Home Improvement Giants Already Pricing In QE

Includes: HD, LOW
by: Peter Pham

Lowe's (NYSE:LOW), unlike in its previous quarter, reported a better than expected set of results for its third quarter with sales increasing by 2% to $12.1 billion versus analysts' estimates of $11.9 billion. Net income increased by an impressive 76% to $396 million which translated into $0.40 profit per share (excluding extraordinary items) again beating the estimated $0.35 per share. This was attributed to:

  • An increase in purchasing activities for generators, flashlights and other emergency equipment following the super-storm Sandy.
  • The improvements in the housing market.

The company is currently implementing a cost cutting strategy that includes layoffs and a slowdown in expansion. Its lack of promotional campaigns has resulted in a loss of customers who have been moving to its bigger rival Home Depot (NYSE:HD).

Despite the change of fortunes due to the hurricane, Home Depot has beaten Lowe's same-stores sales growth of 1.8% for fourteen consecutive quarters. Although Lowe's has raised its annual guidance from a 1% increase to 2% in comps, it came on the back of Sandy while Home Depot's improved forecast was independent of the storm. Meanwhile, Home Depot also reported a 4.6% increase in sales to $18.1 billion against expectations of $17.9 billion and a 1.4% increase in profits to $947 million thanks to a 4.2% rise in comps. The profit takes into account the one-time $165 million charge related to the closure of seven stores in China. Last year's Hurricane Irene caused $16 billion in damages and gave a boost of $360 million to the company while Sandy has caused an estimated $20 billion in damages, a bill which could easily double by the time the cleanup is truly complete, so its impact on sales is expected to be more. As mentioned earlier, Home Depot has upped its year-end forecast by 2.7% to a net income of $3.03 per share, although this does not include the Chinese closures and takes into account the $700 million share buyback expected in the final quarter.

To counter the rising competition from Home Depot, Lowe's has been looking for growth through acquisition, but its $1.86 billion bid to purchase Canada's Rona Inc. failed due to opposition from Rona's shareholders as well as Canadian politicians. Since then, Rona's chief has left the company and the rumors of another offer from Lowe's have resurfaced. Rona's acquisition can have a significant impact on Lowe's balance sheet as the former dominates the Canadian market with 830 stores, while Home Depot and Lowe's have just 180 and 31 stores north of the 49th parallel. On the other hand, Home Depot's big box store model has failed in China and it is exiting the market.

Ultimately, however, both of these firms were built in sympathy with the housing boom of the past 30 years in the U.S. which is now over and likely not coming back anytime soon. The overhang of massive supply (and shadow inventory rarely reported in the media) and the refusal of the Obama administration to truly address debt write-downs/forgiveness as a means to clear the market portends a long, slow slog to recovery in housing.

The recent data suggests that housing market is showing signs of recovery, but so many of those statistics are based on supply being purposefully restricted by the banks. The US census bureau has also reported a 3.6% increase in the construction work, which is the highest level of growth since 2008.

Lowe's is clearly aiming for a bigger market share in North America and its cost cutting and restructuring strategy seems to be working as its operating expenses have fallen by 12.4% sequentially. Moreover, on a year-over-year basis, Lowe's has been able to improve its net profit margin considerably.

Due to strong results, the stocks of both of these companies have easily outperformed the SPDR S&P 500 ETF (NYSEARCA:SPY) and SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) which have been up 10.6% and 4.5% in the same period. Both stocks are trading at rich valuations with investors obviously banking on a recovery in the housing market. With the Fed actively monetizing $40 billion in mortgage-backed securities every month now that may help unclog and mobilize the existing inventory and keep the industry from collapsing further.

Home Depot


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The fact that the Fed put in place a specific program to jump start the housing market is prima facie evidence that the industry is still in serious trouble. I would be leery of both stocks at these multiples/yields and the real risk of a global recession in 2013. There are better ways to play a recovery created by QE in the consumer space as the market has already front-run the Fed with these stocks.

Disclosure: I 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.