Lowe’s Is Outperforming Home Depot

– By Nathan Parsh

The two leading home improvement retailers both released earnings results this week. The Home Depot Inc. (NYSE:HD) reported Tuesday and produced what I felt was a monster quarter. The company’s year-over-year growth rates surpassed what analysts had expected on nearly every metric.

It was rival Lowe’s Companies Inc. (NYSE:LOW) turn to go on Wednesday. As much as I liked Home Depot’s quarter, I thought Lowe’s was even better. This was the second quarter in a row that I believe Lowe’s outdid its main competitor. By almost every measurement, Lowe’s was superior to Home Depot.

Also working in Lowe’s favor is that the stock is considerably cheaper compared to its historical valuation than what Home Depot is at the moment. I believe Lowe’s can still be bought at the current price. Let’s dig into the company’s earning release to find out why.

Quarterly highlights

Lowe’s released earnings results for the second quarter of 2020 on Aug. 19. Revenue was more than 30% higher at $27.3 billion. This easily beat analysts’ estimates by more than $3 billion. Earnings per share increased by $1.60, or 74%, to $3.75, which was 80 cents higher than anticipated.

The average share count for the most recent quarter was down 29 million shares, or 3.7%, from the previous year. This added some benefit to earnings per share growth, but net earnings improved $1.15 billion, or 69%, to $2.8 billion.

U.S. comparable sales were up a staggering 35.1%, with all regions posting comparable sales of at least 30%. May saw 41.5% sales growth, the best month of the quarter. The other months were still extremely high with 34.4% growth in June and a 28.2% increase in July. Canada same-store sales improved 20% for the second quarter.

Sales growth was due to a combination of higher transactions and larger baskets. Comparable transactions were up 22.6%, while the average basket sized grew 11.6%. Gains were seen across the ticket size levels. There was a 23.2% increase in tickets under $50 and 24.3% gains in tickets of more than $500. Where growth was really seen was in the mid-level ticket bracket of $50 to $500, which was up 43.5%.

All 15 merchandising departments had comparable sales growth of at least 20% and e-commerce sales improved 135%. As with Home Depot, Lowe’s benefited from consumers focusing on home repair and maintenance. Sales to both professional and do-it-yourself customers accelerated across channels, geographies and product categories. DIY growth was considerably more than professional, but pro growth was still mid-20%. Both customer categories saw higher numbers of new customers, which aided results.

An increase in demand for indoor and outdoor project materials led to a 30% improvement in lumber, tools and paint. Lumber saw increases in lot quantities as demand increased from both pro and DIY customers. Paint benefited from an exclusive agreement with the Sherwin-Williams Co. (NYSE:SHW) to be its lone nationwide retailer to sell certain paint products.

Outdoor products, such as Weber and Char-Broil grills, and power equipment brands, like John Deere (DE) and Craftsman, were in exceptionally high demand as customers focused on outdoor maintenance. Flooring, millwork and kitchen and bath were also very strong during the quarter.

Margins were strong. Operating margins improved 315 basis points to 14.5%, while gross margins expanded 200 basis points to 34.1%. Expenses did increase $972 million, including $460 million of costs related to the Covid-19 pandemic. As a percentage of revenue, selling, general and administrative expenses actually declined 110 basis points to 18.4%.

Lowe’s has undergone a drastic change over the last year and a half in order to improve its business, and this transformation has played out over the past few quarters. E-commerce has been a main focus as the company’s results in this area in the second quarter have been fruitful, with online sales representing 8% of the total.

The company has attempted to eat into Home Depot’s advantage with professional customers and managed inventory levels much better than before. Investments have also been made in supply chain management.

The retailer has increased its number of bulk distribution locations, direct fulfillment centers and delivery terminals. Lowe’s expects to open an additional 50 cross-dock delivery terminals, seven bulk distribution centers and four e-commerce fulfillments centers over the next 18 months. This will go a long way to improving engagement with professional customers as they often need larger amounts of materials than DIY customers. These improvements are seen in Lowe’s performance in urban areas, where comparable sales outperformed rural markets by more than 500 basis points.

Lowe’s maintained a healthy balance sheet. Current assets stand at $27.7 billion. Following debt issuance of $4 billion and raising its borrowing capacity by $800 million, the company has $11.6 billion in cash and cash equivalents. Around $3 billion in undrawn capacity remains on the company’s revolving credit facilities.

Current liabilities total $21.4 billion, which includes $1 billion of short-term borrowings and $609 million of maturing long-term debt. Remaining long-term debt stands at $20.2 billion.

Lowe’s generated $11 billion of free cash flow during the quarter. The company distributed $836 million of dividends and bought back $966 million worth of stock in the second quarter. A little more than 16% of free cash flow was returned to shareholders.

Lowe’s withdrew its guidance for the year last quarter. Wall Street analysts expect that the company will produce earnings of $8.28 per share for the year, which would be a 44% increase from the previous year.

It is quite clear that Lowe’s had an excellent second quarter, even better than Home Depot in my opinion. Home Depot has generally done better over long periods of time, but right now Lowe’s appears to be ahead. The stock is also cheaper.

Using Wednesday’s closing price of $158.28 and expected earnings per share for the year, Lowe’s has a forward price-earnings ratio of 19.1. This valuation is still higher than the average price-earnings ratio of 18.4 that the stock has traded with over the last 10 years, but there isn’t as much distance between the current valuation and long-term average as there is with Home Depot.

The market has begun to value the stock a bit higher over the last five years as the average price-earnings ratio is 19.3 over this period of time. By this measure, shares of Lowe’s are actually a bit undervalued, and that’s with the stock gaining nearly 67% over the last year.

Given the company’s outperformance and with more inroads to be made with pro and DIY customers alike, Lowe’s likely deserves to trade with a higher multiple.

Final thoughts

Lowe’s reported a quarter that showed high levels of growth throughout the company. Gains were broad-based as every department and region had high double-digit sales increases. Customers were shopping more often at stores and spending more money.

Looking through the release, I believe Lowe’s had a more impressive second quarter than Home Depot. Despite this, Lowe’s valuation is much lower and much more in line with its historical average than its chief rival.

In addition, the company has increased its dividend for 57 consecutive years and the dividend has compounded by more than 15% over the last 10 years.

With a better business result, a cheaper multiple and a commitment to returning capital to shareholders, I feel that Lowe’s Companies is a buy at the current price.

Disclosure: The author is not long any stocks mentioned in this article.

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