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Introduction

In this article I'll have a closer look at Home Depot (NYSE:HD) which has released very decent financial results for 2013. I will provide my view on the financial statements and its balance sheet. Thereafter I will briefly discuss the outlook for 2014 which will result in my conclusion at the end of this article.

All images in this article were directly sourced from the company's press release.

My view on the financial statements

In the financial year 2013 which ended on February 2nd 2014, Home Depot reported a total revenue of $78.8B which is a very nice 5.4% increase compared to the previous year. On top of that, its cost of sales increased at a slower rate which caused the gross profit to increase by 6% to $27.4B. Despite the 5.4% revenue increase, the company's SG&A remained under control as it increased just 0.54%. The net profit increased by 18.7% to $5.4B. And it doesn't stop here. As Home Depot repurchased a substantial amount of shares during the year, the EPS actually was boosted by 24.8% to $3.78.

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The income statement looks good, but what about the cash flow statements? Most of my readers know I always like to have a look at the cash flow statements of a company as well, as I strongly believe the cash flow statements of a company offer a better indication of the quality of the underlying business.

So when I look at the 2013 cash flow statements of Home Depot, the company recorded an operating cash flow of $7.4B before changes in working capital. As the capital expenditures were 'just' $1.4B, Home Depot had a free cash flow of $6B which is approximately $4.34/share. The entire free cash flow was used to fund a $8.5B share repurchase and to pay $2.2B in dividends. This means the company had to borrow additional money to fund its buybacks. This is usually something I don't really like to see, but in Home Depot's case the underlying free cash flow is very strong so some additional debt doesn't particularly worry me.

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My view on the balance sheet

Moving over to the balance sheet, Home Depot had a working capital position of approximately $4.5B with a current ratio of 1.42. As a ratio higher than one indicates the company has sufficient current assets to cover its current liabilities, I'm not worried about Home Depots near-term future, but I hope the company will keep an eye on its total debt situation as 69% of the total assets are financed with debt.

As of February 2nd, the book value per share was approximately $9.10/share. As Home Depot is trading at a price/book value of 8.8, this might sound quite expensive, especially when you see there's a lot of debt on the balance sheet.

Outlook for 2014

Home Depot's outlook looks very upbeat as the company is guiding for another revenue increase of 4.8% and an increasing operating margin. Capital expenditures are expected to remain relatively stable at $1.5B which leads me to expect a free cash flow of approximately $6.3B which will once again be used for share buybacks ($5B) and dividend payments ($2.5B). Whilst I do agree that dividends and share buybacks are a good thing for shareholders, I would prefer to see Home Depot repurchase less shares and focus on some debt reduction as well instead of increasing the debt to repurchase shares.

Conclusion

Home Depot's results were excellent and the company is trading at a free cash flow yield of 5.5% which is acceptable. As HD is getting ready for another excellent year with expanding margins and revenue growth, the near-term future looks good, and I expect the free cash flow to increase further to $5.10/share in fiscal year 2016 for a free cash flow yield of 6.54%.

However, I would like to see the management decrease the amount of share repurchases further, as I don't like it to see a company borrowing money to buy back shares. With a free cash flow of $6B and $2.5B in dividend payments, Home Depot could for instance buy back $3B worth of shares and spend the remaining free cash flow on debt reduction, as I believe this will be more sustainable.

I'm interested in Home Depot, but not at any cost. I'd be interested in writing a P65 January 2015 for an option premium of $2.00 for an annualized yield of 3.35%. If I get assigned shares at $65 and my free cash flow assumption of $5.10/share in 2016 is correct, I'd be buying Home Depot at a forward free cash flow yield of 7.9%.

Source: Home Depot Has An Interesting Free Cash Flow Yield But Is Overspending On Share Buybacks