Home Improvement Duopoly Deep Dive

In this episode of Industry Focus: Consumer Goods, Emily Flippen and Motley Fool contributor Dan Kline discuss the duopoly of home improvement retailers. Discover more about their operations, what differentiates them, their targeted customers, competition, how COVID-19 has impacted their operations, where they can grow, and much more.

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This video was recorded on May 26, 2020.

Emily Flippen: Welcome to Industry Focus. It's Tuesday, May 26^th, and I'm your host Emily Flippen. Today we'll be digging into the notorious competition between the duopoly that is home improvement retailers. Joining me today -- we'll take a deep dive into Home Depot (HD -0.14%) and Lowe's (LOW -0.24%) -- is Dan Kline.

Good afternoon, Dan; how are you doing?

Dan Kline: Hey, there, Emily. I've never understood this thing where like every industry seemingly has two big players. Like, there used to be two big bookstores, there used to be two big sporting goods chains. It's a really weird thing, like, Home Depot and Lowe's, where I lived in Connecticut, were across the street from each other. Home Depot and Lowe's here in West Palm Beach are relatively in the same place. It always seems really bizarre to me that you're competing for the same customer in the same market with products that are not particularly differentiated, but we're going to dig into some of the differences as we go on.

Flippen: And I think the first question I have lined up for you kind of gets at why maybe this Retail segment in particular has merged into a duopoly. So, before we get into it, Dan, I want to ask you, do you know, between Home Depot and Lowe's, which is the older company and when they were founded?

Kline: So, Emily, you put in the notes not to look this up, so I didn't look it up. I am going to guess that Lowe's is older only because I'm pretty sure Arthur Blank, who owns the Atlanta Falcons, founded Home Depot. So, I'm going to guess Home Depot in the 60s and Lowe's a little longer than that, but it could have been, like, 1985, I could be totally wrong. [laughs]

Flippen: [laughs] You're actually not far off; I'm really impressed. So, you're right, Home Depot not quite in the 60s, actually 1978 is when Home Depot came to be. So, it's about 42 years old. But here's what really shocked me. Lowe's is nearly 100 years old. It was founded in 1921. Lowe's has been here a long time. For a 25-year-old, I was a little astounded.

Kline: Yeah. And I'm excited that I am slightly older than Home Depot; [laughs] born in 1973 myself. I'm going to guess that these both started as pretty traditional hardware stores and then added optionality and, sort of, moved into becoming something bigger. And they have largely crushed the traditional hardware store.

Flippen: Yeah. So, Home Depots and Lowe's have largely come into a duopoly and we can debate how this came to be, but from my perspective, it has to do with the size of stores that are necessary for home improvement retailers. And it makes a really interesting comparison between a Home Depot and a Lowe's, because as you mentioned, they compete directly for their core customers, but they've been really successful putting smaller hardware stores out of business because of the breadth and depth of products and services that they're able to supply to those customers. Being a big-box home improvement retailer is definitely advantageous in comparison to being a local mom-and-pop shop for better or worse.

But the fact that both of these companies have been around the block, Lowe's nearly double the amount of Home Depot or more than double the amount of time that Home Depot has been around, it's fair to say that this rivalry has been going on for quite some time.

Despite the fact that Lowe's is the older company, Home Depot has often been touted as being the better-run company, if you will. And we always get questions about what being a better-run company means. In the case of Home Depot versus Lowe's, they've been a little less scandal ridden. You know, Lowe's has had some bankruptcy issues in their past. And Home Depot has just traditionally had better margins, less debt, but in the recent years, and in this most recent quarter, we might start to see some shifting tides here.

Kline: I think it's important to note that Lowe's hired a good CEO. So, Marvin Ellison, who was JCPenney's CEO, came in too late at JCPenney; we've talked about this before. He made a lot of moves that made sense. One of the ones we've talked about is, he added appliances. Sears was vacating appliances, so JCPenney went into it in markets that Sears left. That seemed like a good idea. The problem is when you do that, you need money for advertising, you need money to convince consumers, and he didn't have that.

