Home Depot Still Hasn't Nailed Lowe's

The home-improvement giant's good third quarter wasn't nearly as strong as that of its archrival, which keeps closing the gap

By Dean Foust

Home Depot Chief Executive Robert Nardelli has weathered lots of criticism over his lack of retailing experience since taking the home-improvement giant's helm in late 2000. So the 22% jump in third-quarter profits, to $1.15 billion, he reported on Nov. 18 had to come as sweet vindication.

The Atlanta-based retailer's hell-for-leather expansion in the 1990s masked a lot of operating inefficiencies, but now Nardelli's crusade to tighten Home Depot's management systems and freshen up its aging stores seems to be paying off in higher profits as well as sales, which rose 15% over the same period of 2002, to $16.6 billion.

Home Depot (HD ) execs took particular pride in sales at stores opened a year or more -- or same-store sales, a key retail benchmark -- which after falling during late 2002, jumped 7.8% in the quarter ended Nov. 2. "Our financial results are proof positive that our strategy is working," he told analysts afterwards.


  So why the tepid reaction from Wall Street? Investors bid Home Depot's stock down 50 cents in the hours after Nardelli released earnings, to $34.95 -- leaving it still down more than 25% from when the former General Electric (GE ) manufacturing veteran joined the retailer roughly three years ago. That's because archrival Lowe's (LOW ) -- which has wowed analysts with its cleaner stores and emphasis on service -- is growing much faster than Home Depot, and the North Carolina rival is pushing fast and furious into Home Depot's key urban markets. And while Home Depot's stock has been down the past three years, Lowe's has soared 154%.

Indeed, a closer look at Home Depot's third-quarter numbers -- as well as Lowe's, which reported its own third-quarter results the day before -- may explain investors' reaction. While Home Depot put up solid results, Lowe's shot the lights out: Profits rose 33%, to $452 million, on a 24% rise in total sales, to $7.9 billion. And as for that all-important measure of same-stores sales, Lowe's showed a 12% rise -- the largest quarterly gain in nine years.

Legg Mason Wood Walker analyst David A. Schick notes that if you take a slightly longer view, the gap between Lowe's performance and Home Depot's widens more. Consider that the latter had a lower hurdle to beat in the third quarter, since its third-quarter 2002 performance was miserable. Last year, in his quest to streamline store operations, Nardelli cut inventories too deep, in the opinion of many retail experts, and launched bold makeovers of many stores. Both moves caused same-store sales to turn negative in the third and fourth quarters.


  So Schick argues that you should compare both companies' third-quarter performance to the same quarter two years ago. If you do that, Home Depot's same-store sales have risen 6%. By contrast, Lowe's have leaped 16.5%. And it appears that Lowe's has been pouring more money back into revamping its stores. It has boosted what it spends per square foot of retail space by 13%, while Home Depot has shrunk its corresponding spending by 4%.

Some analysts think Lowe's could have pumped up its numbers even more -- widening the performance gap with Home Depot -- except for two things: Lowe's is spending heavily to beef up its installation services and provide hefty bonuses to keep store managers and other key store personnel happy. That spending dampened third-quarter numbers but should reap dividends next year, the thinking goes.

Some investors grumbled -- preferring to see every incremental dollar of sales fall straight to the bottom line -- but to Lowe's management, the move is part of its strategy of offering customers better service than what they find at Home Depot. While Nardelli has cut the ratio of full-time employees in its stores to around 60% -- hiring more part-timers, particularly during weekends -- Lowe's has held firm with a store workforce that's 80% full-time.


  Home Depot's solid earnings report may have stolen the limelight from Lowe's, whose share price dropped about 75 cents in the two days after it released earnings. Now trading in the $58 range, it's still close to its 52-week high of $60.42 reached last month. Legg Mason's Schick advises investors to put their money on Lowe's, which he feels has the superior product right now. "Home Depot is improving," he told investors in a Nov. 18 research note, "but take advantage of any misreads that this means Lowe's is in any way suffering."

For now, Nardelli will have to take comfort in modest improvements.

Foust is BusinessWeek's Atlanta bureau chief

Edited by Douglas Harbrecht

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