Is Lowe's Foundation Still Cracked?

With all eyes on the housing credit crunch, it's no surprise that home-improvement retailers have had a tough year. Consumers have pulled in the reins on their spending habits, and construction companies have begun to stall their projects. So although I admire Lowe's (NYSE: LOW) as a company, it's still down 4.5% overall so far this year despite showing a few signs of growth. And given the current economic environment, there may be even more bad news coming down the pike.

Bigger doesn't mean better
Lowe's market cap of $43.5 billion is second in size to that of the home-improvement industry's largest competitor, Home Depot (NYSE: HD). But bigger isn't always better. Big Orange has run into its share of problems. It recently had to shed its supply business, and it's having trouble with its customer service, which used to be notable.

From my experiences, I'd say that Lowe's has closed the gap between itself and Home Depot. The Lowe's stores I've visited are bright, the merchandise is well laid out, and there's always someone willing to help. Additionally, Lowe's is more female friendly, as my wife has pointed out. Employees there really try to help her, in plain English, more so than at Home Depot.

Can Lowe's nail its strategy?
I can attribute that extra care to Lowe's focus on providing superior customer service. It's been committed to ensuring that its employees possess the knowledge necessary to help its customers. What's more, the company continually invests in itself to keep its stores fresh and up to date and create a more inviting shopping experience. In its most recent 10-K, management estimated that it will spend $1.3 billion throughout 2007 and 2008 to help drive sales and ensure that stores offer customers superior service and quality.

I do think this approach is working. And I know for certain that my experience with Home Depot has not been as favorable. I find that the merchandise isn't displayed as well, and the customer service is just not what it used to be.

Lowe's has some other advantages, too. Where many of us would once have headed to Sears Holdings' (Nasdaq: SHLD) Sears stores, which used to be the place to shop for appliances and tools, Lowe's has now emerged as a primary choice. Nowadays, when I need one of those items, I typically head to Lowe's because I know I can get competent answers to my questions. And while warehouse clubs such as Costco (Nasdaq: COST), and Wal-Mart (NYSE: WMT) may boast discount prices, they don't offer the same breadth of products, or (again) the service help.

The heavy lifting
Despite the current climate, Lowe's managed to put together a respectable quarterly report. Earnings per share increased 11.7%, to $0.67 a share, though that figure did get a boost from share buybacks. Net income rose by a slightly lower 9%. The gross margin expanded from distribution efficiencies and changes in the flow of seasonal goods. And while sales, general, and administrative costs rose because of growing store payrolls, the company believes the bigger payrolls are a good idea, since they help maintain the high service level that management strives to provide in its stores.

Lowe's balance sheet is still in fairly good condition, too. There's still plenty of liquidity and ample cash flow to continue paying dividends and buying back the $3.8 billion in shares that it promised to purchase. The company's debt load did increase, and debt to equity increased from 23.1% in the second quarter of last year to 30.9% this year. However, Lowe's can handle the debt. It can still pay its interest 21.8 times over with its operating earnings.

In a difficult environment, it's important to see how well a company is managing its inventory. We've seen from many retailers recently that a high stockpile of goods leads to deep discounts. Here, Lowe's appears to be doing a good job. Inventory turnover decreased 36 basis points from the previous year, and while inventory increased, so did the number of stores -- enough so that inventory actually decreased on a per-square-foot basis.

Wait to remodel
I think we're far from turning the corner on the housing market. Housing data seem to confirm it, with existing-home sales for July down 9% and pending home sales down 16.1% from 2006. Furthermore, many people have to finance their larger improvement projects, but with the credit crunch going on these days, it's tougher for consumers to borrow, so those projects become less likely to happen.

Still, I think Lowe's is a star player in the sector. However, given the potential for more bad news to arise from the housing woes and the credit crisis, I think I'd hold off on investing until we see signs of a recovering market.