So, a lot of the strategic decisions he made at JCPenney actually showed you that he was a good operator, but it was too late. You can have the best doctor in the world, if they don't get to you fast enough and you're hit by a car, you might not make it.

In terms of Lowe's, he's come in and he's looked at their business and he made changes pretty quickly. And some of that is focusing on margin and supply chain and all the things you have to do that aren't all that exciting to consumers, but actually make the business run better. So, I think that's kind of leveled the playing field a little bit.

Flippen: I have to be honest, I'm not as big of a fan of Ellison as you are. And we talked about JCPenney before on this show, so people know my biases that inherently exist with JCPenney. But to me, it felt like Ellison had, as you mentioned, maybe some good ideas, but not the will or the know-how to implement them. And the fact that it was a very, very short turnaround from his time at JCPenney before he jumped ship to go to Lowe's says a lot to me maybe about the type of leader that he is. And hopefully things will be different this time around. He does have a background previously working at Home Depot, and maybe home goods or home improvement is closer to his passion. But to me, this is a CEO that needs to prove himself.

And since we're on the topic of Lowe's, let's jump into what the last quarter looked like for Lowe's. And when I think about Ellison proving himself, I'll tell you what, this last quarter looked a bit like Ellison proving himself. [laughs]

Kline: Yeah. So, we have to remember that we're dealing with a pandemic. Lowe's spent $340 million, 17% of sales, to basically deal with the crisis, and that's extra cleaning in stores, personal protection equipment, changing practices, extra workers, all the same things. But comps were up 11.2% globally.

Flippen: ... that's crazy.

Kline: Yeah, that's nuts. And here's a weird number, 8% of its sales were online, but that's an 80% growth rate. [laughs] So, that's a really, really big number. Most of what they sell, you're not going to buy online. It's hard to look at a paint color online, it's hard to pick a lighting fixture. Almost every segment of the business was up. Obviously, there was a lot of interest in do-it-yourself stuff. Margins even went up by 2%; and that amazes me.

And this really was -- and this is true for both companies; less people, but they bought more. And that makes sense, because we're not going out as much, we don't need to go to stores. So, it's one of those scenarios where Lowe's and Home Depot pivoted very, very quickly. They cut their hours, they focused on getting people what they needed, they put social distancing measures. I was in a Home Depot; there's a Home Depot closer to me than there is a Lowe's, I mean, it's like a two minutes difference. But my sink was broken and I had to go into a Home Depot two or three weeks into this, sort of, at the height of the lockdown. And I walked into a Home Depot, got the plunger I needed; I needed two plungers to dual-plunge both sinks at the same time. And I walked in, I picked up the item, I walked to an automatic cashier, I never was within 50 yards of another person. So, they figured out the business pretty quickly, and the numbers were absolutely stunning.

Flippen: Yeah. And I don't want to downplay how impressive the comp sales were this quarter. 11% comp sales for a company like Lowe's is virtually unheard of. And as you mentioned, the fact that they were an essential retailer open during the pandemic contributed significantly to this performance. But it's not so out of line, you know, two quarters ago, Lowe's was still growing comp sales slightly higher than Home Depot. So, this is, in a sense, an extrapolation of a trend that was already happening in previous quarters. So, Lowe's had a great quarter to say the least.

Kline: Yeah. And look, there are some trends that might have pulled some sales forward. So, I would worry a little bit about the next couple of quarters, maybe a lot of people bought a barbecue grill sooner than they would have; maybe a lot of people are doing their home painting that they weren't going to do, but at some point they would have had to do; a lot of people are planting gardens and doing things that -- you know, they otherwise are trying to occupy themselves. So, this is largely a homeowner-driven business, and that actually speaks to Lowe's a little bit better than it speaks to Home Depot. Though, frankly, I think a lot of customers that generally wouldn't go to these stores are probably going to the stores. There are still good local hardware stores, many of those have not opened.

