June 24, 2016

GAAP Accounting Incorrectly Deflates HD Supply Holdings’ ROA


Summary

  • Using Adjusted Earnings and Assets, HDS’ Adjusted Return on Assets was 25% in FY 2016 – thrice the traditional 8% ROA most financial databases report.
  • This difference is primarily caused by HDS’ $2.9bn goodwill and $146mn in operating leases, which significantly distort the firm’s economic reality.
  • Also of note is the difference between HDS’ Adjusted Forward Value to Earnings ratio of 18.6x versus the firm’s traditional forward P/E of only 10.7x.

HDS - PVP

Performance and Valuation Prime™ Chart

Under GAAP, the as-reported financial statements and financial ratios of HDS do not reflect economic reality. The traditional ROA computation understates the company’s profitability by incorrectly including certain items. The distortion of both profitability measures and valuation metrics of HDS are primarily driven by the inclusion of the firm’s goodwill ($2.9bn), which inflates the firm’s asset base, and by incorrectly expensing operating leases ($146mn) rather than treating them as part of the company’s investments.

After adjusting for similar issues and a host of other GAAP-based miscategorizations, Valens calculates HDS’ Adjusted Return on Assets as 25% in FY 2016. In contrast, most financial databases show a traditional ROA of only 8%. Additionally, our analysis shows that HDS has an Adjusted Forward P/E of 18.6x, compared to the firm’s traditional forward P/E at 10.7x. The profitability of HDS’ operations and their equity’s true value are therefore not what traditional metrics originally indicate.


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