts of the company are built around the main concern – to offer safety and security. The company today has 1,8 billion cardholders around the world, mainly in USA, UK, Canada and Brazil. Their brands MasterCard, Maestro and Cirrus became known as synonym for non-monetary business.

Sustainable achieving of high margins in the long-term

Through decades of operations the company developed key competitive advantages, which guarantee today’s success and include strong brand, high level of trust and global network of partnerships. Strong brand impacts the demand, high level of trust as the element of differentiation enables high profit margins and global network of partnerships results in economies of scale and optimal cost structure of operations.

Financials confirm the superb performance of Mastercard Inc. Market share of the company in 2017 hit 17% (2016: 16%, 2015: 12%), while net sales reached 12,5 billion USD. Business performance is improving as a result of consumption rise and changing consumer habits. In terms of value creation, an important fact is linked to the ability to maintain high and stable margins. EBIT margin for years already exceeds 50,0%.

Chart: Net sales and EBIT developments of Mastercard Inc.

Shareholder value creation is what really counts!

The success story of Mastercard Inc. (or some other company operating in tech-sector) recognized by investors is actually a bit deeper. It is linked to the potential of future value generation, which is significantly impacted also by a relatively low operations growth financing needs.

Technology is an interesting phenomenon. It allows one to reach economies of scale fast and without significant investments in capital expenditures (CapEx) or Operating expenditures (OpEx).

The growth as such for Mastercard Inc. does not represent a significant financing burden (compared to non-tech sector companies). In other words, the operations can expand through the existing solutions and significantly impact the value created. If we additionally take into the account the fact that nowadays still 80% of transactions are in cash and the pace of changing consumer habits, we understand the true value drivers.

How easy it is for Mastercard Inc. to finance its existing operations is obvious even now. Despite the relatively high (16,0%) growth of net sales in 2017, the level of shareholder’s equity remained on the same levels. Net profits were paid out in full. The needs of increasing invested capital were addressed completely with increased levels of financial debt. Despite raising of the financial debt, the indebtedness ratios are actually improving, since the market value of equity increases faster than the financial debt.

Every company has its own specifics of shareholder value creation, so it is important to understand what boosts company value the most!

The CEO of Mastercard Inc. Ajay Banga says: »Our investments are focused on the safety, security and development of solutions that fuel high growth of our business.« He is well aware of the areas of the biggest risks and the biggest opportunities. This fact confirms also recent acquisitions, which are executed with a purpose to expand the capabilities of the company and take over the technical solutions, which are about to present a competitive edge for the company in the future. For example, with acquisition of VocaLink Holdings Limited company gained advanced know-how in the area of real-time account transaction processing; with acquisition of Brighterion, Inc. the company gained the AI technology to better understand the transaction flows and prevent the security and safety gaps.

Companies that continuously create value for shareholders have competitive advantage over competitors and wider, meaning in the industry. In case of Mastercard Inc. we talk about the combination of attractive industry and strong competitive advantages. The company stock outperforms even those with biggest potential, selection of NASDAQ index companies.

Chart: Performance of Mastercard Inc. stock vs NASDAQ index

The thoughts of Mastercard Inc. management are concentrated on the core value driver – company’s growth and securitisation of underlying risks. The tools used are exclusively of technological nature. Technology & competitive advantages are the answer to smart managing of companies in 21st century.

The pace at which the technology is brought into the daily operations is high. It requires introduction of new business models. Preparation of more advanced business strategies. Continuous restructuring of activities. Implementation of creative ideas etc. As a result, the capital market positions of the most active companies are drastically improving. They attract investors. Grow the value for shareholders.

What about you? Are you aware of potential that the technology has in the context of your operations? Do you consider its implementation? Do you know which investments are smart and which actually represent a burden for your company?

What are the other shareholder value creation success stories that we know?

Company Uber offers transportation services and has no cars; Facebook is a media company and creates no content; Alibaba is a trading company with no stocks; Airbnb markets real estate, which are in possession of others etc. All these companies master the technology and its impact on value creation. Technology is revolutionizing the whole industries, which is primarily the cause why many sectors stagnate.

The answer on how to “Uber-ize” many other businesses is hiding the potential for new billionaires!

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