Now that the "great retrenchment" in consumer spending has been going on for a couple of years, are shoppers itching to cast aside survivalist shopping at Wal-Mart (NYSE:WMT) and return to the likes of Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) to buff up their houses?
Although one quarter does not prove a thing, Home Depot and Lowe's both did something this week that they have not done in almost four years each - they posted positive same-store sales growth for a full quarter. Perhaps, then, this is the renaissance of two of America's most successful retail concepts.
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The Quarters That Were
Home Depot seems to have won the race for first-quarter results. Big Orange posted overall revenue growth of 5.7%, with U.S. same-store sales rebounding 3.3%. By comparison, Big Blue (well, the "other" Big Blue) had overall revenue growth of 4.7%, but U.S. same-store sales growth of 2.4%. Lowe's seemed to have a slight edge in big-ticket spending, but both companies saw improved traffic during the quarter.
Down the line both companies continued to post better results, but Home Depot appeared to be the stronger of the two on a relative basis. Gross margins improved 70 basis points at Home Depot, while dropping 30 basis points at Lowe's. On an absolute basis, though, Lowe's was stronger at 35.2% versus 34.4% at Home Depot. Big Orange likewise showed better growth in operating margins (160 basis points versus a 10 basis point drop), and a higher overall number at 7.7%. (For related reading, check out Analyzing Operating Margins.)
Where to Now?
Given that Wal-Mart has over 4,000 U.S. locations for its various concepts, there is probably still some room for both Home Depot and Lowe's to continue building stores in America. That said, the real battle is heading overseas, with both Mexico and China likely to be areas of strong growth. Lowe's just recently opened its first stores in Mexico, while Home Depot has already begun expanding its overseas operations.
If it turns out that most of the U.S. territory has been staked, that raises interesting questions about how the two companies will compete. While they focus on leveraging their logistics and buying power to further marginalize smaller hardware competitors like the retail cooperatives Ace Hardware and True Value? Will they expand their niches to take on the likes of Tractor Supply (Nasdaq:TSCO)? Will they focus on picking off customers from home-retailing dabblers like Target (NYSE:TGT) and Sears (Nasdaq:SHLD)? Or will they simply try to beat each other into the ground using price competition as blunt weapons? Given that these two companies know what is at stake, I would say this last idea is the least likely.
Orange Over Blue
I find it interesting that analysts seem to be more conservative towards Home Depot than Lowe's. Looking at the estimates out there, there seems to be a general sense that Lowe's will not being spending much on CAPEX (new stores), while Home Depot may resume a more normal course of spending. Given that extensive store building is a prime reason why Lowe's cash flow yield trails Home Depot's, I find that to be an interesting forecast. That suggests to me, then, that Home Depot either stands to benefit from higher expected growth (assuming most of those new builds are overseas), or better-than expected cash flow growth. Either way, it is another argument in favor of Home Depot.
Home Depot has a slightly better record of returns on capital and I like the company's overseas plans, as well as its second-mover advantage in cherry-picking those logistics advances of Lowe's that seem best for them. In either case, though, a recovery in consumer spending is likely to lift both boats and neither looks terribly expensive today.
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