Artesian-Arts

Lowe’s Has A Significant Upside As It Catches Up With Home Depot (NYSE:LOW)

Lowe’s (LOW) recently reported its second quarter results with sales and earnings beating estimates. The company’s comparable sales of 34.2% smashed consensus expectations of +16.3%. This resulted in its adjusted EPS of $3.75 beating consensus by $0.80 and revenue of $27.3B (+30.1% Y/Y) beating consensus by $3.06B.

Lowe’s company has come a long way from where it was a couple of years back. Not long ago, investors were baffled by stories like Lowe’s website crashing on Black Friday or the company reporting a decline in transaction due to stock-outs despite increased traffic. Even the company’s CEO Marvin Ellison shared his shock with investors on finding out how out of date the company’s project management systems were. Below is an excerpt from Marvin’s presentation on one of the company’s investor day two years ago,

So, while I was visiting a store recently, I posed a question to a group of associates. I said, okay, I am a customer. I am buying flooring, cabinets, countertops, a suite of appliances, so that kind of equals a kitchen remodel, right. So I said to the team how do we manage this kitchen project for the customer? So, you want to know what the associates showed me as our project management system, a dry erase board in the back of the store. So after I got past the shock, I had a follow-up question. I said, well, the customer didn’t have a dry erase board. So how did they keep track of the project? Their answer, well, Marvin, we give them a binder. So dry erase boards and binders as a project management system, hard to believe that a retailer our size with our balance sheet is working with these systems in 2018. But this is the position we put our associates in. So, the question I asked myself is, how much would our sales and customer engagement improve with modern systems?”

The company had a strong balance sheet and no dearth of resources. The problem was an operational one with the company lagging in terms of business infrastructure. Marvin followed a strategy to invest in improving and modernizing the company’s business infrastructure and hiring right peoples in leadership roles. These modernization efforts over the last 18 months have helped the company create technology and operational platforms to meet customer demand and helped it perform well in the current times.

For example, the company replatformed lowes.com from a decade-old infrastructure to the cloud and developed a top rated mobile app. This came handy during COVID-19 pandemic as many consumers shifted to online buying and helped the company grow its online sales by 135%. The company’s initiatives to hire home improvement and retail subject matter experts allowed it to quickly make informed decisions and implement necessary changes during the COVID-19 crisis. In addition recently implemented steps like a customer-centric labor scheduling system, deploying a new price management system to provide merchants with better data to maintain cost discipline, enhanced pro product and service offerings combined with the new Pro loyalty platform are all helping the company’s results.

These steps have begun showing in the company’s results and the company was not only able to handle the recent surge in demand but also was able to post US home improvement comps of 35.1% which was much better than even Home Depot’s (HD) 25%. A 10% point outperformance with a really excellent operator like Home Depot is a big deal in my opinion and indicates the company’s strategy is bearing fruits.

The strength was observed across the board. While DIY sales were really strong as stay at home orders resulted in consumers taking up small DIY project at homes, Pro sales were also strong with comps in the mid-20s supported by the progress the company has made with improving service levels. From a geographic perspective, growth was balanced across the US store footprint, with positive comps of 30% or more in all 15 geographic regions.

While Lowe’s has come a long way from being a retailer whose website used to crash during Black Friday to a company which can handle ~35% increase in comp sales and a triple digit increase in online sales with ease, there is still a meaningful scope of improvement as it tries to catch up with Home Depot. The company’s CEO Marvin Ellison is committed to it and commenting on future investments in improving the company’s operation he said,

Looking ahead, we are confident that we’ll continue to build on the momentum that we delivered in the first half. And in the second half of this year, we are reinvesting in the business to elevate our product, simplify our store environment and improve our service offering. These investments will include store resets to improve product adjacencies, bay productivity and sales per square feet. We’re also advancing our supply chain infrastructure with our recent announcement that we’ll open 50 cross dock delivery terminals, seven bulk distribution centers and four ecommerce fulfillment centers over the next 18 months. Our investments in our stores and investments in our supply chain evolution reinforces our commitment to becoming a world class omnichannel retailer. We’re making the right investments to drive long-term sales growth, operating profitability and sustainable shareholder returns.

There is one dynamic I often observe in retail industry. Once a company starts seeing improvement in its Same Store Sales, a positive loop sets in where it makes more profit from incremental sales which it can again reinvest in the business. This helps in improving Same Store Sales further and the cycle goes on. I believe Lowe’s is likely to see a similar dynamic and the outperformance versus Home Depot we are seeing can continue.

Lowe’s is trading at a significant discount versus Home Depot. For the current year, sell-side expects Lowe’s to post an EPS of $8.31 (up 44.52% versus last year’s $5.75) giving it a P/E of 19.08x while Home Depot is expected to post an EPS of $11.19 (up 9.17% versus last year’s $10.25) and trades at a P/E of 25.08x.

This is a very interesting situation. Investors may argue that Home Depot has better margins, better return on assets, and a good execution track record. So, it should trade at a higher multiple. While this argument is not unjustified, one should also not ignore the fact that Lowe’s will likely grow its EPS at a higher rate that Home Depot for next four to five years as it improves its business operation. While other factors matter, I believe EPS growth potential is a much better indicator of any stock’s outperformance and the kind of P/E multiple it deserves.

Over the next four to five years, as Lowe’s continues to improve its business, its P/E multiple will likely close its gap with Home Depot. Further, I expect its EPS growth to be higher than Home Depot as it improves its operations. So, I believe it can outperform Home Depot meaningfully over the medium term. If Lowe’s was to trade at 25.08x current year EPS, the stock would be near $208 or more than 30% upside from P/E re-rating alone. After the recent run up, many investors are wondering whether they should chase housing or home remodel stocks or not. I believe housing and home remodel trends will remain strong as long as interest rates remain low and consumers prefer staying at home. However, investors who do not want to take market risk can also consider a pair trade with Home Depot. This will eliminate market risk while capturing an upside from turnaround at Lowe’s.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source Article