Amazon Fallout: Home Depot Vs. Lowe's

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Includes: AMZN, HD, LOW, SHLD
by: Mat Litalien

Summary

Amazon's deal with Sears has caused both Home Depot and Lowe's share price to dip.

Home Depot is less exposed if the Amazon deal does impact future appliance sales.

At today's price, Lowe's appears to provide better value for investors.

Amazon (AMZN) has been wrecking havoc on the retail landscape lately and their most recent partnership with Sears (SHLD) to sell Kenmore appliances may have provided investors with new buying opportunities in both Home Depot (HD) and Lowe’s (LOW). The question for investors is which one to buy after the most recent dips?

APPLIANCE FALLOUT

Let’s start with what caused the stocks to dip in the first place. Let's assume that Amazon’s deal with Sears has a bigger impact than feared on both Home Depot and Lowe’s appliance sales. Who stands to lose the most? As of end of the 2016 fiscal year, the appliance category accounted for 7.4% of net sales at Home Depot. At Lowe’s, appliances accounted for double digit share at 11% of net sales.

Advantage: Home Depot

PRICE TO EARNINGS (P/E) RATIO

One measure I like to use when evaluating companies is the P/E ratio. As per the F.A.S.T. Graph below, Home Depot is currently trading at a discount to their historical P/E ratio and as such can be considered undervalued.

Lowe’s F.A.S.T. Graph chart is almost identical than that of Home Depot’s and the company is also trading at a discount to their historical P/E ratio.

Advantage: Lowe’s. Although it’s a close call, Lowe’s edges out Home Depot as they are trading at an 18% discount to their historical P/E as opposed to Home Depot’s 11.7% discount.

GRAHAM NUMBER

Another test that I utilize quite frequently is to determine whether or not the stock is trading at a discount to their Graham Number. As of writing, Home Depot is currently trading at 549% premium to their Graham Number of $22.29 and as such can be considered significantly overvalued. Lowe’s is also significantly overvalued based on this metric, as it is currently trading at a 216% premium to their Graham Number of $21.50.

Benjamin Graham believed in principle that stocks should not trade at a P/E above 15 and a P/B of 1.5. Keep in mind that this notion is quite simplistic and does leave out many fundamental characteristics but I do find it of value as part of a broader analysis.

Advantage: Lowe’s

GROWTH POTENTIAL

Now that we have looked at a couple of historical valuation metrics, let’s take a look forward and see how their earnings stack up to future growth. Here are analysts’ earnings estimates and company EPS growth outlook:

HD

LOW

Analysts' 2018

12.20%

19.07%

Analysts' 2019

12.23%

16.60%

Analysts' 5YR

12.98%

15.68%

Company 1YR Outlook

11%

7.8%

Both companies are expected to grow at a pretty good pace over the next few years. What I find interesting is that Home Depot’s outlook is in line with analysts' estimates, whereas analysts' estimates for Lowe's far exceed the company's outlook. Of note, Lowe's has missed analysts' earnings estimates in 3 of the last 4 quarters. As such, I believe it is prudent to utilize both Home Depot's and Lowe's outlook to calculate their PEG ratio. Home Depot’s PEG ratio comes in at 1.93, while Lowe’s PEG ratio is 2.2. Regardless, both companies appear overvalued as a PEG ratio greater than 1 typically signifies that a company’s earnings is not keeping up with its share price.

Advantage: Home Depot

DIVIDENDS

As a dividend growth investor, it is important that companies show a commitment to growing their dividend. Here is how their dividend growth rates stack up:

HD

LOW

1YR

16.9%

23.5%

3YR

20.9%

22.8%

5YR

21.6%

20.3%

10YR

15.1%

22.9%

Of note, Lowe's is a Dividend Champion having raised dividends for 55 consecutive years, which some also refer to as a Dividend King (50+ years of dividend growth). Home Depot is currently a Dividend Challenger with a modest 8-year streak of raising dividends. Future dividend growth also appears to be promising for both companies as they have respectable payout ratios. Lowe's current EPS payout ratio is 51.4% and their payout ratio as a percentage of free cash flow in 2016 was 49.6%. Home Depot's current EPS payout ratio is 52.3% and their payout ratio as a percentage of free cash flow in 2016 was 47.4%.

Advantage: Lowe’s

LOWE'S EDGES OUT HOME DEPOT

Both Lowe's and Home Depot have performed well over the past few years and despite the Amazon deal, both companies should continue to perform well moving forward. Despite the dip, there are cases to be made that both companies are still trading at high valuations.

At today's share price, I would lean towards an investment in Lowe's over Home Depot. Although Lowe's is at greater risk of the Amazon threat, I do believe those threats are overblown and others agree. They appear less overvalued than Home Depot, and are trading at a greater discount to their historical P/E ratio. Likewise, if you believe that Lowe's future earnings will be more inline with analysts' estimates, then on a PEG basis, Lowe's would be closer to undervalued with a PEG of 1.10 using the 5YR long-term growth estimates. Finally, as a dividend growth investor, Lowe's dividend growth and history far exceeds that of Home Depot and they both appear to have similar dividend growth prospects moving forward.

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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.