Lockdowns and stay-at-home orders put in place by state and local governments in response to the coronavirus pandemic spurred a boom in DIY projects. And the Federal Reserve’s policy of keeping benchmark interest rates near zero to support the economy through the crisis is helping to fuel further spending on remodeling projects.
Those two factors would seem to make this an ideal environment for both Lowe’s (NYSE:LOW) and Home Depot (NYSE:HD), yet Lowe’s has significantly outperformed both its larger rival and the market this year, especially since Wall Street’s early spring plunge. Shares of Lowe’s are up 157% from their March low compared to a 96% gain for Home Depot and a gain of about 50% for the S&P 500.
Over the past decade, however, Home Depot has significantly outstripped its peer. Can Lowe’s can maintain its newfound momentum and make millionaires out of its current investors?
Improving revenue and profits
Lowe’s is the second-biggest home improvement chain, and it turned in a stellar third-quarter performance, though profits came up a little short of analysts’ expectations.
Its revenues rose 28%, powered by a 30% increase in same-store sales and online sales that more than doubled year over year. Adjusted earnings soared by 40% to $1.98 per share, but that was $0.02 per share less than what Wall Street anticipated — a shortfall that resulted from coronavirus-related costs and store remodeling expenses.
Yet that marked the third consecutive quarter Lowe’s gains outpaced those of Home Depot. It also expanded both its gross margin and operating margin, though its net margin still trails that of its rival.
What spooked the market a bit was Lowe’s outlook for the fourth quarter, which was more muted than some watchers had been expecting. Management’s relative guardedness on that front was based on the expectation that expenses will continue to rise.
How long can it continue?
Although states and localities are starting to reimpose lockdown orders as new COVID-19 cases surge to record levels, the emergency economic stimulus funds that helped fuel consumer spending in the earlier phase of the pandemic are long gone. And while another round of direct payments to Americans is possible, talks in Congress about another stimulus package have been bogged down for some time.
Yet as much as consumer discretionary purchases helped increase Lowe’s sales this year, the chain’s greater focus on its professional contractor customers is providing a boost that could outlast the one provided by higher homeowner demand.
The building products category is the second-largest contributor to Lowe’s revenue, amounting to nearly $7.6 billion in sales in the third quarter — up 34% from last year. While home decor is its largest segment at almost $8.2 billion (and it rose 36% in the quarter), the professional-centric segment could be tomorrow’s big driver.
Lowe’s is a Dividend Aristocrat — one of only 65 members of the S&P 500 that has increased its dividend annually for at least 25 straight years. In fact, the home improvement chain has paid a dividend every quarter since it went public in 1961, and has raised its payout for 55 years running, putting it in the even more rarified group of businesses known as Dividend Kings.
It did suspend its stock-repurchase program during the crisis, but reinstated it in September, and bought back 3.6 million shares at an average price of about $170 apiece in its fiscal third quarter. It still has $8.1 billion to spend under its current buyback authorization.
Lowe’s has a strong capacity to support its capital returns. It generated almost $10 billion in free cash over the last 12 months, or double what it produced in 2019. It does have a debt load of nearly $22 billion — high, but also manageable –and it has access to $3 billion in available credit should it have any short-term liquidity needs.
A rich opportunity
Lowe’s shares are trading at 17 times estimated earnings, and with analysts expecting those earnings to grow at more than 20% annually for the next five years, there is a significant reason to expect the home improvement company will make gains for investors. It also trades at just 13 times its free cash flow. By that metric, it’s an exceptional value.
By comparison, Home Depot trades at 22 times forward estimates, and analysts project its earnings will expand by less than 8% annually. It’s also valued at a more elevated 25 times free cash flow.
That suggests that from here, when it comes to building wealth for shareholders, Lowe’s will have a leg up on its closest rival.