Market Overview

Why Home Depot Remains A Better Value Than Lowe's


Following Lowe's Companies, Inc. (NYSE: LOW) and Home Depot Inc (NYSE: HD) reported their first quarter earnings results there was no shortage of analysts who came out on Lowe's side, arguing the latter is a better value with more upside. They argued that the softness that Lowe's experienced in Q1 was entirely weather-related, and Lowe’s has way more runway to capture market share. From the investments the company continues to make in its logistics and supply chain to the growth with their Pro Customer base, the Lowe’s bulls saw the dominance by Home Depot as coming quickly to a close.

However, putting Lowe’s value, efficiency and growth into context, it becomes clear that unless the company starts growing its revenues at a double-digit pace, it will continue to be a second-choice stock.

The Lowe’s Value Trap Illusion

A quick looked at some basic valuation and profitability measurements for Lowe’s versus Home Depot might lead one to think Lowe’s is a better bargain. The stock trades at a lower multiple on P/E, Price/Sales, Price to Cash Flow, Price to Earnings Growth and even Price to Forecasted earnings. Further, Lowe’s delivers a gross margin that’s nearly identical to Home Depot’s.

The company offers $5.42 tangible book per share and cash flow of $6.48 per share.  To most value investors, the protection that Lowe’s seems to provide for a growing retailer would be extremely appealing. That said, there are significant reasons why Lowe’s shares are priced as they are: productivity and growth.

Home Depot’s Value Lies In Productivity

What Lowe’s bulls often miss is not the room that Lowe’s has to grow, but the way in which it grows. Consider that on average Home Depot puts out $42 million per store, while Lowe’s sits at $30M per store. That measurement effectively says that for every store Home Depot runs, it earns 40 percent more than an average Lowe’s store. This is further backed up by the fact that Home Depot put out a third more revenue per square foot than Lowe’s. Going back to 2013, the company still had higher revenues per store than Lowe’s does today. This may have something to do with why Home Depot boasts a current Return on Assets of 19.70 versus Lowe’s at 10.08.

Looking back at the Net Margin, part of the reason the companies differ substantially from Gross Margin to Net Margin is the SMG&A costs. As a percentage of revenues Home Depot runs around 17-18 percent, while Lowe’s runs 22 percent. Again, the evidence points to Home Depot being the more efficient company in how they grow their sales.

Corporate Guidance Comparison

Looking at EPS and consensus estimates, you can guess which is Home Depot and which is Lowes. If you guessed that the one consistently beating estimates was Home Depot, you’re right.

Over the years Lowe’s consistently overpromises and underdelivers. This has led to Marvin Ellison being appointed the CEO of Lowe’s. Ellison is formerly of JC Penny, where he attempted to turn around a company that was destined for bankruptcy. Ellison isn’t wasting much time to get the company on the right side of the market; he is the X-factor for Lowe's. If Ellison can really bring some change, then, on a relative basis, Lowes stands poised to make some solid gains on Home Depot.

Final Thoughts

Any analysis that digs past the cursory details of Lowe’s value metrics would show that the company performs exceptionally poorly compared to Home Depot, though by no means is Lowe’s a bad company. However, the stock price relative to Home Depot is entirely justified given what Home Depot delivers, even in its Q2 results. Lowe’s can continue to exist as it currently is. Yet, without any fundamental shift in strategy and investment, they’ll continue to be the little sibling to Home Depot.

If any catalyst, including earnings, collapses the distance between Lowe's and Home Depot, it would be an excellent opportunity to go short Lowe's and long Home Depot as a pairs trade.

Related Links:

Should Investors Buy Home Depot Or Lowe's? This Analyst Has The Answer

Q2 13F Roundup: How Buffett, Einhorn, Loeb And Others Adjusted Their Portfolio

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

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