OUR TAKE
Home Depot, Lowe's Inventory Story

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By Tom Jacobs (TMF Tom9)
May 20, 2003

With Home Depot (NYSE: HD) reporting its Q1 results today and Lowe's (NYSE: LOW) yesterday, the financial media is focusing on the sound bites from the press releases. But Foolish investors are looking deeper into each company's performance.

We are looking here, as with any retailer, at days sales in inventory (DSIs). Also called inventory turns, this measures how many days it takes a company to "turn over" its inventory. It's obvious why this is a measure of efficiency. Especially for large volume discounters like Home Depot and Lowe's, you must have the right stuff on the shelves and replace it quickly when it sells. Any hot item out of stock is money lost and anything that gathers dust means space not available for something that sells better. Elementary retailing.

What's not obvious is the financial writing convention of calling them DSIs, when it's days sales in inventory, not inventories. It's a mystery. Ditto DSOs (days sales outstanding) and DPOs (days payable outstanding), which along with DSIs you can enjoy in Bill Mann's eloquent Show Me the Money!

For quarterly DSIs, I use the formula (91.25*Inventory Q)/(Cost of Goods Sold Q), where Q is the quarter in question. Here are the last eight, including the ones just reported, for our two home-improvement friends:  

            DSIs      DSIs Change Vs. Year-Ago Q 
Quarter   HD   LOW           HD    LOW
Q1        82   89           +14    + 2  
Q4        85   87           +19    - 2 
Q3        77   85           + 6    +13 
Q2        58   69           - 6    - 7   
Q1        68   87 
Q4        66   89
Q3        71   72
Q2        64   76 
All numbers rounded.

The DSI numbers for the two competitors tell, uh, competing stories. First, for the last eight quarters Home Depot's have been lower. The company manages its inventory more efficiently. But the second and more important point is that the efficiency has been declining -- the trend is worse for Home Depot than Lowe's. Lowe's numbers, though worse, have been more consistent and stable, while Home Depot's have worsened and are now almost identical to Lowe's.

There's much more to evaluating a company, of course, but if you are going to invest in a retailer, take the time to compute DSIs for a few years. Compute both quarterly and annual numbers -- for annual, just change the 91.25 to 365 and use annual numbers for inventory and cost of goods sold. Here, we see that this very important metric shows Home Depot losing an important advantage. 

As a parting shot, I still can't tell the difference between the two stores, and to prove it, I tried to return something I bought at Lowe's to a Home Depot recently! I know that Gene Hackman narrates the Lowe's commercials, in which employees imitate Sammy Sosa, but I couldn't tell you anything about Home Depot's except that there's more orange. So, my shopping experience does not inform my investing views.

But Jeff Fischer and Rick Aristotle Munarriz have very strong opinions all around. Enjoy their duel over the two companies just before earnings came out. How do they look now? Are their crystal balls shiny or in need of repair?

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