It's no secret that the real estate industry has been hit especially hard by the global downturn. With the loss of home equity as owners cashed out their mortgages, and fewer people flipping houses, the home improvement industry has been hit especially hard. Over the last year, there have been a few rays of hope as government stimulus and the homebuyer tax credit have incentivized home purchases. When the tax credits expired at the end of April, however, so did home buying, dragging down the stocks of home improvement retailers in the process.
The Numbers
Who are the major players in this industry? The table below summarizes them across a few key metrics:
|
Name |
Market Cap |
P/E |
Return on Capital |
Dividend Yield |
Cash |
Debt |
Long Term Growth Est. |
|---|---|---|---|---|---|---|---|
|
The Home Depot (NYSE: HD) |
$ 46.2B |
16.4 |
11% |
3.4% |
$ 2.4B |
$9.7B |
14% |
|
Lowe's (NYSE: LOW) |
$ 28.6B |
16.3 |
8% |
2.2% |
$ 2.7B |
$6.1B |
14% |
|
Sears Holdings (Nasdaq: SHLD) |
$ 7.3B |
32.7 |
4% |
N/A |
$ 1.7B |
$3.4B |
10% |
|
Lumber Liquidators (NYSE: LL) |
$ 587M |
20.8 |
21% |
N/A |
$ 51M |
$ 0 |
20% |
Data from Capital IQ.
The Prospects
Home Depot and Lowe's are well positioned as a near duopoly in this industry. While chains like Sears, with its Craftsman line of tools and Kenmore appliances, have maintained a small portion of the market, there has been additional competition from niche retailers, like Lumber Liquidators, which have been able to quickly capture share of the flooring market.
However, both Home Depot and Lowe's possess a wide moat due to their scale, allowing them to spread costs over a larger store base. It would be nearly impossible for an upstart competitor to make the capital expenditures needed to be a viable contender in this industry.
The Decision
If you're looking to add new money into the home improvement space, I'd have to go with Lowe's. Though its return on capital and dividend yield are slightly lower than you find with Home Depot, Lowe's has more room to expand before it reaches saturation, and it recently increased its dividend in a move to return more money to shareholders. Also, Lowe's has benefited from a superior distribution system that has provided a logistical advantage over Home Depot. While Home Depot is working to upgrade its own system, Lowe's is spending money on new stores, including international expansion.
If you're interested in a spicier pick, Lumber Liquidators is worth a look. While the company seems more expensive based on its P/E ratio, it's projected to grow much faster than the industry over the next three to five years, spending every free dollar it has to grow its store base. This is encouraging considering the exceptional store-level economics, which allow new stores to pay for themselves within the first year. The consistent 20%-plus return on capital is a testament to the profitability of the business model.
Either way, I believe that the negative sentiment the market possesses toward the housing industry is offering patient investors the ability to pick up industry leaders at a reasonable price.
