Should Home Depot Start Worrying About Lowe's Again?

Home Depot (HD 0.43%) will release its quarterly report on Tuesday, and investors have ridden the home-improvement retailer's stock to massive gains ever since the housing market hit bottom. But after years of outperforming Lowe's (LOW -0.49%), Home Depot now faces a potential new challenge from its arch-rival, and investors have to wonder whether Lowe's rebound could have an impact on Home Depot going forward.

Perhaps the most impressive thing about Home Depot's performance since 2009 is that the company posted strong gains even before the housing market showed signs of renewed strength. With its smart strategic vision, Home Depot managed to target key markets for remodeling and renovation as homeowners who were underwater on their mortgages couldn't trade up to new homes and therefore had to make the most of their current ones. Now that the housing market has rebounded, though, the question is where future growth will come from, and whether Lowe's will stand in the way of Home Depot's long dominance. Let's take an early look at what's been happening with Home Depot over the past quarter and what we're likely to see in its report.

Stats on Home Depot

Source: Yahoo! Finance.

How far can Home Depot earnings climb?
In recent months, analysts have gotten more optimistic about Home Depot earnings prospects, boosting their October-quarter estimates by a penny per share but raising their fiscal 2014 and 2015 projections by a nickel and a dime per share respectively. The stock has done well in response, rising about 7% since mid-August.

Home Depot continued its positive momentum coming into the quarter, reporting July quarter results that showed the company's continued strength in leading the home-improvement retail industry. Same-store sales rose 10.7%, far outpacing already-ambitious growth estimates for the company, and strict cost-control measures helped push net income up more than 17%. A boost in guidance also pointed to better times ahead, although the increase still left Home Depot's projections somewhat short of what investors had hoped to see.

Part of what has made Home Depot investors increasingly nervous lately is the potential impact of rising mortgage rates on its business. Traditionally, homeowners have often taken on big projects after buying new homes or after getting infusions of cash from refinancing. As rates have risen, those factors have stopped working in Home Depot's favor, and further rate increases could put an end to the company's strong pace of growth.

Yet by many measures, Home Depot still has much further to run. With a sluggish recovery, many homeowners have deferred projects until they felt more financially stable, and that could lead to pent-up demand for home-improvement products in the future. Those same conditions should help Lowe's as well, and with Lowe's working to build tools that allow customers to plan their own projects more easily, Home Depot needs to stay aware of the importance of helping inexperienced do-it-yourselfers gain the confidence to tackle projects on their own.

One key for Home Depot's future success is not letting small niche retailers take over lucrative parts of its overall business. The rise of Lumber Liquidators (LL -4.79%) and Tile Shop (TTSH 1.41%) in recent years has pointed to the opportunity for small players to specialize and capture substantial market share, but Home Depot can nevertheless compete on volume as well as emphasizing its one-stop shopping advantages that help shoppers avoid having to go to multiple stores in order to find what they need for all their projects.

In the Home Depot earnings report, watch to see how well the company does in holding off both Lowe's and some of its niche rivals. To keep rising to new highs, Home Depot needs to demonstrate its ability to stay focused on both contractors and ordinary homeowners to make the most of its dual opportunity.

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