Online Extra: High Expectations for Lowe's
By Amy Tsao
The ongoing saga of big-box home-improvement retailing, which stars Home Depot (HD ) and Lowe's (LOW ), has had some interesting plot twists. Starting about two years ago, the stock market began to bet on smaller, faster-growing Lowe's. Shares of Home Depot, the high-growth retailer of the 1990s, weakened so much that its rock-bottom price of just above $20 -- which it hit early last year -- began to look attractive. So, Home Depot has risen 49%, to $36, in the last 12 months, while Lowe's gained 32%, to $53.
Even so, the Wilkesboro (N.C.) Lowe's may still have more wind at its back than Atlanta-based Home Depot. Lowe's beats its rival on a key measure: new-store growth. It plans to add about 13% to 14% more stores -- often in more densely populated markets than Lowe's traditional rural store base -- in the year ending January, 2005, bringing its total to 1,140. Home Depot expects new-store growth closer to 10%, for a total of 1,877.
Ben Friedman, assistant portfolio manager at Milwaukee-based Dana Investment Advisors, figures Lowe's stock can reach the low-$60s range over the next year, for a hike of some 12%. "It's not a home-run stock, but it definitely should appreciate more than the market," he says. (Friedman's firm owns shares in Lowe's.) Others agree, and Lowe's is ranked No. 9 on BusinessWeek's 2004 list of the 50 top-performing U.S. companies. Though Lowe's stock has had a spectacular run of 70% over the past five years, vs. Home Depot's 13% decline in the same period, it may keep climbing.
Bernstein analyst Colin McGranahan wrote in a Feb. 24 report: "We continue to view Lowe's as a solid long-term growth story with quite impressive 19% compounded earnings-per-share growth over the next two years." Despite tougher sales comparisons beginning in the second quarter, he raised his price target on Lowe's to $65, up from $62. (Bernstein or an affiliate may own more than 1% of Lowe's stock.)
This fiscal year, analysts on average expect EPS at Lowe's to rise 15%, to $2.66, while revenues are forecasted to rise 18%, to $36.3 billion. From a valuation standpoint, Lowe's is more expensive than Home Depot. It's trading at nearly 20 times January, 2005, consensus EPS, while Home Depot trades at 17 times EPS of $2.09. Still, "at the moment, I would pick Lowe's because it has the higher growth rate in the two- to three-year time horizon," says Jim Luke, director of growth equity at BB&T Asset Management.
Besides adding revenues through store expansion, comparable-store sales (sales at stores open at least one year) have also been strong. Lowe's reported that comparable sales rose 7.3% for the fiscal fourth quarter ended Jan. 31. For the rest of the year, it's expecting same-store sales increases of about 5%.
Lowe's is "a company that can grow earnings per share over the next three years at 16% to 17%," Luke figures, adding that its stock should rise at a similar pace to earnings growth. (Luke's firm owns both Home Depot and Lowe's.)
Lowe's has also made concerted efforts to cut sourcing costs and lower inventory shrinkage over the last couple of years. That has helped gross margins inch higher every year since 2001. Lowe's recently said gross margins for the current year can increase a modest 20 to 30 basis points. But that may be too conservative, according to Bernstein's McGranahan. "We would not be surprised to see gross margins in fiscal 2004 once again surprise to the upside," he says.
Of course, the stock's performance could take a pause amid a backdrop of confusing economic conditions. Even those who are bullish on home-improvement retailing are somewhat nervous about mixed signals coming from government data. Friedman, for one, likes the sector for the long term but worries about the outlook on employment and interest rates. Economists fear that while low rates should keep the housing market strong, a lack of new jobs -- and fears of losing existing jobs -- could keep Americans from making big purchases. And if the economy does end up picking up rapidly, rates could quickly head higher and hamper spending in general.
However, in the longer term, new-home construction and existing-home sales "should continue at a healthy clip as long as the population is growing," says Lynn Mander of Bryn Mawr Trust Wealth Management in Bryn Mawr, Penn. Her firm owns both stocks on the belief that the robust levels of home buying and mortgage refinancing of 2003 mean there are "dollars to be spent in 2004." Home buyers generally spend on projects for the home within two years, she says, adding that she's more confident that shoppers will spend more at Lowe's and Home Depot than at other consumer-discretionary retailers, such as Best Buy (BBY ).
Lowe's President Robert Niblock expects home-improvement retailing will remain strong with help from demographics as well as the trend, aided by TV home-decor shows, of keeping homes looking stylish. Also, the rising middle-class Hispanic population is increasingly participating in the "great desire for the American dream of owning your own home," he says. That should help keep home sales robust even as borrowing rates eventually inch up. And Niblock expects that even if higher rates keep some consumers from buying a new home, "they'll probably want to still invest in their [current] home."
Certainly, Lowe's is cementing its brand as a fixture in the home fix-it biz. Many analysts see it as a relatively safe bet on consumer spending. Says Dana Investment's Friedman: "Their [prospects] are very visible for us." The economy may not be on the fast track yet, but even that could be a mere blip for this high-growth retailer.
Tsao covers financial markets for BusinessWeek Online in New York