Lowe's Impresses Despite Housing Gloom

In the home improvement battle, Lowe's pulls ahead of Home Depot thanks to better customer service

Despite being hobbled by a dismal housing market in some parts of the country, Lowe's (LOW) is winning the race against archrival Home Depot (HD).

Lowe's same-store sales fell 2.6% in the second quarter, but Home Depots sales dropped 5.2%.

On Aug. 20, Lowe's reported earnings of 67 cents per share that beat analysts' expectations, and rose from 60 cents a year ago. Total sales were up 5.8% to $14.2 billion.

Analysts and executives were already expecting weak results as lower housing prices hurt sales at home improvement chains like Lowe's. "A lot of negativity was already priced into the stock," says Morningstar equity analyst Brady Lemos.

Lowe's shares rose nearly 6% to $28.39 on the New York Stock Exchange on Aug. 20. The stock has ranged between $25.98 and $35.74 in the last year.

Lowe's said sales were weakest in the cool real estate markets in California and Florida. Sales in the Northeast, though bad, were "showing encouraging signs of improvement," Lowe's chairman and chief executive Robert A. Niblock said in a statement. Stores in much of the rest of the country, however, posted sales increases.

The biggest surprise for many analysts was wider profit margins. Reasons for the better profits, according Lemos: Investments in distribution systems are paying off; less was spent on promotional sales; sales shifted to a more profitable product mix; and also theft — what retailers call "shrinkage" — was down.

More good news: Lowe's expects same-store sales to stop sliding and come in flat in the third quarter. Deutsche Bank analyst Mike Baker wrote Monday that "this tells us that trends have bottomed" for Lowe's. (Deutsche Bank owns and makes a market in Lowe's stock.)

Analysts and Lowe's executives say the retailer is still winning customers away from Home Depot. "We continue to capture market share in this challenging sales environment," Niblock said.

Analysts say customers prefer the service at Lowe's. Home Depot is spending money to improve customer service, but Lowe's has a big head start.

Raymond James analyst Budd Bugatch rates Lowe's a "strong buy." One positive, along with Lowe's "excellent earnings performance," is the "seemingly unfounded draconian fears about anything housing related." (Lowe's may be a Raymond James' investment banking client in the next three months.)

Still, it's unclear when the housing market might recover and when Americans will start spending big on their homes again.

Many analysts are watching the hurricane season closely. Sales at the big home improvement chains tend to benefit as people buy supplies and make repairs in the storms' aftermath.

Lowe's said Monday it expects to earn a bit less for the rest of this year than expected. That's a calculation a lot of retailers are making as they worry about the mood of the U.S. consumers, Lemos says. For Lowe's, it's "not because they're seeing weakness in their business," Lemos says, "but because they get a sense that consumer sentiment is pretty low now."

A.G. Edwards retail analyst Brian Postol wrote last week that overall "the momentum is not healthy going into the all-important back-to-school, fall and holiday seasons."

Still, he notes, Home Depot and Lowe's are in a good spot long-term. They're the two dominant retailers and have been able to keep other big players out of the business.

Despite the slow housing market, Lowe's is expanding quickly. It opened 26 new stores last quarter, bringing its total to 1,424 stores, and expects to open another 40 stores next quarter. Home Depot operates more than 1,900 stores in the United States.

According to Postol, both should benefit long-term as Americans continue spend on their biggest investments, their homes.