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.

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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.

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

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