And how can you be a good local hardware store? If you focus on service, there's a level of customer you can attract, someone like me who will pay more for you to explain how to do it. But your local hardware store can't carry two gigantic aisles of lumber and the drywall and all the things that take up huge space that they're able to carry at a Home Depot or Lowe's. You'll have like a parking lot full of sheds in the Spring; which you see at both of those places.

Flippen: And I'll quickly add before we move on to what Home Depot reported, because they did report before Lowe's, is that the average Lowe's store is actually much bigger than the average Home Depot store. Maybe "much" is a big word, but it is notably bigger than a Home Depot store. So, when you're trying to implement things like social distancing measures, it's easier at both these stores because they're big-box home improvement retailers, but still yet, even easier at a Lowe's, because they have significantly larger garden centers and footprints in general.

Kline: Yeah. And the numbers at Home Depot were spectacular too. Their comps were up 6.4%; 7.5% in the U.S. They started making changes in the middle of March, so really, when there was already some impact but they changed very, very quickly. 11 of their 14 departments were up with, I think, installation, in-home and kitchen were down.

Flippen: Which makes sense.

Kline: Yes, absolutely. Though, I actually will point out that I had a bathroom built during all of this, but not at the house we live in. While total traffic was down, ticket sizes across the board were up. Again, people making less visits, they want to just get everything they need.

They stopped their share purchase program; that's a smart idea, you don't know what the future will look like. And they acknowledged that margins were down, but if you didn't include the costs related to COVID-19, their margins would have increased. So, not quite as stellar, but I think there's a reason for that. They cater a little bit more to contractors. And depending where you are, contractors couldn't work.

Now, my small-time contractor who does solo jobs was able to work. He's done lots of little things for people, either they leave the house for the day or in my case, I just wasn't at the house. But a lot of construction has pretty much stopped, though it is starting to open back up.

Flippen: Yeah. And ultimately whenever I was preparing for this show and I was reading different news articles about their earnings reports; and I largely found myself scoffing a little bit, because I felt like the news reports were missing the true reason for why the performance between Home Depot and Lowe's was so significantly different. Which is to say, sure, they compete for the DIY retailer, if you will. You or I, Dan, if we were going to be making improvements, although maybe you more than I, because I have done very [laughs] little improvements on my own, but the point is --

Kline: -- [laughs] No. I mean, I did, when we lived in Connecticut, do a lot of the gross work in my basement, like, hanging the drywall and stuff, but I'm really bad at it. So, if I can hire someone to do things -- you know, it's telling that one of my closest friends here is my handyman contractor, you know, I literally went to his daughter's first birthday party --

Flippen: -- secret friend to have ...

Kline: ... yeah, it absolutely is. So, no, I'm not a do-it-yourself person. I've been known to move because a lightbulb needs changing.

Flippen: [laughs] So, I assume that there are people out there that do it for themselves, maybe not on this Zoom call at the moment. But the idea being that the person who is typically shopping at Lowe's is a smaller-time purchaser, maybe a more frequent purchaser who's making, yes, smaller purchases but will typically still continue to make those purchases during a global pandemic. As you mentioned, the person who is sitting at home right now looking at that hole in the wall or the color of wall that they've been meaning to find the time to change, and with Home Depot and Lowe's open, they're going to whichever is cheaper, whichever is local, find the supplies they need and making those improvements themselves.

Home Depot has invested a ton of money into their Pro offerings. And I'm frontrunning my next question a bit, so I'll try to digress on this, except for to say that the reason why comps were almost double for Lowe's, what they were for Home Depot, to me, comes down to the fact that that core pro customer was not shopping at Home Depot, whereas the core DIY customer was still shopping at the local Lowe's.

But I think it's also worth mentioning, because you said that Lowe's spent $340 million in COVID-related costs, and that was 17% of this quarter sales, so pretty substantial. Home Depot spent [laughs] way more than that. They spent $850 million, which is 30% of their sales, and they were doing things, like, expanding paid time off for their hourly employees, additional paid time off for people who are at-risk, double overpay time, they were even waiving copays for dependents on their healthcare plans.

