Home Depot vs. Lowe's: Focus on Profitability

Includes: HD, LOW
by: Saj Karsan

Too many investment decisions are made with a blind bias towards choosing the company with the most market share. But profitability is what investors should be looking for, not market share.

In this article by Todd Sullivan, Sullivan suggests that to avoid losing market share, Home Depot (NYSE:HD) desperately needs to invest all its savings into remodeling old stores to get the stores on par with Lowe's (NYSE:LOW). It's quite possible that this would increase profitability, but the argument is unconvincing, as it relies on no profitability data whatsoever.

In this article, we examine the data between these two companies in order to determine the relative strengths and weaknesses of these two home improvement retailers, in order to give us hints into what each company could be doing better.

Because Home Depot is much larger than Lowe's, on the revenue side it makes sense to compare these retailers on a sales/sqft basis. In this article on Build-a-Bear, we showed a chart listing the sales per square foot of several retailers. Here is that chart reproduced below, but isolating for the two home improvement behemoths:Of course, this is only the sales side and doesn't necessarily transform into profitability. After all, it's quite possible that Home Depot is selling the same goods as Lowe's, but for cheaper, and therefore making a smaller profit on each sale. So let's take a look at the companies' gross margins:

Indeed, we do see (from the gross margin percentage) that Lowe's is able to mark-up its products more than is Home Depot, somewhat making up for the lower sales numbers. Nevertheless, we still see (above) that Home Depot makes a larger gross profit per square foot, after taking into account their higher sales per square foot.

But we're not done here. If Home Depot advertises more than Lowe's, or spends more on training or giving their stores visual appeal, they may still prove to be less profitable, so let's take a look at general, administrative and depreciation expenses as a percentage of sales: last fiscal year, these expenses represented 24.2% of sales for Home Depot, and 24.9% for Lowe's.

The result, all said, is that Home Depot actually makes a few bucks more per square foot than does Lowe's. Now, this was just an initial glance at the two companies, and is far from perfect. Being the larger company, Home Depot should benefit from economies of scale, but as Lowe's catches up in size, we may see their margins improve. Also, being the older company, Home Depot may be benefiting from having better locations, which will cost them on lease renewals in the future or tie up capital for owned locations. Furthermore, we haven't even begun to consider the capitalization structures of these companies in order to determine whether shareholders are getting the best bang for their buck.

However, at least it's a start. This is far better than jumping to conclusions on anecdotal data that Home Depot must spruce up all its stores, improve its lighting, better train and better pay its employees. Home Depot's plan of closing its least profitable stores, slowing down new store openings, and refurbishing certain stores could result in better profitability without the huge overhaul that many are calling for. We'll find out soon enough!

Disclosure: Author has a position in both HD and LOW