There's a Reason Lowe's is in Second Place

By Chad Henage - September 4, 2012 | Tickers: HD, LOW, TGT, WMT | 0 Comments

• Email
• Print

I'll be honest, for me personally, Lowe's (NYSE: LOW) has offered a better shopping experience than Home Depot (NYSE: HD). The problem is all of the reasons that Lowe's is better for me are reasons that the company is losing the battle to its major competitor. Lowe's presents itself as a less intimidating, more consumer friendly store than Home Depot. The problem is, weekend warriors only get you so far, and contractors still apparently think of Home Depot first. The good news is, Lowe's still produces a lot of cash even coming in second place. The bad news is, to compete more effectively the company needs to make a few changes.

The Weekend Warrior vs. The Pro:

I'll give an example of my personal experience with each store, and show you why Lowe's is probably losing out. I'm handy to a point, I can make simple repairs, but I know when I'm in over my head. Case in point, I decided to build a pantry in our kitchen a few years ago. I went it alone and while it got done, it took me multiple weeks. Where did I get most of my supplies? I bought them at Lowe's. The reason is, my local Lowe's store is less busy than Home Depot (investors take note), and I can get in and out of the store without being accosted by salespeople. However, when I get help from my father-in-law on projects, he prefers Home Depot. He was a pipe-fitter for over 35 years and he knows his way around a project. When he and I have been into Lowe's, though overall the experience has been good, he's found more knowledgeable staff at the local Home Depot (investors take note again). The point is, for a less experienced weekend warrior like me, I prefer Lowe's. For my father-in-law who knows a heck of a lot more than I do, he prefers Home Depot. While I'm sure there are counter arguments that some might make, the results of the two companies bear out that this same experience is happening across the country.

Lowe's is Good, Home Depot is Better:

Lowe's showed sales down 2%, Home Depot showed sales up 1.7%. Where Lowe's reported comparable store sales down 0.4%, Home Depot reported comps. up 2.1%. What's the most convincing evidence that Lowe's needs to make a change? Home Depot sold an average of $9.12 million worth of goods per store in the last quarter. Lowe's in this same timeframe sold about $8.13 million. When your primary competitor has 510 more stores than you do, and each store sells almost $1 million more than yours, there is a problem.

The Financials Are a Mixed Bag:

Lowe's financials would make the average investor wonder what's going on. The company made positive moves in the last year retiring shares at a furious rate. In fact, the company has retired over 9.3% of their diluted share count. Lowe's also is continually increasing its dividend, and in the last six months paid out just 15.67% of its free cash flow in dividends. The company also increased its cash and investments by over $1 billion. The problem is, while cash and investments went up, long-term debt increased even more by $2 billion. Though free cash flow was impressive, operating cash flow decreased by over 15%. Lowe's also saw their gross margin drop from 34.49% last year to 33.93% this year.

Competition and What Should Lowe's Do:

Lowe's faces multiple competitors besides Home Depot. The company also must fend off competitors such as Wal-Mrt (NYSE: WMT), which offers paints, tools, and small hardware items. Since customers visit Wal-Mart on a much more frequent basis than Lowe's, it's likely the company is losing some market share to the world's largest retailer. Though Wal-Mart doesn't offer nearly the same size selection as Lowe's, if it's a simple paint or repair project, the familiarity of a local Wal-Mart store is likely to be less intimidating than walking into a Lowe's and trying to find what you need.

This same issue affects Lowe's when it comes to stores like Target (NYSE: TGT). Target has made somewhat of a name for itself by offering a small home improvement selection, but also a better selection of home furnishings. As a personal example, my household has bought storage bins, baskets, air filters, small hardware, and other items that we could have bought at Lowe's. The reason we didn't is we were already in Target and making a separate stop didn't make sense. This is the bottom line for Lowe's, the company needs to decide who it is catering to. If the company wants to cater to the weekend warrior, they must stock a greater selection of goods that customers might buy at their local Target or Wal-Mart. Items like cleaning supplies, small furniture items and the like. If Lowe's is aiming to be a direct competitor to Home Depot's contractor stranglehold, the company needs to eliminate some of the frills that contractors are not buying. In short, Lowe's needs to make a choice.

Conclusion:

For investors it's not really a question of, is Lowe's a good investment. I believe there is room for both Home Depot and Lowe's to be successful. However, Home Depot right now is turning in the more impressive results. Analysts currently expect Lowe's to outgrow Home Depot slightly over the next few years. If Lowe's continues on its current path, I don't believe this will happen. Home Depot is simply more efficient and the much higher sales per store speaks to this competitive advantage. Both companies have similar yields, but as long as this competitive advantage exists at Home Depot, not only is the company number one in home-improvement, but the shares should continue their outperformance as well.

• Email
• Print
• Feedback