Editor's note: All figures as of April 17, 2017, unless otherwise stated.
Building season picks up in the United States each year as the weather gets warmer and tax refunds are deposited into bank accounts. The Home Depot, Inc. (HD) and Lowe's Companies, Inc. (LOW) are two well-known retailers that span the nation and are heavily influenced by home building activity. Both companies sell directly to builders and also have significant exposure to do-it-yourself remodeling, home improvement, landscaping and gardening. Therefore, it makes sense to examine the operations and valuation of these peers at the onset of their busy season.
Both companies have a similar number of stores, but Home Depot is a larger company. Home Depot has more employees and nearly 50 percent more annual revenue, and its market capitalization is $100 billion higher than that of Lowe's. This scale discrepancy can distort some head-to-head comparisons, and it is essential context for evaluating these rivals. (See also: Better Buy: Home Depot or Lowe's?)
Home Depot and Lowe's have both grown steadily since the financial crisis, with top-line expansion generally accelerating through the present. The retailers have traded positions as to which is the faster grower, but Home Depot notched a comparable-store sales growth rate that was 140 basis points higher in fiscal 2016. Analysts are also more bullish on Home Depot's two-year sales outlook. Both companies are expected to achieve double-digit earnings per share (EPS) growth over the next five years, although Lowe's has a 330 basis point edge in analyst forecasts. (See also: Lowe's Marching Ahead of the Industry: What's Behind Rally?)
The retail chains have gross margins that are similar and stable. Lowe's maintains a 40 basis point edge on this line and has bested Home Depot in nine of the past ten years. Gross margin for either company has only left the range between 33.5 percent and 35 percent one time in the past decade. Despite lagging slightly on gross margin, Home Depot's operating margin is five percentage points higher, and that gap has grown every single year since 2009. This has helped drive Home Depot's operating income, which is nearly 2.5 times higher than that of Lowe's.
Home Depot also achieves superior efficiency metrics. The company's asset turnover of 5.11 bests its competitor's 1.98. This is largely driven by superior inventory turnover. Home Depot's inventory turns stand at 5.11 versus Lowe's at 4.27. Home Depot has consistently held this advantage since 2008. The discrepancy can be attributed heavily to higher revenue per square foot. Superior efficiency leads to higher return on assets for Home Depot, and the difference in return on equity is even larger because Lowe's relies far less on debt financing. (See also: How Is Asset Turnover Calculated?)
Home Depot's capital structure is significantly more debt-intensive, and its equity multiplier is nearly double that of Lowe's. This creates more risk for Home Depot equity holders in the case that a catastrophic event or a protracted lean period were to cripple the company. However, Home Depot has higher liquidity ratios, which are important to monitor to assess risk in the case of severe short-term shocks. Neither company's financial health ratios indicate exceptional financial risk, but these are nonetheless important metrics to monitor. (See also: Liquidity Measurement Ratios.)
Valuation analysis reveals a mixed bag, depending on which aspect investors choose to focus on. Home Depot is more expensive relative to book value, forward earnings and free cash flow. The discrepancy in PEG ratios is especially stark if consensus estimates are used in the calculation. Lowe's is also slightly less expensive on an enterprise-value to EBITDA basis. Home Depot has a materially higher dividend yield, and its dividend growth rate implied by the Gordon Growth Model is slightly lower, assuming analyst estimates are valid. (See also: Dividend Hike on the Way at Home Depot.)
Overall, Home Depot has delivered superior performance in terms of profitability, efficiency and recent growth. It also carries a superior dividend yield for the time being. However, Lowe's trades at a discount on several valuation metrics, and analysts are more bullish about its EPS growth prospects. Both companies are enjoying strong fundamentals as the U.S. economy improves, and their results will likely be dictated largely by cyclical forces moving forward. (See also: Home Improvements That Really Pay Off.)