The Leading Hardware Store's Turnaround

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

I recently noticed that Dow-30 component Home Depot (NYSE: HD) reported pretty good quarterly earnings on the back of what many see as a turn in the long suffering housing market. This led me to look at some stocks that might also benefit from such a turn. However, it quickly became clear that Home Depot and Lowe's (NYSE: LOW) are, basically, the only two hardware stores in town. I decided to dig a bit deeper.

Although Home Depot went through its own malaise some years ago, it has seemingly gotten its management team in order and appears better positioned than its main competitor. So, I started with this industry leader. I typically start my research using the strengths, weaknesses, opportunities, and threats (SWOT) framework to ensure I don't jump like a grasshopper from interesting fact to interesting fact without ever looking at the company as a whole. I consider a SWOT one of the best ways to force myself to consider both the good and the bad about a company and its prospects.

To create a SWOT analysis, all you need to do is make a quick, though thoughtful, list of what you consider a company's strengths and weaknesses, which are both internal factors, and the opportunities and threats it faces, which are both external factors. In the end, you'll have a valuable, and more complete, picture of your investment candidate.

The Home Depot
Home Depot claims to be the largest home improvement retailer in the world (Lowe's lays claim to being the second largest). Founded in 1978, it is a household name today with operations in the United States, Puerto Rico, the U.S. Virgin Islands, Guam, Canada, Mexico, and China with over 2,200 stores. With products from wood to tile and from pipes to light bulbs, the retailer serves both the professional market and the consumer market. Although there may be competitors in the locations where Home Depot exists, they often don't have the big-box retailer's vast assortment of products, making Home Depot a destination store for hardware needs. Below is my take on the company using the SWOT methodology.

Strengths (Internal)

  • Massive size and scope makes it hard for most competitors to survive around Home Depot stores.
  • Financially strong, which allows for continued growth spending.
  • Impressive brand recognition.
  • Massive size provides for material purchasing power.
  • Despite the company's size, there still appears to be room to capture more industry market share.

Weaknesses (Internal)

  • Tied to demand for hardware items, which was a particular issue during the housing led 2007 to 2009 recession.
  • Stores often considered less customer friendly than those of its main competitor.
  • Distribution and logistics operations considered inferior to main competitor, though efforts to update the system are under way and appear to be resulting in early success.
  • Increasingly difficult to find new locations in its home market, leading to a slower growth profile than historically provided.

Opportunities (External)

  • International growth.
  • Continued store expansion, even though slow, in more mature markets.
  • A leader in a still fragmented industry segment.

Threats (External)

  • Economic cycle lows can be painful for the company.
  • Housing market weakness, regardless of the economic cycle.
  • E-commerce could take market share from an industry that has, historically, been largely immune from such threats.

A Few Thoughts
Clearly Home Depot is the largest player in the home improvement industry. However, size doesn't always lead to good results. For example, Lowe's is considered to have a better distribution system and “friendlier” stores. While I can't speak to the distribution system, if I had a Lowe's near by, I would likely go there over Home Depot. The in-store experience is the same reason why I am a member of Costco (NASDAQ: COST) and not Wal-Mart's (NYSE: WMT) Sam's Club.

This customer service issue is one that can't be overlooked. It has been a major image problem for Wal-Mart for years and has allowed Costco and others to take the company on in the member's club space and retailers such as Target (NYSE: TGT) to take on Wal-Mart's namesake stores. Still, if I need a hardware item, my first thought is Home Depot because of its name recognition, which is a valuable commodity that many don't properly value.

On a negative note, both Home Depot and Lowe's expanded rapidly with the bull market in housing. The pair added thousands of stores very quickly and now appear to be pulling back some after that expansion led to pretty dismal results when the real estate market tanked. This means that both Lowe's and Home Depot are likely to be focusing on market share over store expansion in the coming years. This should lead to slower than historical growth, meaning that investors might be disappointed by the top line.

With a yield below 2%, I'm not sure that now is the time to jump into Home Depot. Lowe's yield is about the same level. While both companies are solid competitors and there appears to be room for both in the industry, investors seem to have bid their prices to a point that fully reflects the potential benefit from a housing turnaround.

ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services recommend Costco Wholesale, 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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