5 Ways This Company Is Crushing The Competition

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

If there is one lesson to take away from Home Depot's (NYSE: HD) recent earnings, it's never underestimate a category leader. To say that the company's results were surprisingly strong would be an understatement. Home Depot essentially proved that their competition doesn't stand a chance against the leader in home improvement.

The category online retail isn't hurting
There are seemingly hundreds of articles written every day about how online retailers are killing physical stores. I read headlines suggesting that online is the end of the big box store, and that they can't hope to compete. Apparently no one told either Home Depot or their customers any of this.

The housing market has shown signs of life for several quarters, with companies like Toll Brothers, Lennar, and others reporting significant increases in their contracts signed, and their backlogs. When you combine the strength in the housing market with a recovering job market, Home Depot stands to benefit from both.

It might seem that Lowe's (NYSE: LOW) should benefit equally from this positive economic news, but the company has consistently underperformed their larger counterpart. Walmart (NYSE: WMT) has improved their tools, fixtures, and home improvement selection over the last few years. The company doesn't have the same breadth of product selection as Home Depot or Lowe's, but the convenience factor allows many customers to buy items for simple home improvement projects.

One of the biggest challenges Amazon.com (NASDAQ: AMZN) has in trying to crack the home improvement market is these are goods that contractors like to see before they buy. The weight of the products is another issue. It's one thing for Amazon to ship a television or smaller items. It's something quite different for Amazon to try and economically ship things like lumber, doors, windows, and more. Amazon's competitive advantage is fast shipping and pricing. Home Depot can match anyone on pricing, and with over 2,200 stores, why would a contractor wait for items to be shipped if they can get them right now?

Sales, sales, sales
Home Depot showed the strength of their brand in the last three months, with overall sales up 13.9% and same-store sales up 7%. When you look at their competition, it's hard to argue that anyone is doing better. Amazon reported faster general merchandise sales growth at 28%, but much of what Amazon seems to be selling are consumer electronics and other goods, not home improvement items. If you look at Best Buy and Sears Holdings reports, you can see they are both struggling in the consumer electronics area, and this is generally an area of strength for Amazon.

Lowe's has nearly the same opportunity for sales growth with over 1,700 stores, but the company just can't match Home Depot. In fact, Lowe's actually saw same-store sales increase just 1.9%, and overall sales were down 5%. While Walmart just reported a single-digit increase in sales, the company said it gained market share in electronics, toys, and grocery items, but home improvement wasn't mentioned.

3 benefits of generating massive cash flow
Home Depot leads its industry in efficiency as well based on their gross margin. In the current quarter, the company's gross margin was 34.89%. By comparison, Lowe's came close at 34.27%, but Walmart at 24.94% and Amazon at 24.13% aren't playing in the same ballpark. While it's true that Walmart and Amazon have broader selections, with different margins, this only increases the argument that Home Depot is a category leader. The bottom line is, Amazon and Walmart can't afford to match Home Depot's focus on the home improvement market.

One thing Home Depot's industry leading gross margin allows the company to do is generate free cash flow like none of their competitors. In fact, the company generated $0.07 of free cash flow from each dollar of sales in the current quarter. Again Lowe's came close at $0.05, but Walmart fell behind at $0.03. Unfortunately for Amazon investors, the company's heavy capital expenditures caused the company to report negative free cash flow during this same timeframe.

Of course, some companies generate huge free cash flow and just sit on it, not so with Home Depot. The company's 34% increase in their dividend might have been the biggest surprise of all. This far outpaced the 18% increase that Walmart just issued. With Home Depot yielding 2.19%, the stock now compares more favorably with Walmart at 2.57%. Again Lowe's is left behind with a 1.63% yield, and of course Amazon doesn't have the cash flow to pay a dividend.

This last quarter for Home Depot seemed to reaffirm that this is still a growth story. The company may have over 2,200 stores, but with an improving housing market and better jobs outlook this could be just the first of many positive surprises.

Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Home Depot, and Lowe's. The Motley Fool owns shares of Amazon.com. 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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