Duel: Home Depot vs. Lowe's
With both Home Depot and Lowe's reporting earnings this week, we asked Fool writers Jeff Fischer and Rick Munarriz to give us their opinion on the world's two largest home improvement retailers. Jeff and Rick? They don't exactly agree. Excellent!
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By
Home Depot Rules
By Jeff Fischer (TMF Jeff)
It isn't by chance that you can spot the big orange billboard that is a Home Depot (NYSE: HD) store from a mile away. Everything about Home Depot's 1,400 giant locations is meant to remind shoppers: We're here, we're right around the corner, and we sell all your home improvement needs.
The largest retailer of home supply products has $58 billion in annual sales and expects to grow revenue 9% to 12% this year, while earnings per share should rise 9% to 14%. Home Depot's fiercest competitor, Lowe's (NYSE: LOW), has about 850 stores and had $26 billion in 2002 sales.
For investors, perhaps the largest difference between the two companies is currently the fact that Lowe's is growing its same-store sales (stores that have been open one year or longer), while Home Depot recently suffered a serious 6% decline in same-store sales. Something wasn't going right at "Big Orange." Shoppers weren't returning as often as they should be.
Home Depot's management looked at the problems and began righting them early this year. Issues include, in some cases, a lack of compelling inventory, mediocre customer service, and dated store interiors. The company has been around since the 1970s.
This year, Home Depot set aside $200 million to remodel stores, improve inventory selection, and hire and train more customer service employees. A slightly negative same-store sales figure is expected in the first-quarter earnings announcement, but for the year, the company projects flat to slightly positive same-store sales.
"Flat to slightly positive" same-store sales aren't great, but it's a step in the right direction. Plus, after this year, 2004's year-over-year same-store sales comparisons will be much easier, meaning 2004 could be rather strong. Meanwhile, 200 new stores will open this year and earnings per share (EPS) overall will keep growing, as they have for years.
Sales EPS 1997 $24 billion $0.52 1998 $30 $0.71 1999 $38 $1.00 2000 $45 $1.10 2001 $53 $1.29 2002 $58 $1.56 2003 $63 est. $1.69 est. 2004 $70 est. $1.92 est.
Home Depot's first-quarter expectations
First-quarter results announced on May 20 are expected to show $0.37 in earnings per share, up about 2%, on 6% sales growth to $15 billion. This should be the weakest quarter of the year. For the year ended January 2004, Home Depot is projected to earn $1.69 per share, up 14%, on $63 billion in sales. If 14% earnings growth is a "bad" year, I'll take it.
At a recent $29 per share, Home Depot trades at 17 times 2003 earnings per share estimates of $1.69. This compares to a 20 price-to-earnings (P/E) multiple for Lowe's $45 stock, which is based on 2003 earnings per share estimates of $2.19. Lowe's is expected to grow earnings 19% this year, so it deserves a slightly higher P/E multiple than Home Depot.
The argument for investing in Home Depot this year is -- actually -- next year's results, and the results in years beyond that. The 25-year-old company is still just getting started. It will continue to open new Home Depot stores at home and abroad, as well as new store concepts including Home Depot Urban stores (smaller, and smack-dab in city centers), Expo Design Center stores (for interior design) flooring and garden stores, and other concepts and services (including tool rentals) that are rolling out or testing.
Given its robust (for a retailer) 5.7% profit margins, Home Depot has shown it can start new stores profitably. The company recently had nearly $2.5 billion in cash and equivalents, compared to $1.2 billion in long-term debt, and it earned $2.6 billion in free cash flow (cash generated by operations and available for use) in 2002.
Summed up, Home Depot is a retailer to envy, and a slower year likely presents a long-term investment opportunity. Good investors learn to buy strong companies when they hiccup for a year or two.
High Fives For Lowe's
By Rick Munarriz (TMF Edible)The aprons aren't orange. The shareholders aren't seeing red over losing their green. It's the limber lumber alternative. Naturally I'm talking about Lowe's. The Home Depot rival has grown its home improvement retail chain to just over 850 stores, ringing up $26.5 billion in sales last year. For decades, the company lurked in the palletized shadows of Home Depot. But times -- like cash registers -- change.
Over the last few years, arguing the case for Lowe's was as easy as pointing to the unfair valuation premium that the market bestowed on Home Depot. I can't do that anymore. The unfinished tables have turned. Lowe's is the one trading at the higher earnings multiple. Lowe's is the one that Fortune magazine crowned as America's Most Admired Specialty Retailer earlier this year. Trading at 25 times last year's earnings, Lowe's is no longer the thinking investor's best-kept secret. It's been discovered.
Now I just have to justify the valuation. But that's not as hard as it sounds because Lowe's is a flat-out superior company. Let me explain why.
