It has paid to be in the home improvement industry. The two industry juggernauts Home Depot (HD 0.94%) and Lowe's Companies (LOW -0.04%) have crushed the market over the last 30 years as they've consolidated the industry from mom-and-pop shops across the country and ridden the U.S. economic tailwind. Combined, both businesses now generate over $250 billion in annual sales and are in the top-100 largest companies in the world by market capitalization.
As the American consumer goes, so go Home Depot and Lowe's. But are investors still underrating these home improvement giants? Let's investigate.
Reverting from the pandemic boom
The pandemic provided an incredible catalyst for Home Depot and Lowe's. With many people unable to travel and cooped up in their houses, they decided to spend money on home improvement. There was also major inflation in lumber prices, which both companies were able to pass on to their customers. For example, in the first quarter of 2021, Lowe's and Home Depot put up comparable store sales of 24.4% and 29.9%, respectively, in the United States. Both were record figures for the companies and sent their stocks soaring during the pandemic boom.
But now, with the world back to normal, people are spending their savings on traveling and entertainment and less money on improving their homes. This has caused a slowdown for both businesses, with Lowe's comp sales down 4.3% last quarter and Home Depot's off by 2%. While declining sales are not good in a vacuum, when you compare revenue from pre-pandemic levels, both businesses look to be in fine shape at the moment.
Profitability is off of all-time highs but also still much higher than before COVID-19. For Lowe's, the company generated $10.1 billion in operating income over the last 12 months compared to $6.3 billion in 2019. Home Depot has generated $23.7 billion in operating income over the last 12 months compared to $15.8 billion before the pandemic.
But the question is, can they start growing earnings again?
LOW Operating Income (TTM) data by YCharts.
Long-term growth drivers still (mostly) intact
On its latest conference call, Lowe's CEO Marvin Ellison said there are three main factors that affect the business:
- Personal income
- Home price appreciation
- Age of the housing stock
Over the past 10 years, personal income in the United States has steadily risen and shows no signs of slowing down soon, hitting $67,000 per person compared to $30,000 in 1990. The age of the housing stock continues to go up, hitting a median of 40 years in 2021 versus 31 years in 2005.
With many homeowners trapped in 3% mortgage rates, it is more likely people are going to spend money improving their aging current residences than sell and move somewhere else. This should be a benefit to both Lowe's and Home Depot this decade.
The one headwind the industry may face is home price appreciation, or lack thereof. Home prices surged during the pandemic but have since fallen as the Federal Reserve has raised interest rates, making the affordability equation much more difficult for homeowners. If home prices stagnate, that could provide a small headwind to the home improvement market, but it should still grow as long as personal incomes and the age of the housing stock grow.
Are the stocks cheap?
Lowe's and Home Depot typically trade at around the same price-to-earnings (P/E) ratio. Today, the stocks trade at a P/E of just over 20, which is slightly below the market average of 25. For companies that should continue to take market share, expand margins with scale, and ride the tailwinds of an aging housing stock, these look like attractive prices for buying shares.
LOW PE Ratio data by YCharts.
The companies will also likely continue to return capital to shareholders through buybacks and dividends. Today, Home Depot and Lowe's have dividend yields of 2.5% and 2.98%, respectively, and have both significantly reduced their shares outstanding over the past few decades. Capital returns will help boost total return levels for shareholders over the long term.
While not sexy, hypergrowth stocks, Lowe's and Home Depot have crushed the market over the long term and look poised to continue their winning streaks this decade as well.
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