Today we analyze the two giant home improvement retailers... both high quality stock picks (plus a bonus). But, which one is better for your goals? That's a question we'll look to answer as we analyze!
Revenue & Business Model
On the surface, both Lowe's and Home Depot are very similar businesses and direct competitors. They both have three segments of business: Home Décor, Building Products, and Hardlines. Home Décor includes Appliances, Décor, Flooring, Kitchens & Bath, and Paint. Building Products include Building Materials, Electrical, Lighting, Lumber, Millwork and Rough Plumbing. Hardlines include Hardware, Lawn & Garden, Seasonal & Outdoor Living, and Tools. Each of those segments make up an equal amount, or a third, of each of their businesses. So, both Lowe's and Home Depot is pretty much identical in their revenue split. Beyond comparing the two, I also wanted to see if any specific category was a abnormal beneficiary from COVID (demand, supply constraints, or inflation), which would make forecasting easier. However, all categories grew evenly – which indicates more "healthy" growth.
Both Lowe's and Home Depot have more than 90% of their business in the U.S. Lowe's has 1,974 doors worldwide, whereas Home Depot has 2,312. So Home Depot has 17% more doors, whereas Lowe's is looking to optimize the ones it currently has.
Speaking of optimization, however, Home Depot is a clear winner with $544 revenue per sq ft.; whereas Lowe's sells $431 per sq. ft. and trying to catch up. Lowe's is trying to close the gap on that 26% difference by focusing on its omnichannel distribution and attracting the PRO customer (professionals & contractors). Right now, about 45% of Home Depot’s total sales come from pro customers versus about 20% to 25% at Lowe’s. That's a significant advantage Home Depot has, which present an equally significant growth opportunity for Lowe's.
Home Depot also has advantages over Lowe's in supply chain efficiency (seen its higher margins) and physical presence. More than 90% of the U.S. population lives within 10 miles of a Home Depot store. That compares to 90% of the U.S. population that lives within 20 miles of a Lowe's store. In a world of omnichannel shopping (i.e. curbside pickup) this is a significant advantage. In fact, Home Depot's online sales grew 86% in 2020 and now represent around 15% of total sales. Home Depot has grown to become the fifth-largest online retailer in the U.S. But, again, these are all growth opportunities for Lowe's which CEO Marvin Ellison is laser-focused on.
Marvin Ellison joined Lowe's in 2018, and has done a phenomenal job so far. He was an executive at Home Depot from 2002 to 2014 and helped oversee its turnaround at the time. Marvin is proving to be best leader for who Lowe's needs right now.
The home improvement industry, as you can see, had a significant boost of sales from the pandemic. People were stuck at home, and the pandemic allowed them to finally get around to their home improvement and DIY projects. It was the perfect storm to stimulate the industry. Home Depot grew sales 20% in 2020, while Lowe's grew 24%. These are huge numbers!
The biggest question is, "how much of the post-pandemic slowdown will impact the industry and each of their businesses?" The answer, although not clear, is a bit evident with Q2 2021 results. Home Depot still managed to grow sales +8% whereas Lowe's was +1%.
When we dig deeper into comparable sales – which is a more telling metric – we see that Lowe's was down -1.5% in Q2 2021, whereas Home Depot was +4.5%.
There's no doubt that both HD and LOW will have challenging YoY comps, but I think it's clear that Lowe's will have a bit more of a challenge because of its weight on DIY customers (vs. PRO). The PRO customers are still driving demand due to bigger projects that have been delayed due to the pandemic, so there is still some tailwinds there. Although Lowe's is a great company and stock, this is the biggest risk I see for it.
At the end of the day, it all comes down to valuation. Both Home Depot and Lowe's are quality stocks with solid dividends. Lowe's is now a dividend aristocrat. So I can understand the case for either of these companies to go in any portfolio... but at what price?
The metrics above tell me there is likely a bit higher upside (though with some additional risk) to Lowe's, which is congruent with the story we've been building. One of the main things that stick out to me, for both companies, is the level of debt. I usually don't like investing in companies with such elevated levels of debt, because this brings another set of risks relating to interest rate sensitivity. However, Lowe's buyback yield is very impressive, and shows the confidence they have in their own growth story.
But, if you know me, the main driver for my intrinsic valuation is always a DCF analysis. In this case I performed both the DCF and the DDM (dividend discount model). These were entirely based off analyst expectation, because I do think there is high uncertainty around the future earnings of this industry at the moment. There is an extreme bear case that can't be ignored, but it was for the purposes of time in this case. But, I'll explain in my conclusion below.
- Post-pandemic drought on sales is unclear. How much of the demand has been shifted up?
- Housing market has been on fire, and overexposure to real estate on any portfolio needs to be checked.
- Interest rates & high debt is a risk, but given the dividend payout ratios and history it is likely this is a small risk... but a risk nonetheless.
If I were to ignore the biggest risk in the macroeconomic environment impacting this industry (i.e. the post-pandemic drought), I would pick Lowe's. The numbers make sense because for my style of investing where I do like the upside growth potential. That is, arguably, limited with Home Depot. However, factoring in that risk, Home Depot is a much better play right now because of its focus on PRO customers – which would significantly lessen the blow from softer DIY sales in the years to come.
The extreme bear case in this scenario is that the CAGR of 5% is achieved over the next 5 years and the demand drops significantly post-pandemic. In that case, the entire demand has been pulled forward and we'd see negative growth in this industry for several years until its stabilized. I wouldn't ignore this scenario. That being said, I believe both companies can survive a scenario like this... as they have in 2018 housing crisis. Lowe's still managed to pay and increase dividends through this. However, I'm not trying to find out with my money.
If I were to own a piece of this industry today, I'd go in with an allocation of both stocks to diversify. But, the risk/reward just isn't attractive to me from here. If we do see negative growth, that would present really good buying opportunities for which I'd jump on.
Investing is a game of patience, and it doesn't always pay off... but in this case, I will exercise mine.
Disclaimer: All material presented in this newsletter is not to be regarded as investment advice, but for general informational purposes only. Day trading does involve risk, so caution must always be utilized. We cannot guarantee profits or freedom from loss. You assume the entire cost and risk of any trading you choose to undertake. You are solely responsible for making your own investment decisions. Owners of this newsletter, its representatives, its principals, its moderators, and its members, are NOT registered as securities broker-dealers or investment advisors either with the U.S. Securities and Exchange Commission or with any securities regulatory authority. We recommend consulting with a registered investment advisor, broker-dealer, and/or financial advisor. If you choose to invest with or without seeking advice from such an advisor or entity, then any consequences resulting from your investments are your sole responsibility. Reading and using this newsletter or using our content on the web/server, you are indicating your consent and agreement to our disclaimer.