Did you hear that Home Depot grew sales by 9% last year? Lowe's did 20%. Home Depot's earnings were up by an impressive 21% in 2002? Lowe's did 44%. Home Depot went for a dry martini? Lowe's ordered a double.
The contrast becomes even more apparent when you compare each company's January quarter. Sales and net earnings fell at Home Depot while same-store sales declined by 6%. Meanwhile, the wider, brighter and more inviting aisles of Lowe's produced a 17% uptick in sales, a 46% surge in profits and a healthy 4% spike in comps.
Now, before my Foolish friend Jeff counters that I'm comparing apples to orange aprons because Home Depot had one extra week during the previous year, let's just look ahead to what each company has projected for its current fiscal-year performance.
Home Depot sees sales growing by 9-12% this year. Lowe's is looking for top-line gains to come in between 16% and 17%. Home Depot expects to improve earnings by 9-14%. Lowe's thinks it can grow its net profits by 17%-19%.
So, yes, the premium has moved over to the Lowe's camp, but isn't it more deserving? While Home Depot is fetching 17-18 times this year's profit guidance, Lowe's isn't too far ahead when it's asking for just 21 times this year's company projections for earnings.
The world's second-largest home improvement retailer doesn't have to fear Number One anymore. Lowe's is the one taking a hacksaw to market share and if you're wondering why one chain is losing foot traffic at the expense of the other, come inside and see the difference. Lowe's has always appealed to female shoppers with its more conventional retail setting of well-lit cleanliness over the simplicities of sawdust.
The trend has been the specialty retailer's friend. Think about it. When you look back to the defining faces of home improvement ten years ago who do you see? Bob Vila from This Old House? Tim Allen on Home Improvement? Who do you see now? The women of Trading Spaces and While You Were Out. Do-it-yourself has become an equal-opportunity endeavor.
That's why Home Depot is looking into installing brighter bulbs, building out its appliance centers and promoting its how-to clinics for women, acknowledging the reality that goes beyond an unfathomable Forrester Research study that pegs each chain's female shopper base at 45%. Guess who is chasing whom, now? Logic -- like a cash register -- rings a bell.
Jeff's Rebuttal
Rick, lover of Lowe's, can point to that company's superior growth rate compared to Home Depot mainly because Lowe's is much smaller. It's easier for a smaller company to grow more rapidly. What's surprising is the fact that Lowe's is so much smaller. Home Depot is the 2nd largest retailer in the United States, while Lowe's is 14th.
What's more surprising is that Home Depot was founded in 1978, and Lowe's... 1946. So, who's lagging whom here? Clearly, Lowe's, which has been public since 1961, has learned a lot from Home Depot, which has been public since 1981. Home Depot is setting a soaring pace and has created $68 billion in market value in 22 years, compared to Lowe's $35 billion in 42 years.
If Rick really believes Home Depot is taking its cues from Lowe's, he must have been hit in the head by a two-by-four. Home Depot has experienced only minor setbacks the past year for a company that has grown so far, so fast. Meanwhile, it has nearly twice the locations as Lowe's and it is improving those locations, and adding more, as we speak.
Wal-Mart (NYSE: WMT) -- which, granted, has a more general customer base -- has more than 3,000 locations in the country. Home Depot has about half that, and more and more Americans are becoming homeowners. Home Depot has plenty of space to grow and should handily maintain its number one position in home improvement retail.
Rick's Rebuttal
Home Depot is good. Lowe's is better. I don't want to slam those who bleed orange, but just about everything that Jeff has singled out comes with real numbers to show that Lowe's is doing it even better. Since both companies are set to report their first-quarter reports, Jeff points out how Home Depot is looking to grow sales and earnings by 6% and 2%, respectively.
Lowe's is guiding its investors to expect 15% growth in sales this past quarter with earnings coming in between 16% and 20% higher. Forget the meatier steps forward being taken by Lowe's and hone in on the difference between a company saying that its margins will contract -- while Lowe's will expand. Last year Home Depot's 5.7% in net margins edged out the 5.6% produced by Lowe's, but that, too, is apparently changing.
Home Depot's been around for 25 years? Listen up, sonny, because Lowe's has been serving customers for 57 years. The only claim that Home Depot is entitled to is the cleaner balance sheet. So, yes, I'll concede that Home Depot's got the uglier stores but the prettier balance sheet. But that's no reason to buy into the slower giant that's running out of expansion space while the nimble leader is there for taking. Sorry Home Depot, but you can't swing Lowe's, sweet chariot.
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What do you think?
Fool Community members are always discussing the merits of both of these companies on our award-winning discussion boards. Let us know what YOU think on our Dueling Fools board (joining is cheap and easy!).
Jeff Fischer and Rick Munarriz have been Dueling Fools since 1997. We just let them argue in public as long as nobody gets hurt. Jeff and Rick don't own shares in either company, though they sure did argue as if they did. The Motley Fool has a disclosure policy.
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