You have to wake up pretty early to work construction, and to sell materials to construction workers. It seems that old habits are hard to break, because when home improvement company Lowe's (NYSE:LOW) reports earnings on Monday, the sun still won't be up in much of the country.
While I'm not much for early rising myself, I have to admit that the habit seems to be serving this company well. Lowe's is expected to announce a 16% year-over-year improvement in sales, to $15 billion for its third quarter 2005, and $0.77 in diluted profits per share -- a 24% improvement over the prior year. These numbers would also mark an improvement over Lowe's already stellar performance last quarter, in which it grew sales by 17% and profits by 20% against the previous year's numbers.
Supercharging the profits that drop to the bottom line from Lowe's surging sales numbers has been the company's ability to expand its gross margins and pass part of the savings along to its net margins. Although Lowe's trailing-12-month net margins still lag behind those of its nemesis, Motley Fool Inside Value pick Home Depot (NYSE:HD), Lowe's has been closing the gap this year. Lowe's expanded its gross margin last quarter by 52 basis points over the year-ago quarter, and its net margin by 14 basis points. Year to date, the company has done even better, expanding gross margins by 91 basis points and net margins by 43 basis points. Those busy analysts seem to think that this trend continued through Q3; otherwise, they would not likely be predicting profits growth to be so much stronger than sales growth.
While the Wise on the Street will probably focus on the margins reflected in Lowe's income statement, Fools might want to pay more attention to the company's cash flow statement. It's there that we see Lowe's main deficiency when compared with Home Depot: free cash flow far below what it reports as its net income under generally accepted accounting principles. Over the past three fiscal years, Lowe's has reported $5.5 billion in net income but only $1.1 billion in free cash flow. In contrast, Home Depot has reported $13 billion in net income and $7.4 billion in free cash flow. Both companies are expanding at a frenetic clip, and the capital expenditures incurred in building new stores explains the bulk of the gap between their "accounting profits" and their "cash profits." Still, it's hard not to notice that Home Depot has the free cash flow to back up more than half of its GAAP income, while 80% of Lowe's GAAP income stands without any free cash flow support.
For more Foolish coverage of this big-box seller of things that come in big boxes, read:
Fool contributor Rich Smith owns no shares in any of the companies mentioned in this article.
