Lowe's and Home Depot: What's the Difference?

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Recent quarterly reports from two of the United States's largest home-improvement companies has drawn renewed attention to their apparently divergent fortunes. Despite nearly identical business structures, market geographies and penetration strategies, these two firms do not seem to be playing on a level field. According to its most recent report, Lowe's (NYSE: LOW) saw worse-than-expected sales and profit figures during the first quarter. Meanwhile, Home Depot (NYSE: HD) enjoyed a banner quarter and saw its stock hit an all-time high immediately following the release of its numbers.

Investors and market-watchers have a number of theories about this divergent performance. It is important to note that Lowe's has been kind to run-of-the-mill investors: Over the past few months, its stock has appreciated by about 20 percent. This compares to an increase of 30 percent for Home Depot. Investors who wish to gain exposure to the home-improvement space would do well to compare these two firms to another well-known competitor in the industry.

Lowe's: Recent Moves and Price Performance

Over the past two years, Lowe's has more than doubled in value. In theory, the company stands to derive immense benefits from continued improvement in the housing and commercial real estate sectors. Although the company has issued solid earnings reports for much of this time period, it is fair to say that some of its run-up was due to investors' expectations of secular tailwinds.

Lowe's lackluster earnings report can be attributed to some long-planned adjustments to the firm's business model as well as to geographical and weather-related quirks that may have benefited Home Depot during the past quarter. While the firm's management ranks have been stable for some time, Lowe's is in the process of changing the type and frequency of sales that it offers. It is also adjusting some important re-stocking and warehousing protocols. Market-watchers and company officials have speculated that these changes have caused confusion and inefficiency among rank-and-file store employees. However, this is not an existential issue: As the changes work their way through the corporate ecosystem, their top-line impact should lessen.

What About Home Depot?

For its part, Home Depot may have benefited from its outsize presence along the West Coast and in the American Southwest. Whereas historical Lowe's strongholds in the Midwest and South saw an unusually cold late winter and spring that delayed the start of the home-improvement season, the West Coast experienced unusually warm temperatures and sunny weather that conspired to jump-start the building season. Although this thesis cannot explain all of the issues that afflict Lowe's, it could account for some of its problems. If it is correct, the company should have a better third quarter.

Of course, improved performance on the part of Lowe's will not change the fact that Home Depot appears to be in a better position at the moment. Despite its expensive valuation, Home Depot may be a safer pick for investors who worry about the staying power of the U.S. housing recovery.

Can Sears Compete?

Charlotte-based Lowe's and Atlanta-based Home Depot must compete with a still-formidable force in the retailing and home-improvement businesses: Chicago-based Sears Holding Corporation (NASDAQ: SHLD).

When it comes to market capitalization, Home Depot dwarfs its two competitors. The company's valuation of nearly $120 billion exceeds the figure for Lowe's by a factor of 2.5 and crushes Sears's valuation by a factor of 20. In 2012, Home Depot earned a profit of about $4.5 billion on revenues of nearly $75 billion. Lowe's managed a profit of around $2 billion on revenues of $50 billion, and Sears reported a $930 million loss on total revenues of about $40 billion. To complement its poor earnings performance, Sears also reported an annual operating cash bleed of over $300 million. This compares to operating cash flow figures of nearly $7 billion for Home Depot and about $3.8 billion for Lowe's. Unsurprisingly, Sears has a price-to-book ratio of just 2.3. By comparison, Home Depot's price-to-book figure exceeds 6.5. Lowe's has a middling P/B in the neighborhood of 3.4.

Industry Outlook

Overall, the state of the home-improvement industry continues to improve. While it may be premature to call the future "bright" for companies like Lowe's and Home Depot, it is clear that well-run retailers have a place in the portfolios of value-minded investors. As existing home sales increase, more and more Americans will need to make significant outlays to refurbish and update their homes in preparation for listing. At the same time, small-scale commercial home builders and contracting companies that source many of their materials at Lowe's and Home Depot will increase the frequency and scope of their trips to these stores.

Invest or Stay Away?

Given all of the factors that favor the home-improvement space, investors have every right to look seriously at these two companies. In the end, the final buying decision is likely to come down to price: Lowe's still appears fairly cheap compared to its larger rival. With both companies offering yields of about 1.5 percent, investors may wish to bet that Lowe's can recover from its recent hiccup and post better-than-expected numbers in the coming quarters. Likewise, market-watchers might determine that Home Depot's stock price is ripe for a period of consolidation after hitting fresh all-time highs.

However, every investor's calculation is likely to be different. Both of these companies offer clear value. Moreover, they're well-positioned in an industry that looks poised to grow. Although there are no "sure things" in the world of investing, Lowe's and Home Depot both appear to be on the right track.

Mike Thiessen has no position in any stocks mentioned. The Motley Fool recommends Home Depot and Lowe's. 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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