This 1 Number Explains Why Lowe's Is in Second Place

Just a few years ago, both Lowe's (NYSE: LOW  ) and Home Depot (NYSE: HD  ) were struggling with a weak housing market. It wasn't unusual for each company to report negative same-store sales, and some articles even suggested that the traditional housing market had changed. Others still suggested that the American dream of owning a home was dead.

Just a few years later, Lowe's and Home Depot are benefiting from housing's recovery. Unfortunately, Lowe's needs to improve one number if it hopes to take the crown from Home Depot.

Strong results
If Lowe's were the only company in the home-improvement industry, this quarter's results would be impressive. However, Lowe's not only must compete with Home Depot but also with traditional retailers like Wal-Mart Stores (NYSE: WMT  ) .

Home Depot seems to be at the top of the housing food chain with its focus on professional customers and knowledgeable sales staff to help the casual home-improvement customer. Lowe's seems to be content to focus on the retail customer while Wal-Mart offers roughly twice the stores of Lowe's or Home Depot and has expanded its home-improvement section as well.

If we look at Lowe's revenue growth in the current quarter, the numbers look impressive. With revenue growth of slightly more than 7%, Lowe's matched Home Depot's revenue growth. Wal-Mart is focused heavily on the grocery business, and this slower-growing industry contributed to the company's revenue growth of just 2.4%.

In the same way, Lowe's same-store-sales growth of slightly more than 6% was very close to Home Depot's 7%-plus growth. In similar fashion to each company's revenue growth, Wal-Mart's domestic same-store sales growth lagged Lowe's and Home Depot's severely. As you can see, Lowe's investors have a lot to be excited about.

Strong tailwinds support this growth story
One of the inescapable truths of Lowe's and Home Depot is that their fortunes are tied to the homebuilding industry. Whether it's new homes being built and furnished or existing homes being upgraded and updated, each company benefits from a stronger housing market. Wal-Mart also benefits from an improved housing market but to a lesser extent, as its sales are more diversified.

The good news for all three companies is that multiple homebuilders are reporting strong backlog growth. For instance, Toll Brothers and Lennar both reported backlog unit growth of more than 30%. In addition, Toll Brothers, Lennar, PulteGroup, and KB Home all reported strong pricing gains. With this tailwind supporting the recovery of Lowe's and Home Depot, each company should continue to report strong growth.

The one problem
While Lowe's and Home Depot reported relatively similar revenue and same-store sales growth, their expense management is one key difference. Wal-Mart might report lower revenue growth, but the company is relatively more efficient.

If you look at each company's spending on selling, general, and administrative expenses, you can clearly see where Lowe's can improve. Wal-Mart's huge size and efficient use of resources allowed the company to report SG&A expenses as a percent of revenue of slightly more than 19%. While Home Depot reported its SG&A expenses used 21% of revenue, Lowe's reported SG&A expenses of more than 24%.

Though a few percentage points of SG&A expenses might not seem like a big deal, keep in mind each of these companies reports billions of dollars in sales. If you want to see what a difference a few percentage points of SG&A expense makes to the bottom line, consider the difference in cash flow generated by Lowe's relative to its competition.

The bottom line is, this affects the bottom line
In the last nine months, Home Depot generated $0.08 of core free cash flow (net income + depreciation - capital expenditures) per dollar of revenue. By comparison, Lowe's reported $0.06 of core free cash flow from each dollar of revenue. Wal-Mart's slower revenue growth and focus on the grocery business caused the company to generate just $0.03 of core free cash flow per dollar of revenue.

As you can see, while Lowe's yield of 1.5% looks similar to Home Depot's yield of around 2%, and is less than the 2.5% yield of Wal-Mart, there are differences below the surface. Wal-Mart is expected to grow earnings by around 9% annually in the next few years, compared to earnings growth of around 18% for both Lowe's and Home Depot.

However, if Lowe's continues to carry a higher and higher SG&A expense, the company's free cash flow generation will likely continue to lag Home Depot's. Since both stocks sell for nearly the same forward P/E ratio, it's hard to recommend Lowe's while Home Depot is available to purchase. The company has been improving, but until its SG&A expense percentage drops, Lowe's will continue to finish in second place. 

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  • Report this Comment On December 22, 2013, at 9:11 AM, hbk72777 wrote:

    I only shop at Lowes, Cleaner, better customer service, and they get my online orders correct.

    Home Depot is filthy and constantly screws up my orders. The last one, on Black Friday, they said my they couldn't confirm my home address in Paypal. I've had this Paypal account for 8 years, and run my business through it. I've bought from Lowes, Walmart,Kmart, Sears, Thinkgeek etc, without a problem. When I confronted them about this, they told me to contact Paypal. They just wouldn't take the blame. This was not the first time. But it will be the last time.

