Can Home Improvement Retailers Improve Your Portfolio?

The Home Improvement Research Institute, or HIRI, publishes an annual Home Improvement Products Market Forecast. In September the group made an upward revision to the forecast they released in March, predicting that total home improvement product sales will increase 5.4% in 2013. The forecast for 2014-2015 is even more encouraging: a projected increase averaging 6.9% for those two years.

Further good news was HIRI's opinion that they do not expect higher interest rates to put the brakes on the housing market rebound. They anticipate rates easing somewhat by the end of the year, and not rising appreciably through 2014.

Where "Never Stop Improving" is more than a marketing tag line
Lowe's Companies (NYSE: LOW  ) occupies the second place position among home improvement retailers. It has 1,758 stores in the U.S., Canada, and Mexico as of Aug. 2.

Sales for the second quarter ended Aug. 2 jumped 10.3% from the same quarter of 2012. Comparable store sales for the quarter showed an excellent 9.6% increase. CEO Robert A. Niblock described the company's performance as being driven by "a healthy balance of ticket and transaction growth."

Margins were healthy, too. On a percentage of sales basis, the gross margin improved 42 basis points. This may not sound like much, but on a sales tally of $15.7 billion, the percentage gain accounted for $66 million of the total $563 million increase in gross margin dollars. Lowe's also efficiently managed selling, general, and administrative expenses, which were down 53 basis points. Meanwhile, net earnings soared 26% to $941 million.   

A core strategy of Lowe's is to increase the interaction between the company and customers as they plan home improvement projects. The company's online tool, MyLowes, helps homeowners design and manage these projects.

The benefits of remodeling your operations model
The Home Depot (NYSE: HD  ) is the giant of the home improvement retailing industry. It had sales of $22.5 billion in the second quarter of 2013, which was an increase of 9.5% from the second quarter of 2012. As with Lowe's, comparable store sales registered an impressive gain, with a 10.7% increase.

Home Depot CEO Frank Blake said these robust sales results exceeded management's expectations.

Gross profit as a percentage of sales held steady at just over 34%. Selling, general, and administrative expenses as a percentage of sales dropped 70 basis points in comparison with the same quarter last year.

The result was a 17.2% increase in net earnings, to nearly $1.8 billion. In regard to the outlook for the remainder of 2013, Home Depot raised both its sales guidance and earnings per share guidance.

The company has made strides in becoming more customer-focused in terms of providing know-how and expertise, as well as products at good prices.

Home Depot found that 60% of in-store staff time were devoted to operational tasks and only 40% to helping customers. The company made a goal of reversing those percentages by introducing operational efficiencies to free up staff time. The positive results of this refined operations model are showing up in higher sales.

Definitely not hard times in hardwood
Home Depot and Lowe's both strive to provide everything the homeowner needs to complete a wide range of home projects.  Lumber Liquidators (NYSE: LL  ) has a different but equally effective approach: to be the largest specialty retailer of hardwood flooring.

For the second quarter, the company announced that net sales surged 22.2% in comparison with the same quarter last year. Comparable store sales were outstanding, up nearly 15% as the number of customers invoiced rose 9.1%, and they spent on average 5.4% more per transaction.

Gross margin percentage can be very difficult to significantly increase. This number increased a full four percentage points to 41.3% because of lower product costs, increased unit prices, and operational efficiencies that took hold across the organization.

Although selling, general and administrative expenses as a percentage of sales increased 50 basis points compared to the second quarter of 2012, the net result was a 350 basis points increase in operating margin to 12.9%, which was a record performance for the company.

Lumber Liquidators' formula for success includes offering 340 varieties of flooring at its 300 locations. The company competes with the much larger home improvement stores by the combination of price, selection, quality, availability and expertise.

The company has a well-designed online and mobile application called "Floor Finder" that helps the customer choose the flooring product that best meets their needs and budget. Customers can be armed with product knowledge before they set foot in the store, increasing their confidence in making a purchase.

Lumber Liquidators has introduced a new store format that appeals to a broader base of customers, according to management.

What we learned
Each of these companies is riding the wave of an upward-trending demand curve as a result of consumers feeling confident enough to undertake the home improvement projects they postponed during the recession.

Lowe's and Home Depot are employing technological innovations that make it easier to learn about products and make product selections. Both are also focused on providing the valuable information needed to make home improvement projects more successful. This creates the kind of retail experience we hope for from all the stores we do business with, but we don't always receive. The outlook for both of these companies is excellent, particularly if the cheery HIRI forecast turns out to be true.

My favorite of the three -- by a narrow margin, call it a 50 basis points endorsement -- is Lumber Liquidators. Installing new hardwood flooring can dramatically improve the aesthetics of a home for a relatively reasonable cost. Because the company purchases directly from a host of lumber mills, it can pass cost savings along to customers.     

Will these home improvement retailers rule the market?
The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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