Which of These 3 Home Improvement Companies Is the Most Secure?

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

With the housing market on the rise, companies in various sectors are set to profit. One of those industries is home improvement, and analysts have good reason to be optimistic about the following three companies. As people move into new homes, and as new houses are built, homeowners will need to renovate, and that means major profits for these three firms. 

I think the housing market is on the recovery, despite the housing start permits reaching a 10-month low in June after climbing by 6.8% in May. However, bad weather was blamed, and I don't see the decrease as a trend. This year is still up about 26% from 2012. 

Lumber Liquidators increases profit margin

Lumber Liquidators (NYSE: LL) is set to earn major profits from the housing recovery. In fact, it reported a 68% increase in quarterly profit over the previous year when it filed earnings on July 24. Much of that was due to lower expenses, as revenue rose just 22% (which is significant, but significantly less than the previous 68% profit increase).

The company's ability to lower operating expenses tells me it can continue to increase profits. After all, company expenses are much more controllable than sales, as they aren't completely at the mercy of the economy's well-being.

Furthermore, those expenses were controlled even though the company opened seven new stores in the quarter. That comes as a relief, because Lumber Liquidators plans to open between nine to 13 more stores by the end of the year, according to Times Dispatch. Lowering expenses during a time of corporate expansion is a major accomplishment.

Lowe's is at the mercy of the housing sector

Lowe's (NYSE: LOW) is the second-largest home improvement store chain -- it operates 1,755 stores. Unlike Lumber Liquidators, it has stable expenses, which is not good. The profit margin has been around 4% over the last four years, and that shows the company isn't optimizing operations.

An inability to increase the profit margin makes the company completely vulnerable to consumer spending power and the housing market's health. For now, the company will do well, because of the overall recovery of the housing market. However, I consider this stock to be risky because it could run deficits given any fall in the housing market -- whereas a company such as Lumber Liquidators will be able to cushion lower sales because of its ability to keep costs down. 

Also, Lowe's appears to be falling behind the competition by not expanding as fast as its industry counterparts. Home Depot (NYSE: HD), for example, is moving into Lowe's market share of the automated supply chain.

Home Depot is increasing market share

Home Depot (the largest home improvement store chain) is making efforts to expand its IT and distribution network, which is a competitive advantage that is currently controlled by Lowe's. However, the supply chain at Home Depot isn't as automated as Lowe's. Despite that, the company is increasing efforts in that department, and about 66% of its merchandise is flowing through its rapid deployment outlet. That's an increase of about 25% from two years ago.

Analysts like that prospect. In fact, the consensus opinion of 30 analysts says Home Depot will increase EPS by 17% this year, and another 17.5% next year. Much of that optimism is likely hinged on the recovering housing sector, but also on the firm's market share strategy.

Success depends on housing

The housing recovery is likely to last many years into the future, but it should be noted how much these companies depend on the health of the sector. Investing in these companies is banking on the housing market, and that has been a tricky sector over the last several years and is largely the cause of the recession.

Lumber Liquidators looks to be the best of these three firms due to the company's ability to decrease expenses, so it isn't completely at the mercy of the housing sector. I'd consider adding that company to my portfolio, while giving Home Depot a "hold," and Lowe's a "sell."

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Phillip Woolgar has no position in any stocks mentioned. The Motley Fool recommends Home Depot, Lowe's, and 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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