Home Improvement Vs. Discount Big Box: Where Are The Deals?

Includes: HD, LOW, TGT, WMT
by: Phil Lassiter

Home improvement big box retailers are in the limelight, while discount retailers like Target (NYSE:TGT) and Wal-Mart (NYSE:WMT) are trading at cheaper valuations. Contrarians should find this an amusing opportunity to buy defensive stocks at more attractive valuations than related cyclical stocks in the market's current euphoria.

Home Improvement Improving

Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) announced excellent results for the fourth quarter. Their positive results support the hypothesis that a housing recovery has already started. The store sales of both the companies increased, although the increase was more for Home Depot (4.6%) compared with Lowe's (1.4%). Home spending is expected to grow at a rate of 4% in 2013 (compared with 4.5% in 2012). Home sales are expected to increase by 7.7% while sales from single-family homes are forecast to increase at 22% in the year 2013. The growth in the sector will be constrained by slower growth in the U.S. Economy, moderately improved economic conditions. and tight bank lending.

Between the two companies the results of Home Depot were received more favorably. The net earnings of Lowe's actually fell to $288 million this quarter, as compared with $322 million in the same quarter last year. According to management of Lowe's the clearance sales of older merchandise are hurting profits. Analysts estimate the earnings per share for Lowe's to be $2.10 while the management's estimate for the same is $2.05.

Some of the analysts who are bullish about Lowe's stated that although the sales are encouraging, the margins of the company are a matter of concern. Management warned that the profitability of Lowe's would be constrained by expensive store improvements and hiring. Lowe's also announced a buyback program of $5 million that will be completed over the next two years. In comparison, Home Depot announced a buyback plan of $17 million, and increased its dividends by 34%. Home Depot raised the guidance of its earnings while it announced the fourth-quarter results. Due to better financials, many analysts recommend Home Depot as a bet on the recovery of home improvement business. The performance of the industry (home improvement) has been consistently increasing over the last six quarters.

Wal-Mart's Public Image

Meanwhile, back at Wal-Mart, investor sentiment is horrible, partly because of bad press. One of its more notable scandals involves alleged bribery in Mexico, which has tarnished Wal-Mart's already dubious image and stymies its ability to expand internationally. Allegedly state federal lawmaker, Graco Ramirez Garrido Abreu, now Morelos state governor, was the "the main contact person" to facilitate $156,000 in bribes to expedite store openings. A Wal-Mart summary of the accusations released January 10, by Representatives Henry Waxman of California, and Elijah Cummings of Maryland, revealed lawyer Sergio Cicero Zapata's accusations that he, while employed at Wal-Mart, used Ramirez to get needed permissions from the Urban Development Ministry faster.

Governor Ramirez's official website denied Cicero's allegations stating no relationship with Wal-Mart existed during the period in question.

Wal-Mart said it provided the documents to the Securities and Exchange Commission and Justice Department in cooperation with the agencies. Wal-Mart spokesman, Randy Hargrove, said, "There is nothing new in these documents. This information has been part of the company's ongoing investigation of potential violations of the U.S. Foreign Corrupt Practices Act for more than a year and has been the subject of two New York Times articles."

Some of the details in the documents stated that: Wal-Mart paid about $273,000 in bribes to local officials and power company managers to expedite construction projects; paid more than $117,000 in bribes to managers of Luz y Fuerza del Centro to facilitate installation of power for a distribution center; company lawyers were hired as consultants distributed cash envelopes worth around $156,000 to government regulators in Mexico City to hasten environmental permits to build new stores.

Being responsible for real estate issues at Wal-Mart's Mexican unit, Cicero alerted colleagues in the company's legal department regarding the bribery operations in September 2005, as revealed in the notes and emails included in the files.

Wal-Mart's consultants reportedly gave more than $97,000 to 7 out of 11 city council members in Teotihuacan, a famous archaeological site about 30 miles NE of Mexico City, and paid the president of the National Institute of Anthropology and History about $12,000 to secure approval for the store's location near a historical site. The NIAH however, declined to comment about Cicero's accusations.

A draft report of the 2005 audit made in response to Cicero's bribery allegations showed investigators found almost $13 million in suspicious payments listed as contributions or donations starting in 2003. While investigating the allegations, some Wal-Mart officials disclosed worries about their safety in Mexico. Ronald Halter, a former FBI agent and a member of Wal-Mart's investigators, noted that some security consultants hired by the retailer were pistol-whipped when they attempted interviews in the country regarding the company's real-estate deals.

The allegations prompted investors like CalSTRS (California Teachers' Retirement System) to sue Wal-Mart's board in Delaware state court alleging directors' failure to oversee its Mexican unit's operations and failure to disclose such questionable payments. Investors contend Wal-Mart could be liable under the FCPA and other anti-bribery laws relative to the alleged payments.

Declining Organic Revenues

Many discounters are facing weak sales. Canaccord Genuity analyst, Laura Champine, downgraded Big Lots (NYSE:BIG) based on declining same-store revenues. She wrote, "We believe the near-term picture is too cloudy to warrant a Buy rating."

Big Lots is not alone. Target also suffered declining same-store sales. Costco was a bright spot amongst retailers, with sales growth of 6% beating analyst expectations for 5.1% revenue growth.


The market has priced in the success of Lowe's and Home Depot as each company now is trading at about 23 times trailing earnings. In contrast, Wal-Mart trades at 14.4 times earnings and Target trades at about 14.7 times earnings. Among these companies, I view the more defensive and cheaper discount retailers as being the clear choice over the more cyclical and pricier home improvement retailers.

In Conclusion

Investors who did not already buy home improvement retailers should accept that they missed their opportunity. Instead of buying them at high multiples, investors should consider discount retail stocks. Target should top their lists because it is cheap, defensive, and is not clouded by the scandals that surround Wal-Mart.

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. I have no business relationship with any company whose stock is mentioned in this article.