2 Stocks Whose Bull Run is About to End

By David Gould - October 17, 2012 | Tickers: HD, LOW, WMT | 0 Comments

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While both Lowe's and Home Depot have delivered fantastic returns since 2011, they have started to slow in recent months. Investors are beginning to realize that the multiples of these two home-repair giants are too high for uncertain growth. As we enter a full recovery (despite aggravatingly sluggish macro growth), investors will be willing to back stocks that trade at low multiples. I thus encourage not jumping into the bull run too late.

Lowe's Companies (NYSE: LOW): When Nothing Gold Can Stay

Over the last twelve months, Lowe's has returned 54% to shareholders, along with a 2% dividend yield. Even though reorganization efforts have caused Bank of America and Normura Securities to upgrade the company, its stock looks fairly pricy at 21.3x past earnings and a PEG ratio of 1.5x. Strangely enough, this multiple is at a premium to the S&P 500, despite the fact that EPS has fallen by 6.3% annually over the past 5 years.

I am also concerned about how Lowe's continues to see market share declines against Home Depot. Weak second quarter earnings were characterized by a 0.4% decline in same-store sales. In fact, EPS of $0.65 was 7.1% below consensus. Margins contracted 56 bps, but the company has told shareholders that it's"not a big deal" in light of restructuring efforts. Implementation of mobile technology, for example, might sound good, but it's not meaningfully different than what any retailer is pursuing.

Assuming the company meets expectations and grows by 14.7% annually, 2016 EPS will come out to around $3.06. At a multiple of 17x, this translates to a future stock value of $52.02. Discounting backwards by 10% yields a present value right in-line with the current market cap. In my view, there are safer retail picks that have partial exposure to home improvement, like Wal-mart (NYSE: WMT).

Wal-mart has the best of both worlds: recession-proof business demand and diversification across a wide swath of categories. Consumers are still weary about macro uncertainty and are unlikely to continue to go to Wal-mart before shopping at Lowe's for the most essential housing items. Put differently, a recovery in demand for premium retail brands will lag behind a recovery in the macroeconomy overall.

Despite this diversification and safety, Wal-mart is still considerably cheaper than Lowe's. It trades at 16.2x past earnings and has excellent liquidity to penetrate into emerging markets. While Lowe's has been forced out of markets due to competition from Home Depot, Wal-mart (always characterized as the "predatory pricer") has been successful in driving out competition.

Home Depot (NYSE: HD): Better Than Lowe's But Still Expensive

Home Depot has at least produced solid performance over the past 5 quarters, beating expectations four of those five quarters. In 2Q 2012, Home Depot generated EPS of $1.01 - a return that was 4.12% ahead of consensus. This outperformance against Lowe's has paid off, with shares returning 73% over the last 12 months. In a recent interview with Fox Business, the company's CEO explained that the business is "not [in] a reovery, but a kind of thawing out."

Unfortunately, this "thawing out" has not been as great as investors may have hoped. While Home Depot increased its dividend yield by 30% over the last 5 years, Lowe's doubled its own. Yes, margins have improved, but they are significantly higher than competitors and unlikely to expand much hereafter. Analysts forecast EPS growing 14.5% annually over the next 5 years, despite the fact that it has declined by 0.6% annually over the past 5. While the company has relatively limited debt, with a debt-to-equity ratio of 0.6x, it is still very expensive at 5.2x book value.

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