As the housing market in the U.S. continues to improve, the housing industry is gaining momentum. Within the housing industry, home improvement companies benefit from the increase in demand for home building material and appliances. The world's second-largest home improvement company, Lowe's (LOW), continued to benefit in the second quarter of this year and reported sales of $15.7 billion, 10.3% growth year over year.
Smart move in the booming market
Lowe's has been struggling to capture market in California, a market dominated by The Home Depot (HD) with 233 stores in prime locations across California. In contrast, Lowe's currently operates around 110 stores in California. According to real estate analysts, California's housing market will continue to grow in this year and next year. Home sales in California are expected to increase 1.3% to 530,000 units this year. The employment rate in California is expected to grow from 1.3% in 2013 to 2.4% in the next year, which leads to spending increases. Also, the low mortgage interest rates have encouraged buyers to invest in new homes.
To take advantage of this opportunity, Lowe's made a smart move acquiring Orchard Supply Hardware, which spun off from Sears Holdings in 2012. Orchard operates around 89 of its 91 stores in California, out of which 72 were acquired by Lowe's for $205 million in cash at the end of August. This will help Lowe's to expand its footprint in California's lucrative housing market. We believe California's improving housing market and the increase in the number of stores can bring potential growth prospects and opportunities for Lowe's, helping it improve its profitability.
Performance and opportunities
As mentioned earlier, Lowe's reported significant growth in its revenue for the second quarter. We believe that Lowe's will continue to generate higher revenue; according to IBISWorld, the current $164.4 billion housing market is expected to grow 3.1% annually over the next five years. Lowe's is also planning to open new stores this year in other U.S. locations. As of August 2, 2013, it operated 1,758 stores in the U.S., and it plans to open around 10 stores by the end of this year. Currently, the company seems to be performing well with its existing stores, and the addition of new stores should drive extra profits and boost sales in the coming quarters.
Being the world's second-largest home improvement company, we believe that Lowe's has positioned itself to capitalize on the improving housing market. Looking at the overall growth opportunities, Lowe's has raised its sales guidance for this year, expecting it to grow by 5% and comparable sales by around 4.5%.
In the second quarter of this year Home Depot and Lumber Liquidators (LL) reported sales of $22.5 billion, a 9.5% year-over-year rise, and $257.1 million, a 22.2% year-over-year rise, respectively. As the housing market is expected to grow in the coming years, both Home Depot and Lumber Liquidators are also taking initiatives to capitalize on the recovery. As discussed in our previous article, Home Depot is taking several measures to improve its current stores' productivity rather than add new stores. The measures include technology upgrades such as installation of self-service checkout machines and its online shopping website. This saves the customer time, and it will help the company to save billions by reducing its staff numbers. At the end of the second quarter, Home Depot operated around 2,250 stores in the U.S., and it will continue to benefit from the existing stores.
Lumber, a specialty retailer of hardwood flooring, offers a wide range of hardwood floorings enhancements and accessories. Also, it provides installation accessories, molding, tools, etc. Its business gained momentum due to the rise in demand for wood and other services. In June 2013, Lumber opened its 300th store in the U.S., and it expects to open a total of 25 to 35 stores by the end of the year.
Here we can see that Lowe's does not face a strong competition from Lumber, but it lags behind Home Depot in store count. This restricts Lowe's ability to take maximum advantage of the recovery. Home Depot has strongly placed itself in terms of performance compared to Lowe's. In the past few years, Lowe's has reported revenue growth around 2%. Considering 2% as constant revenue growth, we estimate revenue of $51.53 billion for this year.
Source: Yahoo Finance
If we take a look at the multiples, all three companies are undervalued as a stock; a lower forward PE ratio compared to its trailing PE ratio is considered undervalued. All three companies have an attractive valuation as lower forward PE compared to trailing PE shows an upward trend in each company's earnings. There's close competition between Home Depot and Lowe's. Both stocks have relatively low PE, which represents that the companies will generate higher earnings. Lowe's PEG ratio is slightly lower than Home Depot and Lumber. A lower PEG is always better, and the PE multiple makes Lowe's a suitable option for investors.
Home Depot will remain the leader in the home improvement industry and continue to benefit from the improving macro-economic factors. However, we believe that Lowe's will remain well positioned and continue to benefit from the housing market recovery. The acquisition will help Lowe's expand in California and help it generate higher revenue. Considering its valuation and the two fundamentals that will bring overall growth for the company, we consider Lowe's an attractive option for investment.
Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Shweta Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.