The bullish case for buying Lowe's (LOW 0.92%) has been a tough one for investors to get behind in the past. The retailer consistently trails rival Home Depot (HD 1.25%) on key operating metrics, including sales growth, profitability, and financial efficiency. Yet Lowe's stock has outperformed its bigger peer in recent months on rising optimism that this performance gap might shrink or disappear altogether.
Below we'll look at the reasons for that shifting mood, and whether they make Lowe's a more attractive candidate for investors today.
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The latest trends
Lowe's recent results did nothing to change the broader story of a business that operates firmly in the shadow of its larger, better performing competitor. Sure, sales sped up to a 5% increase last quarter from 1% in the prior quarter. But Home Depot managed a more robust boost (8%), as warmer weather spurred higher demand for seasonal items like gardening supplies. As in each of the last several fiscal years, Home Depot has captured more than its fair share of the industry's growth so far in 2018.
Lowe's also saw its operating profit margin dive to 10% of sales from 12% last quarter. And while some of the decline came from one-time writedown charges, the retailer is still far behind Home Depot on this score.
HD operating margin data by YCharts. TTM = trailing 12 months.
In fact, Home Depot executives are expecting to reach a margin of roughly 15% of sales this year while Lowe's has predicted weaker profitability results -- closer to 10% -- as it fights to boost customer traffic and protect market share.
Trying a new strategy
Lowe's holds the edge over its chief rival in the potential for improved results, an area that's especially difficult for investors to quantify. In Marvin Ellison, the company has a new CEO who has accumulated deep industry experience as a top executive at Home Depot. That combination of fresh leadership with highly relevant expertise has many investors optimistic that Lowe's can finally make headway at clawing back some of the market share it has lost in recent years.
That happy scenario hasn't emerged yet. In fact, in one of his first acts as Lowe's leader, Ellison had to lower the company's short-term outlook for fiscal 2018. However, investors were pleased to learn that Ellison plans to bring big changes to the company, starting with an aggressive trimming of underperforming stores and the rollout of a new inventory management process.
It will be a huge challenge to create the type of highly efficient multichannel retailer that the new management team envisions. Ellison is optimistic, though. He told investors in late August, "I've been down this road before, and I have a clear understanding of the steps and processes required to build a world-class omnichannel environment."
For the stock's rally so far this year to find support and extend into 2019, Ellison and his team must back up their bluster with numbers that show better customer traffic trends, accelerated comparable-store sales growth, and improved operating margin. Income investors might even reasonably expect more-robust dividend hikes over the next few years given that Lowe's currently allocates 35% of profits to its payout, compared with Home Depot's 55%.
Ellison will be free to boost the dividend payout as Lowe's operating trends improve. But for now, investors buying the stock have to be comfortable betting that the retailer's market share struggles will end soon. Until there's a concrete indication that they will, investors might want to watch Lowe's stock from the sidelines.
