It turns out that there wasn't room for two big-box retailers in book retailing or electronics, but that may not be the case in hardware and home improvement retailing. Neither Home Depot (NYSE:HD) nor Lowe's (NYSE:LOW) are showing the same sort of troubles as Barnes & Noble (NYSE:BKS) or Best Buy (NYSE:BBY), perhaps because so many of the goods they sell make little sense as online orders.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

While there may be room for two, it seems like Home Depot and Lowe's are fated to play a lifelong game of leapfrog. Home Depot has solved many of the problems that drove away customers and is now trying to drive better savings through logistics. On the flip side, Lowe's looks like it's in the middle of a problem-solving store reset program, and its performance is lagging.

Q1 Results Should Have Been Better
This should have been a strong quarter for Lowe's. Mild weather drove customers to the shops across the retail segment, and it looks as though the combination of better weather and some stability in the housing market pushed more maintenance and renovation activity.

Unfortunately, Lowe's didn't seem to come through. Revenue rose nearly 8% this quarter, but comparables were up just 2.6%. Not only was this lower than the 4% or so expected by most analysts, this was the easiest comp of the year for the company (last year was down 3.3%), Home Depot delivered a very strong result, and rivals like Walmart (NYSE:WMT) and Sears Holdings (Nasdaq:SHLD) continue to be relatively weak.

Margins were a mixed bag too. Gross margin declined 75 basis points this quarter, which was not only directionally worse than Home Depot, but also a little weak relative to most sell-side expectations. Operating income performance was a little better - operating income rose 16% on good SG&A control and though Lowe's trails Home Depot in operating margin as well, the relative performance was a little better here.

SEE: Analyzing Operating Margins

2012 Should Be an Interesting Year
Lowe's is not only trying to refurbish its stores (new end caps, signage, etc.), but it's also looking to rebuild its everyday low price strategy. At the same time, both Home Depot and Lowe's are trying to find that sweet spot between building their own private label brands and stocking the "leading brands" that shoppers want.

All of this is happening against a retailing and housing market that can be charitably called "challenging". With shoppers looking for bargains, it's worth asking if Home Depot's relatively better sales were a product of geography (relatively more stores in stronger regions), or pricing and promotion. Looking at the full year, while analysts and investors are feeling better about tool and building material companies, there's still a lot that can go wrong and Lowe's performance and guidance doesn't erase the risk that this quarter saw a lot of sales pulled forward.

The Bottom Line
Home Depot is showing stronger margins and stronger sales, has a better international growth story, and a better history with respect to return on capital. Yet Lowe's is the stock that looks cheaper today. Even if Lowe's cannot close the gap on Home Depot in terms of free cash flow conversion, the stock looks about 25% undervalued if the company can grow its free cash flow at a compound rate of 5% over the next decade. While that degree of undervaluation is interesting, value investors should realize that lagging same-store sales growth could weigh on these shares for a few more quarters.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  2. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  3. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  4. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  5. Investing News

    The UAE: An Emerging Economy for Investors

    The learning from UAE on how it succeeded with timely diversification when the BRICS nations and the neighboring oil-rich economies faced challenges.
  6. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  7. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  8. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  9. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  10. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center