Lowe's Companies Is Less Attractive Compared To Home Depot

| About: Lowe's Companies, (LOW)

Summary

Lowe's Companies, Inc.'s Q1 2016 numbers are solid, and reflect on the fundamental soundness of the US home retail market currently.

With the company indicating that it has a target payout ratio of 35%, and the anticipated growth in earnings, LOW will potentially remain a steady income generator for its investors.

Taken in conjunction with the sizeable difference in scale and in profitability, LOW’s price currently seems high in comparison with HD.

Lowe's Companies' (NYSE:LOW) Q1 2016 numbers are solid, and reflect on the fundamental soundness of the US home retail market currently. In the quarter where other discretionary item players like apparel and accessory retailers have posted weak numbers, the home improvement retail segment has been a bright spot. LOW has achieved 8% YoY revenue growth, coupled with robust same-store sales growth of 7.3% and slight expansion of operating margin to about 9.4% (excluding the non-recurring gain on a hedge).

From an investor perspective, the company has been a steady dividend payer, with a reasonable yield of about 1.8% currently. The dividend payout has also risen along with the company's growth, increasing at about 19% CAGR in the five years ended January 2016. With the company indicating that it has a target payout ratio of 35%, and the anticipated growth in earnings, LOW will potentially remain a steady income generator for its investors.

The increase in US housing starts, and the anticipated growth in home remodeling spend in 2016, will translate into growth drivers for LOW in the year. The integration of RONA in Canada could potentially have a near-term margin impact, while the company's ability to increase its average ticket, seen in the last few quarters, should support long-term profitability. The company's guidance is sales growth of 6% for FY 2016, and expansion of operating margin by 80-90 points.

Strong financial performance and the anticipated increase in dividends make the stock a good investment option. However, in comparison with Home Depot (NYSE:HD), LOW's attractiveness seems slightly diminished.

As discussed in my recent article on HD, the improvement in the US housing sector that is likely to drive growth for the home development retailers. The difference between HD and LOW is centered on the breadth of their retail networks and the efficiency of their store level operations. HD had 2,275 stores at the end of Q1 2016, which is about 22% higher than the 1,860 stores operated by LOW. However, the difference in the number of customer transactions that HD had in the quarter was a whopping 67% higher than those by LOW. This higher throughput of customers more than offsets the slightly lower average ticket at HD, and is possibly the biggest factor for the difference in the two companies' scale and profitability.

Q1 2016

FY 2015

LOW

HD

LOW

HD

Revenue ($ million)

15,234

22,762

59,074

88,519

Operating Margin

9.4%

13.5%

9.3%

13.3%

Stores

1,860

2,275

1,857

2,274

No. of customer transactions (in millions)

223.8

374.8

878.0

1,500.8

Average Ticket ($)

68.08

60.03

67.26

58.77

* LOW Operating margin is excluding one-time items

Click to enlarge

LOW plans to add 45 stores in FY 2016, against the plan of 5 store additions by HD, which will narrow the gap in terms of retail footprint. Online sales are still less than 10% of either company's total sales, and dependence on physical stores is going to remain high in the near medium term, and HD's wide geographic presence will be its sustained strength.

While both the companies are positioned to benefit from improvement in the US housing market, from a returns to investor perspective, LOW still has some distance to go before it can catch up with HD. LOW's expected earnings per share for FY 2016 trails HD's by about 56% (based on consensus estimates); the gap has been over 70% over the last 5 years. Given that HD is continuing to keep its strong hold on the Pro segment, and successfully maintaining its market position; it seems unlikely that LOW's earnings will overtake HD in the near term, although the gap may shrink as LOW expands its store presence in the US and Canada.

However, the gap between the two stock prices seems very low, in comparison with the gulf in scale and earnings. With a P/E of 19.1 times (based on FY 17 market earnings estimates), LOW's shares seem only marginally cheaper to HD, which is currently at a P/E of 20.3. Taken in conjunction with the sizeable difference in scale and profitability, LOW seems overpriced in comparison with HD. Even from a dividend perspective, HD's targeted payout of 50% seems more promising to long-term investors than LOW's indicated 35%.

Both the stocks have seen strong momentum in the last 12 months, and are certainly priced in for their fundamental strengths and strong quarter-on-quarter results. HD's stock has increased by 15% in the period while LOW has increased 12%. The pullback on HD's stock after its Q1 results provided a window to enter, as the stock is now over 6% lower than its 52-week high.

The US home improvement segment is definitely a good investment option today, and the two dominant players are steady investment options. But given the small differential in the price, and the substantial difference in their earnings and scale, the market leader seems to be the better option currently.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.