Hammering Lowe's Home

Lowe's (NYSE:LOW), the No. 2 home-improvement retailer, nailed another quarter. In fact, fourth-quarter and full-year net income jumped 27.6%.

When compared to leader Home Depot (NYSE:HD), the weed that lurks in Lowe's balance sheet is its nearly $3.7 billion in debt. Home Depot has similar operating margins and a pristine 6% debt-to-equity ratio. At a still-manageable 39% debt to equity, is Lowe's faster growth worth paying a premium? If you plumb the year-end results and the balance sheet, the answer is yes.

Sales increased 18.1% last year, while inventories increased just 15.5%, implying a company that is getting better at managing inventories as it grows. Total debt -- that weed in the garden -- decreased $10 million. Although modest, the decrease implies that Lowe's has reached critical mass and can continue expanding by 18% a year, using operating cash flows to fund its rapid growth. Higher growth of both sales and earnings justifies Lowe's higher price-earnings multiple.

Where Home Depot shines like a new Kohler faucet is in free cash flow (a Fool's real friend). After capital expenses of $2.4 billion last year, Lowe's generated cash flow of $500 million. With almost $3 billion in free cash flow, Home Depot clearly has the resources to remain a threat, but Lowe's accelerating free cash flows do bear watching.

Meanwhile, Lowe's has guided analysts to expect sales growth of at least 17%, and earnings growth of 20%, for each of the next two years. Unlike El Paso (NYSE:EP), which I covered just a few days ago, Lowe's has the credibility to project that far into the future.

What might surprise you even more is that Lowe's enjoys excellent operating margins. Wal-Mart (NYSE:WMT), whose 5.5% margins pale next to Lowe's 9.7%, trades at a higher price to earnings. Sounds like they need a price check at the NYSE. Target (NYSE:TGT) doesn't even come close at 6.2%, and even specialty retailer Williams-Sonoma (NYSE:WSM) falls short at 8.4%.

Let me hammer this home: Lowe's had a great quarter and a great year. It improved its balance sheet and expects to increase earnings by 44% over the next two years. Like the premium hardware it sells, there is a reason Lowe's costs more.

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Fool contributor W.D. Crotty owns stock in Home Depot (poor guy) and will be covering Home Depot's results tomorrow.