  • Report this Comment On December 22, 2013, at 11:59 AM, BearlyLarry wrote:

    I bought a fixer-upper home that was barely a mile from a Lowes. I ordered my appliances there and other household items like blinds etc. At first I spent about 3 grand there. I thought it would be great and convenient.

    I had a problem when I ordered the blinds and the rod for the vertical blinds was not the right color. I tried to call the woman that ordered the blinds for me but a different woman stated it only came in white for the verticals. I said I was disappointed for not being told this from the other woman. Then 7 am the next morning the first woman called, waking me and started chewing me out, yelling that she told me about the color difference. I hung up on her and wrote an email to her manager.

    Then I was in the store looking for a certain plumbing tool. I asked a young man who worked there where it might be. He looked me right in the eye, turned around and walked away without a word. Needless to say I was angry. I found the manager, told him what happened. Of course he apologized and offered me a 5% discount.

    I've never spent another cent at Lowes and will drive 8 miles out of my way to Home Depot when I need something. When I ask for help the person will take me to where I need and stay there and help me look for whatever I need and won't leave until I find it.

    I wouldn't exactly call HD filthy but to each their own opinion. Sure, Lowes may be cleaner and even more organized but it's customer service is second to none and a DIY guy like myself appreciates that a lot more than a shiny floor.

  • Report this Comment On December 22, 2013, at 12:50 PM, mystery23 wrote:

    This is hilarious. Down here in San Antonio, the Home Depot stores are manned by the least helpful or knowledgeable people ever at a building supply store. For years IK drove 15 miles to Lowes when there were 2 HD within 3 miles of my home. We finally got a Lowes in our neighborhood and it is the only place I go for these products. As far as I'm concerned Home Depot should go the way of Builder's Square.

  • Report this Comment On December 22, 2013, at 4:43 PM, mrScott187 wrote:

    The only reason why I do to HD is that it is close by. Mostly the HD people have no clue, their products are cheaply made, they don't always carry what I need, the management is terrible, and ordering takes a long time. Sorry, but HD is the Walmart's of the hardware/lumber world. I'd rather shop at Menards and Lowe's. Even better would be a REAL hardware store! These outfits (HD, Walmart's and Lowe's) want to be everything to everybody and they fail miserably at it.

  • Report this Comment On December 22, 2013, at 9:21 PM, sailor11 wrote:

    we highly prefer home depot. lowes doesn't honor warranties well, they are apathetic, and have associates that don't care. still in a warranty dispute with lowes over a lawnmower they refuse to repair after about 12 uses. lowes is the pits.

  • Report this Comment On December 23, 2013, at 11:39 AM, kellimeiann wrote:

    I used to work for HD and it is by far the walmart of its retail world. My cousin and boyfriend both workrd there almost 6 years before I did and made 10.00 to start with full time and over time hours offered. In 2013 when I was hired I made 8.75 and maxed out at 29 hours with no full time at all. Even over night stockers who in every other industry including walmart get full time hours HD gives 5 hours a night. Because they didnt want to offer health care all of their workers including those who were full time before were switched to part time except managers of departments. The bragged about success sharing and when the checks came an employee who had been there 3 years got 31 dollars. The training they offered that took days to finish was about catching thieves, cleaning up spills, and not being in a union. At a hardware store where you hire people with no experience shouldnt you teach people about the store layout or what we sale. We are forced to stand at the end of the check out and cannot move. Since I was new and everyone hated that job I was the one left time in and time out alone at the whole front in. I got chewed out a lot because I didn't know where things were or what they were. A week after starting I cut my hand and had stiches my doctor put me on light duty my manager said there is no light duty because people fake doctors notes so companies dont take them anymore and put me on the register told me not to use the hand and call her if it gets heavy. Then suggested I put a bandaid on stiches. When it got heavy of course she was gone and a shopper who felt bad helped me then called the store manager and complained. Result I was sent home and told to return when I was better without pay of course. After that I wanted to quit I almost cried how could people be more concerned with money then its employees. Hd makes it their mission to undercut Lowes at the expense of its staff and needs to be taken down!

  • Report this Comment On December 23, 2013, at 12:28 PM, badkat7 wrote:

    For several years HD catered to builders which meant they stocked the cheapest rubbish in town (you may have noticed that builders hate their customers and try to short change them wherever possible? You're right). However after the housing market downturn HD has been steadily improving the quality and range of its stock. I still rate Lowes better for service and help, however HD is rapidly catching up. These days I shop both stores and increasingly I find what I want at HD.

    Both stores are, however, pretty stupid when it comes to associated products. For instance they sell an item like a air tool sanding machine but forget to stock the appropriate hook sanding disks. They sell sinks which require drilling of holes but the don't offer a multi-stage drill bit that goes to the appropriate size for most faucets / air gaps / RO taps! The list of mismatches is endless...

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