How Home Depot Outperforms Lowe's

| About: Home Depot, (HD)

Summary

Continually increasing market share in the United States.

Increasing net income through reduced corporate overhead.

A 1,000 basis point increase in return on invested capital.

Over the past 10 years, home improvement retailer Home Depot (NYSE:HD) has easily outperformed its nearest peer Lowe's Companies (NYSE:LOW). Home Depot's 5-year average annual net income growth is 16% compared to only 4.84% for Lowe's. Please note the statistic just referenced is net income and not earnings per share; share repurchases do not increase net income. What's driving Home Depot's outperformance versus Lowe's?

Home Depot vs Lowe Click to enlarge

Market Share

Identical store sales growth measures how much sales increased in stores that have been open for at least one year. Companies that are growing identical store sales faster than their peers are growing market share faster with their existing locations.

Though both Home Depot and Lowe's have operations in Canada and Mexico, the United States is the primary market for both companies. During the past two fiscal years, Home Depot has grown identical store sales faster than Lowe's in the United States. In Q1 2016, Lowe's grew comparable sales slightly faster.

Home Deport Lowes Comparable Store Sales Growth Click to enlarge

Going a level deeper, Home Depot has increased its sales per square foot faster than Lowe's during the past three fiscal years.

Sales Per Sq Foot vs FY Ago Click to enlarge

Home Depot is increasing sales faster than Lowe's with its existing stores and increasing sales per square foot faster.

Reduced Corporate Overhead

As mentioned in the introduction, Home Depot's average net income growth over the past 10 years has surpassed Lowe's (16% vs. 4.84%). In addition to faster same-store sales growth, what else is driving Home Depot's outperformance in net income?

According to Morningstar, Home Depot and Lowe's have similar gross margins (~34%) but different operating margins (13.30% for Home Depot versus 8.41% for Lowe's). Why is Home Depot's operating significantly higher than Lowe's?

In 2007, both companies had similar selling, general and administrative expense ratios. Home Depot has since reduced its SG&A expense by 132 basis points while Lowe's has increased by 283 basis points.

Home Depot vs Lowe Click to enlarge

(sources: Home Depot and Lowe's)

Lowe's requires more corporate overhead as a percentage of sales today than it did 10 years ago while Home Depot requires less.

Return on Capital Invested

Retail is a capital intensive business; new stores have to be built, existing locations must be expanded and renovated and warehouses are required for the supply chain. Return on invested capital (ROIC) measures how effective a company is in generating profit from capital investments.

In fiscal year 2006, Home Depot and Lowe's had near similar ROIC (17.69% vs. 16.83%). In the past 10 years, Home Depot has increased its ROIC to 27.66% for FY 2015 versus 14.82% for Lowe's. Home Depot has increased its ROIC by nearly 1,000 basis points the past 10 years while Lowe's has declined by 200 basis points.

Return on Invested Capital Click to enlarge

(sources: Home Depot and Lowe's)

Home Depot's outperformance is partly driven but it efficient allocation of capital investment.

Conclusion

In conclusion, Home Depot's net income is growing faster than peer Lowe's due to faster growth in same-store sales and sale per square foot, consistent reductions in corporate overhead and more efficient investment of capital. Home Depot's operational excellence has led to generous returns for shareholders the past five years.

Contrarian

Home Depot has repurchased massive amounts of shares the past 5 years. The company currently has an authorization to buyback $18 billion of its own shares. If Home Depot cannot maintain the current buyback levels, investors may be turned away from the stock.

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.