Now, a lot of this, Lowe's was doing as well, but based off the scale of the spending, I think it's safe to say part of the reason why Home Depot stock was down on the earnings report, whereas Lowe's was up, was because Home Depot failed on the bottom-line because of this huge increase in COVID costs.

Kline: And there's no reason either of these companies should be down. Basically, both have proven that short of a zombie apocalypse or, I don't know, a dinosaur invasion, these companies are going to do well. And like, I know, in two years when we have the dinosaur invasion, you and I will be doing this show and you'll bring this one back.

But this is a scenario where these were always relevant companies, their only competition on a grand scale is each other. Sure, if I need a hammer, I can go to the local hardware store, if I'm building something big and I need to look at, you know, 50 different doors, I have to go to Home Depot or Lowe's.

We just bought a refrigerator freezer and the selection at Home Depot and Lowe's -- and you can throw Best Buy in the mix; but compared to other places that sell those types of things -- is gigantic. Now, they don't show everything in the store, and that's a little bit tricky. We actually had to buy something we couldn't see. But these companies own a lot of markets and it's very difficult to compete with them.

Flippen: I always forget that Best Buy sells appliances too. You're right, Best Buy does, in a sense, compete with the Home Depot and Lowe's of the world. [laughs]

Kline: Yeah. And I actually think, Best Buy, if you can go to a store, offers a better experience, they have sales people that are much more knowledgeable about what you're buying, in my opinion. Now, I'm not saying that's not true in a Home Depot or Lowe's, but I didn't find the experience all that great. We bought from Lowe's; I want to say. And placing the order online was tricky, getting -- we still don't know exactly when they're going to deliver it, we're not entirely sure what it comes with. The websites are both lacking; I think that's fair to say. And it is frustrating when there's something that they're not showing in any store. We didn't even need to see the model, just that brand and that color we couldn't find, because we wanted to know what their stainless and their black looked like compared to our existing kitchen. So, there's definitely some room for improvement here.

But you're going to be in that store because you need a little something and go, "Oh, yeah, they sell appliances," or they have a guy that can redo my kitchen or install a new bathtub or whatever it is. There is a lot good here.

And then the pro side is really where both, I think, have a ton of room to grow. Emily, if you want to explain a little bit what I mean when I say the pro side?

Flippen: Yes. And it's actually interesting. I'll quickly define pro. Pro, it's an abbreviation for professional shoppers, this could be anything from small-time local contractors to much bigger national contractors. It really does service anybody who does home improvement for a living. But the way that Lowe's and Home Depot define and target pros are completely different.

So, Home Depot targets much larger pros, whereas Lowe's targets, what they call, pickup truck pros. So, these are the pros that you'd imagine exactly like what a pickup truck pro is. Local, smaller contractors who are more likely to make smaller but more frequent purchases.

Kline: Yeah. And Home Depot is more doing -- they have a pro desk. You call in your order, they bring it to the job site, as opposed to the guy who's, you know, redoing my bathroom and he picks up two sheets of drywall and a toilet and a couple of other things and some tile. And he maybe has to run back a couple of times; there's a lot of opportunity for both of these companies.

So, I've talked about, I have a background in the scaffolding industry. And there are some Home Depot locations that do scaffold rental. But small-time scaffold rental is an incredible markup, so maybe it costs you $45 to bring in a frame from China. And you're renting that -- if you went to the local scaffold house, you might rent it for $5 and $6 per frame. When you do it at a Home Depot, it's $12, it's $15, it's dramatic; I'm making these numbers up, I haven't looked at them in years. But it was dramatically higher. But it's a guy who doesn't really care. He needs to go 8 feet high, 12 feet high, he's painting a wall, he's doing something -- he's not, you know, building a skyscraper -- that guy is going to go to the scaffolding house.

