Third-quarter results of home improvement stores Lowe’s (LOW, Financial) and Home Depot (HD, Financial) has brought investor focus back to the diverging fortunes of both companies.
Lowe’s, the older of the two, has been lagging behind Home Depot on several fronts, and the latter continues to expand its lead with strong numbers this year.
In the first three quarters of the current fiscal Home Depot’s U.S. comps read 7.4%, 5.4% and 5.9% while Lowe’s recorded 7.3%, 2.0% and 2.7% during the same period. While Lowe’s kept the pace in the first quarter, it fell far short of the numbers Home Depot was able to post in the second and third quarters.
To add more pain to its misery, Lowe’s missed Wall Street expectations during the third quarter, which added more downward pressure to the stock price. Lowe’s reported earnings of 88 cents per share with revenues of $15.73 billion while the market was expecting 96 cents per share with revenues of $15.85 billion.
The contrasting fortunes of both the companies can be clearly felt in the way their stocks have moved this year. Lowe’s declined by nearly 7% since the start of the year and is trading around 1.01 times its total sales while Home Depot declined by 0.69% and is trading around 1.72 times sales.
“Our third-quarter operating results were below our expectations due to slower sales in the first two months of the quarter. While we expected moderation in the second half of the year as reflected in our guidance, traffic slowed more than we anticipated in August and September before improving in October, which put pressure on our profitability.” – Lowe's CEO Robert Niblock, third-quarter earnings call
The good news is Lowe’s still expects its sales to increase 9% to 10% for the full fiscal with comparable store sales increasing by 3% to 4%, which is better than Home Depot’s expectation of 6.3% sales increase but lower than comparable-sales growth expectation of 4.9%.
Lowe’s needs to keep the pace with Home Depot and, if possible, get ahead of it. Home Depot’s $23.2 billion third-quarter sales numbers are way ahead of Lowe’s $15.85 billion, and the further Home Depot moves away from Lowe’s the bigger the problem for Lowe’s in the future. Size plays a unique role in retailer fortunes because it can bring cost benefits, better negotiating power and more money to reinvest in the company. The effect can already be seen in the operating margin numbers. Home Depot’s operating margins were almost consistently at around 13% over the last two years while Lowe’s got stuck at around 8.5% during the same period.
Though it will be a difficult task for Lowe’s to catch up to Home Depot on the margin front in the short term, it ideally tries to keep pace when it comes to comparable-store sales. If it can’t, the gap is going to widen, and the stock’s valuation will follow suit.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
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