Lowe's Earnings Preview: Comps And Operating Margins Lag Home Depot, But For How Long?

May.17.13 | About: Home Depot, (HD)

Lowe's (NYSE:LOW) reports its fiscal q1 '14 earnings before the bell on Wednesday, May 22, 2013, a day after Home Depot (NYSE:HD). Analyst consensus, per ThomsonReuters is looking for $0.51 in earnings per share (EPS) on $13.45 billion in revenues for expected year-over-year growth of 16% and 2%, respectively.

Quarterly comps are expected between 2%-3%.

You cannot talk about LOW without also talking about Home Depot , since the two competitors are like dueling banjos in the oligopolistic, do-it-yourself home improvement business, and in terms of competitive strategy, they've "yinged and yanged" their way through the last 13 years, i.e., when HD flags, LOW seems to do better, and vice versa. (Read our HD preview here, since HD reports its fiscal q1 '14 the day prior to LOW.

To give readers some background or history, HD and LOW had many tailwinds in the housing market of the late 1990s and a favorable housing backdrop, and then in 2000, HD was hit, first when large-cap growth stocks blew up as an asset class in March 2000, but also at the same time, LOW started gaining market share and outperforming on quarterly comps as HD's larger-market strategy was thought to be saturated.

From 2001 through 2006, LOW put up very nice quarterly comps, between 3%-6% (and sometimes higher), while HD struggled, until both stocks were felled by the Great Recession of 2008-2009, and the housing depression that ensued.

Exiting the 2008-2009 recession, HD was "leaner-and-meaner" operationally and has fixed its merchandising issues, so HD is now generating higher quarterly comps than LOW once again. HD's quarterly comps are 2(x) LOW's quarterly comps at this time.

The point of all this is that as the housing and new home construction cycle has turned, HD was far better positioned than LOW because of its leaner-and-meaner expense rationalization prior to the housing downturn, combined with the fact that HD has done a better job merchandising its stores, getting its SKUs right and improving its average ticket during the housing recovery.

For LOW specifically, management is in the process of "re-merchandising" the stores and rationalizing SKUs with the intent of closing the comp differential with HD.

LOW vs HD Comp and Operating MGN Comparison

4/13 (est) +2.5% +5.0%
1/13 +1.9% +7.0% 5.1% 9.6%
10/12 +1.8% +4.2% 6.9% 10.5%
7/12 -0.4% +2.1% 9.1% 12.5%
4/12 +2.6% +5.8% 7.2% 9.6%
1/12 +3.4% +5.7% 5.0% 8.3%
10/11 +0.7% +4.2% 6.6% 9.3%
7/11 -0.3% -0.6% 9.8% 11.3%
4/11 -3.3% -0.6% 6.8% 8.4%
1/11 +1.1% +3.9% 5.2% 6.9%
10/10 +0.2% +1.4% 6.3% 8.7%
7/10 +1.6% +1.7% 9.9% 10.5
4/10 +2.4% +4.8% 7.0% 7.7%
1/10 -1.6% +1.2% 3.7% 5.0%
10/09 -7.5% -6.9% 5.3% 7.7%
7/09 -9.5% -8.5% 9.3% 9.6%
4/09 -6.6% -10.2% 7.1% 6.9%
Click to enlarge

* Source: internal spreadsheet, from earnings reports, 10-Qs

In terms of "big ticket" comps, and as our HD preview details, HD has seen a faster return of big ticket than LOW, although the retailers define big ticket differently. HD defines "big-ticket" as a sale of $900 or more, while for LOW, the "big-ticket" is $500 or more.

For all but two quarters of the last 4 years (16 quarters), HD has beaten LOW in the quarterly comp, and the differential has widened in the last year as housing construction and the housing cycle has really begun to accelerate.

In all but the April '09 quarter, HD has generated a higher operating margin than LOW.

However, today LOW has the slightly lower valuation, relative to HD, so even though HD is executing better, with higher comps, margins and generating EPS growth at a faster rate, LOW is slightly cheaper and can be thought to have less downside risk.

The bottom line is once LOW can get through this merchandising rationalization and get straightened out in the stores, what HD undertook in 2005, 2006, and 2007, assuming no change in the turnaround occurring in the housing market, LOW comps should eventually close the gap with HD.

If you need one metric to watch for LOW going forward, watch that operating margin.

Neither retailer has opened many new stores or generated much revenue growth in the last 5 years. The next growth phase for these two do-it-yourself giants should come from faster revenue growth and leveraging streamlined expense structures.

Both stocks can be thought of as pretty fairly valued at current prices, although technically both recently traded at all-time highs and broke out above previous resistance.

LOW vs HD - valuation metrics

Price/sales 0.82(x) 1.35(x)
Price/bk 3.0(x) 5.6(x)
2016 (est) EPS gro 21% 13%
2015 (est) EPS gro 21% 16%
2014 (est) EPS gro 19% 13%
2016 (est) rev gro 4% 3%
2015 (est) rev gro 4% 4%

2014 (est) rev gro

4% 3%
Price/cash-flo 11(x) 14(x)
Div yield 1.2% 1.6%
Free-cash yield 6% 6%
Internal model "fair value" $47 - $48 $75 - $77
Morningstar "fair value" $37 $64
Click to enlarge

We think most of retail and not just the housing-related retail names are pretty fairly valued with the current market rally.

Faster revenue growth is (in our opinion) the next big catalyst required by the sector. We give LOW the slight edge on valuation.

Both DIYs are great operators with experienced management teams.

Disclosure: I am long HD, LOW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.