There is so much money to be had in that and tool rental and all the other things that they're not doing a ton of. But I bring up steel scaffolding because you've paid for it in roughly five or six months at their prices, maybe even less than that if it comes in-and-out, because you usually pay for a month, whether you have it for a month or not. And then it makes you money for you'll amortize it in five years, but you might have it in your inventory for 20 years.

If you're willing to repaint it and make sure its structural integrity is intact, there are a lot of things like scaffolding planks, the things you put between two ladders and you stand on. Well, they last somewhat forever and they rent really well. And Home Depot and Lowe's could be doing a much better job in those areas. And I have to feel like they know that. So, as they get their business correct, I would think they're going to go after more of that; what else can we sell to contractors and homeowners? Like, you know, the adventurous guy who's going to paint his house needs that equipment. The person who's doing an in-home project needs the little scaffolding piece that could go from four feet to eight feet and you can do your painting. They need a drywall cart; something else you can rent. They need the stilts you can wear to paint certain things. All of that stuff is rental equipment and they haven't done much of it. Home Depot has it in some locations, but in terms of going pro, they could both do a ton more, because the big-time job is not buying stuff from Home Depot or Lowe's.

Flippen: [laughs] I'm laughing here, because I feel like if there's any executives from Home Depot or Lowe's listening to this podcast right now, they might try to poach you from us after listening to your enthusiastic response about scaffolding.

Kline: Yeah. I will actually say that perhaps some of -- maybe not those two, but some players in that space would always sniff around. When I was in the scaffolding business, there's very few people that had expertise there. But I'm not an expert so much as, if you're an ice cream store, and you say, "Okay, we're really doing well with cones and sundaes." If I came in as a business executive, I'd be like, "Milkshakes!" like, "Let's add milkshakes." And then after the milkshakes are going well, I'd be like, "Gee! Maybe some hot food would be good," you know.

And I would assume that Home Depot and Lowe's are figuring that out, and they're also figuring out how to leverage their buying power to go after a much bigger audience. The difference there is, if I'm building a skyscraper, if I'm a giant construction company, I can go direct-to-source. Like, the guy who is buying 32-foot wood planks for me to put on the scaffolding he owned, that guy is buying six. The person who's buying a truckload can make the same deal that Home Depot can make, so. But I could see them using just how much bigger they are, to keep going into bigger and bigger things and expanding what they do.

And that could be a lot of areas. They could blow out their gardening section. If you go into a traditional hardware store, they do a lot more with grills than just sell grills. There's not a great selection of, like, barbecue sauces and grilling supplies at a Home Depot, there usually is at an Ace Hardware. So, I see a lot of ability to just be a bigger market. Maybe it's less inflatable Christmas tree ornaments that nobody is happy to see. So, if you wanted to devote more of that space to other stuff that would be fabulous.

Flippen: [laughs] Well, I like to force people's hands here. So, before we sign-off, if your hands are tied behind your back and you have to choose one of these companies, Lowe's versus Home Depot, which one are you buying and why?

Kline: Yeah. So, I'd buy Lowe's. And it's going to be a typical reason for me. They're both good companies, I'm not against owning stock in either company. Home Depot may have been treating people better, that's something to think about. As a consumer I find, at Lowe's, there's at least a chance someone will help me; at Home Depot, no one will help you. And I don't feel that customer service is baked into their business, and I think some of that is because they are targeting the no-DIY customer or contractor. They are not targeting a guy who comes in with a shopping list from his contractor and goes, "I don't even know what department any of these things will be in."

That experience of me literally having pictures on my phone and showing someone at Home Depot versus Lowe's; worked at Lowe's, it didn't work at Home Depot. Customer service is really important to me, that's why if I had to buy one, I would buy Lowe's.

Flippen: I agree that, I think, owning both is perfectly fine. What I will say is, is that Home Depot would be my pick, because not only has it always traded at higher multiples in comparison to Lowe's, and it has typically backed that up with stronger financial performance, but Lowe's feels like, to me, a turnaround story. So, yes, there's definitely more growth opportunity for Lowe's if Ellison and his team are able to implement the changes that they plan to, especially with the digital omnichannel experience.

