Crashing the Home Improvement Party

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

The U.S. home improvement retailing duopoly of Home Depot (NYSE: HD) and Lowe’s (NYSE: LOW) have been content to carve up their industry among themselves, leaving few scraps for their competitors.  They have used their size and national scale to put mom-and-pop retailers out of business, with a seemingly limitless inventory of products in their warehouse-style stores, which average more than 100,000 square feet.  However, customer service hasn’t always been their forte.  So, it is nice to see a smaller competitor, Lumber Liquidators (NYSE: LL), crashing the party and taking market share in the flooring category.  With a big stock price gain over the past 12 months, can Lumber Liquidators continue to deliver for investors?

What’s the value?

Founded in 1994 to sell surplus quantities of wood products, Lumber Liquidators has grown into the largest specialty retailer of hardwood flooring in the U.S.  The company operates almost 300 stores throughout the U.S. and Canada, offering a diverse inventory of wood floor coverings, including its premium Bellawood brand that comes with a transferable, 100-year warranty.  In contrast to its larger competitors’ warehouse-style stores, Lumber Liquidators’ stores average roughly 7,000 square feet, which allows their employees to take a more personalized approach with customers.

In FY2012, Lumber Liquidators achieved a breakthrough year, with increases in revenues and operating income of 19.3% and 84.6%, respectively, versus the prior year.  The company’s sales growth benefited from a solid rebound in the domestic housing market, as higher prices gave homeowners more confidence to spend money on value-enhancing renovation projects, including new floor coverings.  In addition, rising customer demand led to a favorable pricing environment as more buyers opted for premium hardwood styles.

In the first quarter of 2013, Lumber Liquidators successfully built on last year’s results, with a 22.5% increase in revenues.  The gains were generated from both a very strong 15% rise in comparable store sales and the further build-out of the company’s national store expansion strategy.  More importantly, Lumber Liquidators’ operating margin hit a record high during the period, as its larger scale translate into higher profit margins.  The resulting operating cash flow is allowing the company to further invest in its capabilities, including an iPad application that allows customers to search through a catalog of 200 floor samples.

The angry giants

Naturally, the home improvement giants aren’t standing still in the fight for customers’ home improvement purchases.  Home Depot, in particular, has recognized its customer service deficiencies and has initiated its Customers First program to enhance its employees’ communication skills.  The company’s goal is for 60% of each store’s total employees’ work hours to be spent on customer-facing activities.  In addition, Home Depot is pursuing tuck-in acquisition opportunities in the flooring area, including the 2012 purchase of MeasureComp, a floor measurement and quoting service provider.

Meanwhile, Lowe’s is also focusing on its customer service metrics, with the goal of increasing its market share among its active customer segment.  The company’s MyLowes online tool allows customers to create profiles of their home projects, to-do lists, and potential purchases.  Lowe’s is also aggressively pushing its proprietary credit card product, which provides an option for a 5% discount off of a customer’s total purchases.  While the discount has hurt the company’s overall profit margin, management hopes to instill loyalty among its customer base and provide opportunities for sales of higher margin products and services.

With a combined $125 billion in annual sales and national store bases, Home Depot and Lowe’s have likely attained their steady state level of domestic market share.  While international expansion possibilities are available, Home Depot’s flameout in China shows that the warehouse-style store model in not a universally successful format.  The companies need to take a page from Lumber Liquidators’ playbook and become high-touch information and service centers for their customer base, if they want to deliver on their profit goals.

The bottom line

While the rising tide in the housing sector is currently lifting stock prices for all competitors, rising interest rates will eventually put a crimp on stimulus-generated sales gains for the home improvement retailers.  In the long run, the winners will be the companies that can form strong relationships with customers based on good advice and product value propositions.  Using that measuring stick, Lumber Liquidators is the current winner.

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Robert Hanley owns shares of Lumber Liquidators. 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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