Citi: Home Depot, Lowe's Valuation Gap 'Unjustified'

Recent results reported by several department stores companies and other retailers have indicated a tough consumer spending environment ahead.

Citi’s Kate McShane commented, however, that a larger share of spending was going to categories outside apparel. She added, “The pockets of growth within retail appear to concentrated with home improvement and home furnishings spending.”

Analyst Kate McShane upgraded the rating for Lowe's Companies, Inc. LOW from Neutral to Buy, while raising the price target from $83 to $90, saying that the company stands to benefit from the shift in spending towards the Home category.

Related Link: Lowe's Completes RONA Acquisition For $2.4 Billion

The company’s comps and margins are expected to improve going ahead. McShane wrote, “The housing market is improving, pent-up demand remains, and credit scores continue to ease.”

Wide Valuation Gap With HD Unjustified

Over the past few months, the valuation gap between Home Depot Inc HD [Rated: Buy, PT $152] and Lowe's has continued to widen and is now at a 3-year high. Home Depot has exhibited more consistent execution, which could justify a higher multiple. The analyst pointed out, however, that this has been the case for more than 3 years, and “the valuation gap has usually stayed tighter.”

Moreover, Lowe's may achieve better comps than Home Depot going ahead. Reaching higher comp levels would have a positive impact on operating expense leverage. Lowe's has to achieve 400 bps expansion in operating margins to reach Home Depot’s levels. McShane added, “In our view, if LOW continues to execute well, its earnings algorithm could be a more interesting story.”