Quick Draw: Home Depot vs. Lowe's

In the home improvement world, few companies get a say between Home Depot (NYSE: HD  ) and Lowe's (NYSE: LOW  ) . As the year comes to an end, both companies are achieving 52-week highs and have their respective investors seemingly satisfied. Unfortunately, when constructing a holiday wish list, one must make compromises -- "both" is not always an option. Let's take a quick look at the state of the union for these two retail giants and see which one deserves a spot on your portfolio shopping list.

History of success
Since March 2009, when both Home Depot and Lowe's seemed to have bottomed out, its been, overall, an upward trend. Lowe's landed at around $13 per share, but since has rebounded 140%. Home Depot found $18 per share around the same time, but has made an even more impressive 224% rise in less than four years. For investors who held on through the tough times, or bought in when housing became a bad word, it's been a lovely few years.

With such substantial gains, and the aforementioned 52-week highs associated with both stock prices, one may argue that it's time to step back from the home improvers, but with housing continuing its inevitable rebound, there is reason to suggest both companies have room to run.

Start with the basics
For better or worse, basic valuation metrics give us an early clue as to whether a company is a buy or not. They can be misleading, and some investors, the growthy ones, seem to abandon them all together. For the more value-oriented of us, though, overpaying for a stock is tantamount to shopping the day before Black Friday.

On a P/E basis, the most-often-cited yet imperfect metric, Home Depot is trading at nearly 23 times trailing earnings, and 18.6 times one-year forward earnings. Lowe's is a bit less expensive, at 21 times trailing numbers and 17.2 on a forward basis. For very similar businesses, these companies appear to be in market cahoots. It's necessary to keep in mind, though, that Lowe's is a $40 billion company, whereas Home Depot is more than twice the size at nearly $97 billion. The growth runway for Lowe's is therefore greater, all else being equal.

When looking at enterprise value to EBITDA, a good metric for a retail, cash-generating business, Home Depot trades at a ratio of 11.43 on a trailing-12-month basis. Lowe's comes in lower again, at 8.38. Selling the tools and supplies to build and revamp our homes is a low-margin business. Lowe's profit margin is 3.9%, which is better than the supermarket business, but a good bit lower than some less-commodity-like retail businesses. Home Depot manages to earn 5.9% on its profit margins.

So far, the two companies don't offer much change on a metric-based basis. They trade at similar P/Es and seem to offer similar growth. Home Depot does look more appealing with those stronger margins, which should bode well in the favorable environment going forward.

How else can we distinguish between the two companies in our quest to make a call?

Management grades
As any value investor will tell you, a good management team is absolutely crucial. Many companies can sell for cheap, but few are cheap undeservedly and have the management to make things better.

For Home Depot, things have improved since several years ago, when investors often complained of a management team that was paid too much and did too little. When former General Electric CEO Bob Nardelli took the reins in December 2000, things were quick to deteriorate as he had no retail experience and seemed to treat the company like a Harvard BusinessReview case study instead of a real business. By 2007, Nardelli was gone and Frank Blake, a company insider, took the reins and improved things, or at least brought them back to where they were before Nardelli. Investors seemed soothed, and the market share battle waged by Lowe's through the first part of the decade seemed to scale back a bit.

Lowe's is run by Robert Niblock. Niblock made headlines after an issue regarding pulling advertising from the TV show All-American Muslim in the wake of threats from the Florida Family Association, a conservative group. Many thought Niblock's move was a major snafu and incredibly insensitive. In 2011, the company missed earnings targets, closed stores, and reduced the number of new stores slated to open, which brought lower pay for Niblock. Overall, though, the company continues to drive higher and higher under his leadership, and the competitive pricing model has established Lowe's as the one company that can effectively compete against Home Depot.

Both companies seem to have an adept enough chief executive, though neither are particularly stunning. These businesses are also ones that may not require brilliant management, as their product lineup doesn't change too much over time and isn't as sensitive as, say, a clothing retailer or electronics store facing Internet sales pressure.

Last-minute stunner
If I were to recommend a buy between the two companies -- I wouldn't. I'm sorry, but I think that both of these companies are too expensive for an investor to own today. Yes, the housing rebound is great and the unfortunate Hurricane Sandy will no doubt boost the year-end for both companies, but at such lofty valuations and with a yet-to-be-determined fiscal cliff situation, I wouldn't feel comfortable buying into either company at these prices.

In my opinion, Lowe's may offer investors better growth opportunities and value creation in the long run. The sheer fact that the company is less than half the size of Home Depot and trades at a discount to it on multiple metrics pushes me toward Lowe's as the long-term pick.

But for me the bottom line for both home improvement outlets, as of this point in time, is to stay on the sidelines.

Are these homebuilders on our list of 3 Companies Ready to Rule Retail? Find out by reading our special report. Uncovering these top picks is free today; just click here to read more.


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  • Report this Comment On December 01, 2012, at 3:48 PM, stockdissector wrote:

    I agree. The lofty valuations of these companies make future returns more questionable.

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