On this episode of The Five, Motley Fool contributors Jason Hall, Auri Hughes, and Taylor Carmichael discuss their favorite rebuilding stocks. Jason Hall compares mega-caps Home Depot (NYSE:HD) and Lowe's (NYSE:LOW), and suggests that one of these stocks is stronger than the other.
This discussion was recorded live on August 31.
Jason Hall: I'm going to second Taylor's comments about Home Depot and Lowe's, and I really wanted to focus on like the bigger picture opportunity because I think it's easy with those companies because of their size. Already, they're like the duopoly of the mega home improvement retailers in the U.S. But I think it's easy to miss how much of an opportunity there continues to be for these two businesses, and in particular, I am going to focus on Home Depot here because I really think that it's in the better position if you think about the economics of the business, if you think about the return profiles over the long term, that Home Depot has been able to consistently capture. It's just such a wonderful high floor business that is so compelling. The three legs of the stool for me for Home Depot, number 1, and this is something that it shares with Lowe's, and that's just the power of its logistics engine. Because they are so close to so many homeowners and so many users, end-users already. That is just a massive moat. I think it's a bit of a durable moat as well because the cost of entry is substantial for another company to try to jump into this same business. It would just be foolhardy, to try to add a third major competitor here, and that's why you don't see private equity going after it. This isn't something that I think there's going to be a big appetite for anybody to try to do. That is just a powerful moat. The other two aspects of it has to do with the bigger trends around housing. The first one is the age of the housing stock in the US, the average American home is about 38 years old. That's old. There's a lot of homes that need a lot of work. You think about the inventory situation with existing family homes, it's like half of where it normally is. Existing single-family homes for sale is about half where it usually is. It's a little bit more than a million. It's normally about two million at a time. You think about the massive demand to buy homes? There's not enough housing stock and it's going to take builders forever to catch up. That means that there's a lot of money that's going to be spent on existing homes to bring them up to standard, to improve them, add the features that people want to have, make them safer for baby boomers who are retiring in place, make their homes improve, lighting and railing, just things like that to make them safer. All of those things are absolutely in Home Depot's favor to continue to do well. Oh, by the way, a ton of people figured out after the fact that DIY project, they need to hire a contractor to do it, and there is no home improvement retailer that has better relationships and does better business with the home improvement professionals than Home Depot. I think you add all of those things up and that's the three legs that that business stands on. I think even at its scale, this can be a market beating business for the long term. I really believe that's the case. Love it.
Taylor Carmichael: Jason, I've always thought Home Depot is immune to Amazon (NASDAQ: AMZN), unlike Walmart, that their market is not going to be taken, hasn't been taken by Amazon. I think of Carvana and their ability to sell something you wouldn't think could get sold online, cars, and I wonder, can they ever be undercut by an Internet competitor? I'm sure they've thought of it. And do they do a lot of business through their website? Are they getting that way?
Jason Hall: Taylor I'm glad you asked that because that's actually one of the things that's become a real strength for Home Depot, and this is something they started focusing on years ago, is really building out a really robust e-commerce experience. That's part of the omni-channel of really leveraging all of their assets. Again, because this is a company that already has a store within, 20 miles of 90 percent of Americans, I can't remember the exact statistic --
Taylor Carmichael: Wow.
Jason Hall: -- but the vast majority of us live within less than a gallon of gas of a Home Depot. We're all really close to Home Depot's. What that means is if you're a DIY, if you have a plumbing problem, if you want to do a weekend projects, there's a Home Depot that you can get to in less than 20 minutes, less than a half an hour. You want to order it online, you can order it online and you can go to the store and pick it up. If you want to have it delivered to your house, they already have the last mile logistics there, they're already really close to customers. That's a huge lever. While Amazon and so many other e-commerce companies are having to build the last mile. Home Depot is already there.
Taylor Carmichael: They already got the warehouses. They pretty got them, right. The warehouse is their business.
Jason Hall: It is their business and they have leveraged their physical footprints and built amazing technology to help leverage it. If you look at, let me do this here real quick, I'm going to share a screen share here, and this really emphasizes why I prefer Home Depot over Lowe's. I'm going to split this up by metric. You look on Home Depot's return on invested capital, and you look at its return on assets, it is a substantially high return business. You wouldn't necessarily think of this for a big box retailer, because those are the businesses often that margins can seem like they're going to be thin and hard to get, but they turn their inventory so quickly that they're able to generate incredible returns on their invested capital and on the assets they already have in place. It is just an incredible business.
Taylor Carmichael: Jason, how big are they now? I know they're a mega-cap, offhand I don't know what their market --
Jason Hall: Market cap?
Taylor Carmichael: Over a $100 billion, right?
Auri Hughes: $345 billion, Home Depot.
Jason Hall: Yes, it's more than double the size of the Lowe's. Lowe's is about $140, so about $345, yeah.
Taylor Carmichael: Wow, and then my other question, do you think they'll get to a trillion? It sounds like they will, eventually.
Jason Hall: Eventually, yeah. Here's the thing, I think you've got a dividend yield, it's modest, but pretty good and great track record of growing the dividend. I think in terms of total returns. Also, this is a share buyback focus too, we've taken that free cash flow, invest a modest amount back into the business as necessary, return the rest to investors in dividends and buybacks. Really getting to a trillion dollars. I think that's like a 15-20 year thing. In terms of increasing per-share value, dividends and share buybacks means that it doesn't have to be a trillion-dollar company to still be a 3x, 6x investments over the next 5-10 years.
Taylor Carmichael: Cool.
Jason Hall: Auri, any thoughts on this space?
Auri Hughes: No, it's really interesting. I would like this as the dividend play is very secure. The dividend payout ratio, when I looked it, was like 50 percent. They're basically signaling there is a lot of cash they don't need. I think it's a good play to secure your wealth and play on the economy and just a staple of American business, essentially.