Atlantic Equities Goes Overweight Lowe's: What It Means

• Home Depot Inc HD shares are up 6 percent in the past one month, while shares of Lowe's Companies, Inc. LOW have risen 4 percent.
• Atlantic Equities’ Sam Hudson maintained an Overweight rating on Home Depot and upgraded the rating on Lowe's to Overweight. The price targets for both companies have been raised.
• Both the companies reported robust Q3 results, indicating the ongoing momentum in the retail sector, Hudson said.

Both Home Depot and Lowe's reported their Q3 comps and operating margin ahead of expectations. The broad-based growth across regions and categories indicates the strength of the sector, analyst Sam Hudson said.

Sequential acceleration in big-ticket growth is “an encouraging indicator of future home improvement demand and the consumer’s willingness to invest in the home,” Hudson mentioned. He added that comp momentum can be expected to continue, backed by the favorable housing backdrop, despite the overall retail environment being mixed.

Reasons For Lowe's Upgrade

Although Lowe’s benefited from the attractive backdrop, the margin expansion of 130bps generated by the company marks a “significant sequential improvement and an inflection point from the underperformance in H1,” Hudson mentioned.

He believes that the main drivers of this margin expansion can be sustained in Q4 and into FY16, providing reassurance that Lowe’s can meet its margin targets on an annualized basis. “Our growing confidence in sector performance means that we are now incrementally more positive on the higher risk/higher growth (+18% 3-yr CAGR) opportunity at LOW,” the analyst said.

Price Targets Raised

Hudson raised the price target for Lowe’s from $79 to $94, while raising the price target for Home Depot from $133 to $154, due to the rolling forward to an FY16 yearend.

Hudson believes that Home Depot’s 10 percent premium to Lowe’s is “warranted,” since the former is a “lower-risk, higher-quality operator” and can be expected to continue to generate higher comp performance. “We see a mid-teens EPS and dividend growth profile as a base case given management's consistent execution and the favourable momentum in the sector,” the Atlantic Equities report stated.