Which Stock Is Best in the Home Improvement Space?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Here’s a recent trend worth noting: Shares of Restoration Hardware (NYSE: RH) have fallen 9% in the last month, while Lumber Liquidators (NYSE: LL) has risen 18.5%. Both stocks have seen one-year gains of 120%, but why have the two stocks separated as of late, and is this trend indicative of what may come next?

An Earnings Catalyst

While Lumber Liquidators’ one-month gains are large, more than 6% of its gains came on Wednesday after earnings. In the quarter, Lumber Liquidators posted a 22.2% rise in revenue year-over-year, to $257.1 million, beating expectations by $13.7 million. Moreover, its EPS of $0.73 beat the consensus by $0.13, as net income increased more than 67% over the prior year.

Lumber Liquidators’ quarter was solid. Not only were their headline numbers strong, but gross margins rose 400 basis points and comparable sales growth increased 14.9%. Overall, Lumber Liquidators has emerged as a home improvement contender, and a long-term threat to the likes of Home Depot and Lowes.

The Most Important Retail Metric

Restoration Hardware’s business model is similar to Lumber Liquidators', but there are differences. Restoration Hardware is a home improvement company, but is the Michael Kors of the space, meaning it’s mostly luxury home improvement. Due to the continued strength of the economy’s 1%, luxury improvements is growing rapid, and Restoration Hardware is living proof.

While Lumber Liquidators’ revenue growth was over 22%, its near 15% rise in comparable sales shows that much of Lumber Liquidators' growth has been due to the expansion of new stores. Restoration has revenue growth of 38%, and comparable growth of 41%. This shows that all of Restoration’s growth is coming from its existing stores, not the inclusion of new stores. Such growth is unprecedented, and signals that Restoration Hardware still has many quarters of explosive existing store growth and can accelerate growth with the addition of new stores.

In retail, comparable sales is golden, and is the best metric for identifying strength. A retail company can easily expand its stores to boost revenue, but comparable expansion shows that more consumers are coming into existing stores, which also boosts margins. With that said, Lumber Liquidators’ comp growth is very strong, but is tiny relative to Restoration Hardware.

A Look at Next Year

Looking ahead, both companies have given detailed guidance and are expecting solid growth. Take a look at full-year guidance and how it compares to last year

<table> <thead> <tr><th> </th><th> <p><strong>Lumber Liquidators</strong></p> </th><th> <p><strong>Restoration Hardware</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Revenue/Growth Year-over-Year</p> </td> <td> <p>$951 million/ 17%</p> </td> <td> <p>$1,491 million/ 25%</p> </td> </tr> <tr> <td> <p>Comparable Sales Growth</p> </td> <td> <p>High single/low double digits</p> </td> <td> <p>25%</p> </td> </tr> <tr> <td> <p>Earnings per diluted share (EPS)</p> </td> <td> <p>$2.52</p> </td> <td> <p>$1.74</p> </td> </tr> </tbody> </table>

Clearly, you can see that Restoration is growing revenue and comparable sales considerably faster, despite being the larger company. However, if Restoration Hardware is the more expensive of the two then it could explain why it has fallen while Lumber Liquidators has risen as of late.

Here are price/sales and P/E ratios based on guidance for both company’s current market capitalization. Keep in mind, faster growing companies almost always trade with larger premiums to fundamentals.

<table> <thead> <tr><th> </th><th> <p><strong>Lumber Liquidators</strong></p> </th><th> <p><strong>Restoration Hardware</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Market Cap</p> </td> <td> <p>$2.53 billion</p> </td> <td> <p>$2.59 billion</p> </td> </tr> <tr> <td> <p>Price/2013 Sales</p> </td> <td> <p>2.66</p> </td> <td> <p>1.73</p> </td> </tr> <tr> <td> <p>Forward P/E Ratio</p> </td> <td> <p>36.52</p> </td> <td> <p>36.03</p> </td> </tr> </tbody> </table>

Here Are the Facts!

It doesn’t matter how we spin it, the bottom line is that Restoration Hardware and Lumber Liquidators trade with a near identical market cap, yet Restoration Hardware is growing revenue and comps faster and is cheaper relative to sales with more expansion opportunities.

In my opinion, based on the facts, Restoration Hardware is the clear winner. Restoration trumps Lumber Liquidators in all relative metrics and has significant room to improve its operating margins. Therefore, while I believe that Lumber Liquidators is deserving of its valuation, Restoration Hardware is particularly undervalued, and is worth your due diligence. 

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Brian Nichols owns RH. The Motley Fool recommends Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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