The Home Depot (HD) and Lowe’s Companies, Inc. (LOW) compete in the home improvement retail industry in the US, which comprises retailers that sell plumbing, kitchen fittings, hardware, appliances and other home improvement products.
The total size of the US home improvement retail industry is approximately $129.2 billion by revenues, with Home Depot leading the market with a 58.9% share. Together, Home Depot and Lowe’s account for 97% of the market share by revenues.
Source: Forrester’s study; Glassdoor
Home Depot divides its products into four major categories, displayed in the chart below.
On the other hand, Lowe’s divides its products into 15 categories, which are displayed in the chart below.
Although the demand for home improvement retailers is driven by both new housing starts and existing home sales, Home Depot and Lowe’s Inc.’s revenue growth rates are more dependent on existing home sales than housing starts. Existing home sales drive demand for plumbing, electrical and kitchen products, which are major contributors to these companies’ revenues, while housing starts drive demand for building materials, lumber and millwork, which contribute less to their total revenues.
To learn more about the impact of changing economic factors on the home improvement retail industry, read Bidness Etc’s article “Home Depot: Little Room for Growth”.
Lowe’s tends to outperform Home Depot during economic downturns, but underperforms it during economic recoveries. This is mainly because Home Depot earns a greater portion of its revenues from professional customers, such as building contractors, as compared to Lowe’s. Demand from professional customers grows at higher rates during periods of economic and housing recovery, compared to demand from do-it-for-me (DIFM) and do-it-yourself (DIY) customers.
Most of these professional contractors are based in metropolitan areas, where Home Depot has more stores as compared to Lowe’s. This is one of the reasons why professional customers account for 35% of Home Depot’s total sales, compared to a lower 25% of Lowe’s total sales.
Due to these reasons, Lowe’s annual same store sales growth has averaged a lower 0.9% over the last three years as the economy recovered, compared to Home Depot’s 3.6%.
Home Depot has consistently increased its gross margins over the last three years, which reached 34.6% in fiscal year (FY) 2012. Lowe’s margins, in comparison, were slightly lower at 34.3% in FY12, after consistently declining from 35.1% in FY10.
Home Depot’s inventory management initiatives – such as RDCs (Real Deployment Centers), MyInstall and Red Beacon – have helped reduce costs and expand gross margins. The MyInstall initiative allows customers to schedule appointments and track their projects online, while Red Beacon helps DIFM customers find professionals who will help them complete their home improvement projects.
RDCs help improve inventory management by aggregating orders from multiple stores, then rapidly deploying inventory to stores. Home Depot operated 18 RDCs in FY12, compared to Lowe’s 14, which makes its inventory management system more efficient as compared to Lowe’s.
On the other hand, Lowe’s gross margins have fallen consistently due to its proprietary credit programs, which give customers a 5% discount on their purchases every day. Although this program contributes to revenue growth, it impacts gross margins negatively. For example, Lowe’s total revenues grew by 0.65%, while margins contracted 0.19 percentage points in FY12.
Home Depot has a higher three-year revenue CAGR of 4.1% compared to 2.3% for Lowe’s; but a lower five-year CAGR of -0.7% compared to 0.9% for Lowe’s. The five-year growth rate for Lowe’s is higher mainly because it increased the number of its stores by 14% from FY2007 to FY2010, while Home Depot expanded by less than 1% over the same period. This is a key difference in their strategies: while Lowe’s supports its revenues during an economic downturn through expansion, Home Depot supports its earnings by shutting stores.
Home Depot not only has a higher number of stores, its sales productivity is greater as well. Home Depot generates $318 in sales per retail square foot, compared to $256 for Lowe’s.
Two key reasons account for Home Depot’s better sales productivity compared to that of Lowe’s. Firstly, Home Depot’s average store retail area is lower at 104,000 square feet, compared to Lowe’s 113,000 square feet. Secondly, over 57% of Home Depot’s total labor force is involved in customer facing activities, and it plans to increase this to 60% by the end of FY17. More labor hours in customer facing activities helps Home Depot improve productivity by making more workers available at all time to serve customers.
Home Depot’s stock underperformed Lowe’s during 2008 by 10%. However, it has outperformed Lowe’s by over 27% over the last three years.
As discussed previously, Home Depot’s stock price tends to outperform Lowe’s during economic recoveries, and underperform it during recessions due to the company’s dependence on professional customers for revenue growth.
Even though it has outperformed Lowe’s for the last three years, Home Depot’s stock has underperformed Lowe’s by over 11% year to date (YTD). This is because Lowe’s beat analyst estimates for its 2QFY13 earnings by 11%, while Home Depot’s earnings beat estimates by a nominal 2.4%. Lowe’s has also benefited recently from lower product pricing compared to Home Depot, which drives more traffic to its stores.
Home Depot and Lowe’s are currently trading at one-year forward P/E multiples of 18x and 19x.
Bidness Etc will discuss the two companies’ stock valuations and prospects in a future article. Stay tuned!
*Compound Annual Growth Rate