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Better Buy: Costco vs. Lowe's

By James Brumley - Jan 15, 2021 at 8:15AM

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One is just starting to pick up speed, while the other is starting to lose steam. Perception matters.

Retailers Lowe's (LOW 3.69%) and Costco (COST 1.97%) are arguably as alike as they are different. Sure, the latter sells groceries and select other products in bulk in a membership club/warehouse environment, while the former sells home improvement solutions to any and all patrons. But both are consumer-centric retailers and both must impress prospective customers in a fiercely competitive environment.

For investors looking to put some of their cash to work, however, timing can be everything. One of these companies' stocks is overbought and overvalued, and the other is not only cheaper, but cheaper at a point when things are about to heat up for its target market.

Woman looking at two chalk arrows on pavement, pointing in different directions.

Image source: Getty Images.

And the winner is...

There's no need to dance around the matter -- Lowe's is the better buy of the two stocks right now, for a couple of reasons. One of them is that the home improvement market is still humming regardless of the pandemic.

It's not exactly the kind of data covered by the mainstream media, but it's noteworthy all the same that Metrostudy/Zonda's Residential Remodeling Index (RRI) indicated a 9% increase in big-ticket remodeling spending during the third quarter of last year, jibing with numbers from Harvard's Joint Center for Housing Studies pointing to remodeling spending growth. In the same vein, the National Association of Homebuilders' confidence index reading for December came in at 86, which is the second-highest reading for the past 12 months (second only to November's level).

Better still is the second key reason Lowe's has become the better buy. That's its so-called "Total Home" strategy to drive market share growth that was unveiled in December.

Admittedly, most corporate growth initiatives end up being little more than a mashup of fiscal wish lists and publicity fodder under the umbrella of a catchy slogan. The Total Home strategy looks and feels more substantial, though, in that it cites some specific business-building actions to be taken. Among the most meaningful are Total Home's plans to localize its operations (particularly online) for greater geographical relevance and to win more contractor business.

We've already seen progress on both fronts. During the quarter ending in October, Lowe's saw online sales growth of 106%, for instance, leveraging an overhaul of Lowes.com that was initiated nearly a year ago. For perspective, Home Depot only saw an 80% improvement of its online business in the same quarter.

The real game-changer Lowe's investors can look forward to this year, however, is on the contractor front. Lowe's says between 20% and 25% of its revenue is driven by professional contractors, and though Home Depot is a little less forthcoming with specifics about this side of its business, it's been suggested in the not-so-distant past to account for between 40% and 45% of its sales. If Lowe's can simply close some of that gap, it still represents an opportunity to add billions of dollars' worth of incremental revenue.

And there's no denying Lowe's is getting savvy about drawing these high-dollar customers into the fold. In August the company announced it would be rolling out nationwide tool rental service, following June's launch of a digital tool called JobSIGHT that allows contractors to virtually look at -- and price -- jobs.

All of these initiatives should really start to gel for the company this year.

Costco and its investors have some things to think about

None of this is necessarily a call to sell a stake in Costco -- if you have one -- particularly if doing so would result in an untimely tax bill. The club-based retailer is hardly doomed.

On the other hand, the stock's become richly priced at a time when rival retailers have really stepped up their omnichannel game.

Yes, Walmart (WMT 0.08%) is one of those competitors. Already the world's biggest retailer as well as the nation's biggest grocer, data released by market research outfit BrandSpark in October indicates the company is also the country's most trusted curbside pickup player. It's not just Walmart, however. Target (TGT 2.46%) began offering curbside pickup of fresh and frozen foods on a nationwide basis in July 2020, and for the quarter ending in October, online sales were up 155% year over year, easily outpacing e-commerce sales growth of rival retailers.

Costco's strategy, meanwhile, focuses heavily on drawing consumers into its stores where they make selections of bulk-bought goods. Indeed, CFO Richard Galanti has been adamant about the company not adding curbside pickup service at its stores, explaining last year that in-store shoppers are likely to spend more than online shoppers do. The approach works to be sure, but it's a decreasingly potent model in a market where Walmart and Target increasingly offer home deliveries and easy curbside pickup of the same basic goods.

Granted, it hasn't been easy to find clear evidence that Costco's model isn't as competitive as it could be. There are subtle hints, however, that a headwind is finally brewing. December's same-store sales growth of 11% was solid, but a clear slowdown from the same-store sales growth pace of more than 14% for the past four months. It's curious that the retailer saw such a dramatic slowdown before the one-year anniversary of the pandemic's arrival in the U.S., implying at least some of its shoppers are test-driving offerings from Target and Walmart.

Perhaps more telling is the fact that Costco shares sold off since those December sales figures were posted on Jan. 6, with the stock -- unlike the broader market -- well below its record high reached in November.

Valuation may be an issue. With shares valued at nearly 38 times their trailing profit and more than 37 times this year's projected earnings, the stock's earnings-relative valuation is richer than it's been in years, leaving little to no room for anything less than stellar results from the company. December's 11% same-store sales growth wasn't stellar enough, and there's no particular reason to believe January's figures will be any better.

Bottom line

Neither Lowe's tailwind nor Costco's headwind will last forever. Lowe's may be the weaker pick of the two a year from now. Costco may regroup and adapt to the post-COVID environment once we see what that environment is actually going to be.

If there's only room for one pick in your portfolio right now, though, it should be Lowe's.

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Stocks Mentioned

Lowe's Companies, Inc. Stock Quote
Lowe's Companies, Inc.
LOW
$182.84 (3.69%) $6.51
Wal-Mart Stores, Inc. Stock Quote
Wal-Mart Stores, Inc.
WMT
$123.72 (0.08%) $0.10
Target Corporation Stock Quote
Target Corporation
TGT
$150.42 (2.46%) $3.61
Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
COST
$484.37 (1.97%) $9.37
The Home Depot, Inc. Stock Quote
The Home Depot, Inc.
HD
$283.00 (2.75%) $7.58

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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