But Home Depot to me has been way more proactive at targeting the pro buyer, and that, to me, is the higher margin business that will allow them to really corner a market target. And if you look at them --

Kline: -- well, lower margin, but bigger sales. They'll make more money because someone is buying a truckload, but they're definitely marking up, you know, one sheet of drywall for me, more than they're marking up, you know, a house-worth.

Flippen: Of course. And that's why you'll see that a lot of smaller time purchases will go to Lowe's. They're much more price sensitive and they tend to have lower prices on, yeah, small purchases as opposed to bulk purchases.

But Home Depot, if you look at their most recent annual report in comparison to Lowe's, they mentioned pro shoppers twice as much as Lowe's does. And despite the fact that Lowe's has been saying that they want to target these pro buyers, Home Depot has just been doing it more successfully. Neither company breaks out the total number of pro customers, but as of the third quarter in 2019, Home Depot said they had over a million different registered pro customers in their loyalty program. In that same quarter, Lowe's had said they had added 35,000 pro customers.

So, they're both targeting the market, but analysts project that only 20% to 25% of Lowe's sales are pro customer sales, whereas it's closer to 50% for Home Depot. And I think, as an investor, if you're looking between these two companies, it comes down to which target part of the market do you like better? Do you like the retail side or do you like the pro side?

Kline: And, Emily, if either one of these companies really wanted to go after the pro side, there's a there's a way to do it, you hire sales people who --

Flippen: -- hiring Dan.

Kline: [laughs] No. No, I don't want to work at either of these companies, I will point that out. You hire sales people who go to the job site. So, when I was working in my family business, scaffolding, all the midsize jobs are generally local, they're not national companies. So, it's one of those scenarios where I had people and they went to the job site, and not only did they introduce themselves, they brought coffee, they brought doughnuts, "What do you need?" "Oh, you need this today? Alright, I'll run this over to you." And you have to ingratiate yourself.

Anybody they're trying to get on the pro side has a supplier, has a relationship that might be with them already and then they can pull it in, get a discount, that's great. But they could do way more outreach. And if they did that, I hate to say, they could crush a lot of competition. Probably not going to matter to the bigger scaffold companies, because I doubt Home Depot and Lowe's are going to want the liability of doing big-ticket jobs, they want the guy painting a house that if he falls, he falls eight feet, he probably is OK; they don't want what my family deals with, which is, sort of, endless lawsuits of people who weren't that smart and hurt themselves.

My grandfather was literally on 60 Minutes talking about this in the 90s. So, he's no longer with us. But this is one of those things where they'll limit some of that, but I could see them literally doubling sales if they did it correctly.

Flippen: Well, every single time I have you on, Dan, I learn something new about you. [laughs] I have to say, I think your grandfather's scaffolding business represented on 60 Minutes and the legal liabilities that come from it, has to be one of the more interesting conversations that we'll have to have --

Kline: [laughs] ... so, Emily, I'll quickly share the story my grandfather told. We got sued once because somebody set up his ladder on frozen horse manure. And the next day he went out and used the ladder, it was warmer, and he fell. And we had to answer the question, why is there no label on the ladder saying, "Do not set up on a frozen surface". And that's what you deal with. For a while there was a "Do not eat" label on some of our wooden step ladders; we no longer make ladders. So, liability is probably a whole show we could do, because it is a crazy, crazy world.

Flippen: There's a lot of lawyers listening out there nodding their heads right now. [laughs] Well, Dan, thank you so much for taking your time today to come talk to us about home improvement retail earnings; it's been a pleasure.

Kline: Thanks, Emily. As always, a little silly, but a lot of good information.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions, or just want to reach out to say, "Hi!" you can always shoot us an email at [email protected] or tweet us @MFIndustryFocus.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Austin Morgan for his work behind the screen today. For Dan Kline, I'm Emily Flippen, thanks for listening and Fool on!