Lowe's Set to Take Bite out of Orchard Supply

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Following the expiration of the deadline for its "stalking horse" bid for bankrupt Orchard Supply, do-it-yourself retailer Lowe's (NYSE: LOW  )  says it's ready to move forward with the acquisition  of 72 stores and the assumption of payables the chain owes to nearly all of its suppliers.

The proposal will be presented to the bankruptcy court next week with completion of the transaction expected by the end of the month if it is approved. Yet the fact that no one else came forward to bid on the hardware store retailer -- a stalking horse bid sets the floor against which others compete -- it suggests there may be some queasiness that Lowe's is paying too much for a declining business.

While Lowe's will get some additional real estate in California, where Orchard Supply is centered, it's not as though the DIY specialist doesn't already have a presence there. It operates 110 stores on its own, and while the housing market may have improved in the state, California remains a financial basket case that can't possibly sustain itself much longer given the way it's going.

Sure there's some urban appeal in the real estate, and Orchard Supply has a hometown flavor along the lines of Ace Hardware and True Value, but that hasn't helped the chain rev up sales as revenues tumbled from around $850 million in 2007 to a little more than $650 million in 2010. It's also a concept that a number of its rivals, including Sears Holdings (NASDAQ: SHLD  )  and Home Depot (NYSE: HD  ) have tried and abandoned.

It was Sears that Orchard Supply was spun off from in 2011, but the department store operator also rid itself of its Sears Hometown & Outlet Stores. Home Depot tried to snooker shoppers into thinking its Villager's Hardware concept was a local hardware store, but that also failed miserably and was subsequently abandoned.

While Sears Chairman Eddie Lampert apparently set up the chain to fail from the outset with a heavy debt load predicated on significant recapitalization dividends that had to be paid to its former parent, I'm not convinced the discounted value Lowe's is getting is enough to warrant buying in.

Analysts contend the purchase provides a low-cost way for Lowe's to regain some of the momentum lost to Home Depot, which operates twice as many stores in California as it does, and it gives it some nice real estate in difficult-to-access Cali markets, but that's the same sort of rationale we've been fed about Sears for years -- it's not a retail play but one that's all about real estate -- and we know how well that's worked out for investors.

In the end, as much as the shopping experience at Home Depot is substandard (I prefer shopping at Lowe's), the Big Orange Box is a much better investment. At around 25 times earnings, you're paying about the same for both retailers' profits, but net margins run nearly double at Home Depot compared to Lowe's, and with its return on equity twice that of its rival, Home Depot is the one that's making the better use of its invested capital -- and I don't see this acquisition helping Lowe's overcome that deficit.

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Related Tickers

9/23/2016 4:01 PM
LOW $72.35 Up +0.27 +0.37%
Lowe's CAPS Rating: ****
HD $127.79 Down -0.96 -0.75%
Home Depot CAPS Rating: ****
SHLD $11.54 Down -0.17 -1.45%
Sears Holdings CAPS Rating: *