Home Improvement Retailers: 6-Month Rematch

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

Six months ago, when I first began writing for financial websites, I began a series of articles comparing two companies in the same industry, in order to determine which I felt was the better buy at the time. The first of these articles included Home Depot and Lowe’s.

Back then, the housing recovery was just starting to turn the corner, with new evidence of confidence popping up in every suburb as new housing starts.  At that time, I called both companies a Buy, with a year-end 2013 target price of $67 for Home Depot and $47 for Lowe’s. I concluded that while both companies offered terrific growth potential, Lowe’s had more share-price upside.

Since then, the housing market has exhibited a few more positive signs. September housing starts were greatly improved over August’s, and August figures were up nearly 30% year-over-year. And September’s new homes sales figures were the highest in two years.

Although Robert Shiller, professor at Yale University and co-founder of the S&P/Case-Shiller housing price index, is urging caution when reading the numbers. In an interview on Bloomberg Television’s “In the Loop” with Betty Liu on Tuesday, Shiller said, “There are positive signs; the problem is that … it’s not a resounding recovery.”

In other words, while the housing market is starting to recover, it still has a lot of ground to make up. And that makes it the perfect time to get in on the ground floor (pun intended!)

Both Home Depot (NYSE: HD) and Lowe's (NYSE: LOW) are reporting their 3Q 2012 earnings this month: Lowe's on Monday, November 19, and Home Depot reported Tuesday before the bell. Home Depot reported earnings that beat analyst estimates by 5%, and raised guidance for 4Q as well.

“Sales were considerably higher than we had anticipated,” said Chief Financial Officer Carol Tome in an interview. “The whole store performed better than expected.”

Home Depot, six months ago, was trading at $50 per share. After the 4% jump on Tuesday’s excellent earnings release, causing the stock to hit a new 52-week high, it is now trading slightly off that at about $61 per share.  This is an increase of 22% in the past six months, since I recommended it.

Analyst opinion is still good, with a mean of 2.1 (1.0 being Strong Buy, 5.0 representing Sell). Of the 30 analysts covering the stock, 9 recommend a Strong Buy, 10 a Buy, and 12 a Hold, with no Underperforms or Sells. The mean target price for Home Depot is $61.96, which is just above the current price. The FY2012 (January 2013) consensus earnings is 23% higher than actual FY2011, and FY2013 consensus is 12% higher than FY2012. . The estimate of annual growth for the next 5 years is 15.09%.

With a PE of 21.8, this puts the price of stock at $66.05 for year-end 2012, and at $73.90 for year-end 2013, a terrific 20% potential return by the end of 2013.

My original estimate for the end of 2012 was $59.36, which Home Depot has already achieved, and $67.12 for the end of 2013.

Lowe's is currently trading at about $32 per share, just slightly off its 52-week high of $33.63 reached last week. This is a 7% increase from six months ago.

Analyst opinion of Lowe’s is similar to that of Home Depot, if a tad more conservative. A mean of 2.3, with 6 Strong Buys, 9 Buys, 12 Holds, and 1 Underperform. The mean target price is $32.55, which is the current price. The consensus earnings for FY2012 (January 2013) consensus is exactly the same as FY2011, and FY2013 is 22% higher than FY2012. Annual growth for the next 5 years is estimated at 15.0%.

With a PE of 21.2, this puts the stock price of Lowe's at $35.19 by year-end 2012, and at $42.82 by year-end 2013, a 34% potential return from today. However, I note that those numbers are actually much reduced from when I calculated them six months ago, when I anticipated a year-end price for Lowe’s of $38.71 and a 2013 price of $47.20.

Six months ago, I said that both companies were a Buy, but that I anticipated more share-price growth from Lowe’s than from Home Depot.  With today’s information, I am reversing my position.

Home Depot’s performance over the past six months has exceeded my forecast, and I will stick with the industry leader as the economy continues to improve and the housing market returns to normal.

Home Depot noted in their earnings conference call on Tuesday that the upward guidance for 4Q does not include any Hurricane Sandy-related activity. The recent devastation caused by Hurricane Sandy, while tragic and horrendous in many ways, also means a great deal of rebuilding in the New York/New Jersey area, where Home Depot has an incredibly strong presence. Not only did the retailer reap the benefits of the pre-storm preparations (plywood for boarding up windows, etc.), but it will be one of the main sources of materials for the recovery effort.

The housing sector is on fire this year, with the Housing Sector Index (HGX) up 51% YTD. Homebuilder stocks are also hot, and that means building materials are in demand.

In its 2nd Quarter results, Lowe’s reported dismal numbers in comparison to Home Depot, and acknowledged the fact that it continues to lose share to Home Depot. I frankly don’t expect that to change in the upcoming Lowe’s earnings release set for next week.

Home Depot is the leader in the category, with the best profit margins and the greatest number of stores. As the housing climate improves and the economy continues its road to full recovery, Home Depot is poised to capitalize on increased spending in the building sector, while Lowe’s seems to be treading water.

 I am placing a year-end 2013 target price of $75 on Home Depot shares.

 


khern0203 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend The Home Depot and Lowe's Companies. 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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