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There’s a perpetual challenge for investors in home improvement stocks.
There are two category killers in the form of Lowe’s Companies (NYSE: LOW) and Home Depot (NYSE: HD). They are the leaders, and they are companies that are going to survive through thick and thin. They made it through the housing crisis, and have thrived since then.
Which one to choose, though? Or is neither worth your dime?
For me, it has always been a matter of which company is growing more quickly organically, which has better same-store sales, and which is selling at the most attractive valuation. Sometimes, that may mean swapping one out for the other if one gets too expensive.
Let’s check out the earnings report from both companies that were released this week.
HD
Home Depot delivered revenues of $24.79 billion for the second quarter, up 4.3% over last year. Same-store sales increased 4.2%, with a 5.7% jump alone in U.S. storefronts.
Ah, but don’t get tricked when it comes to earnings per share, which increased to $1.73 from $1.52. Share buybacks make that increase seem larger than it was on a net income basis. Net income only showed a 9% gain to $2.2 billion from $2.05 billion.
Thus far in 2015, Home Depot’s sales are $45.6 billion, an increase of 5.1%. Year-to-date net income jumped upward to $3.81 billion from $3.43 billion, which is a 10.9% increase.
EPS rose to $2.95 from $2.53 in 2014, but again, that’s due to share repurchases. There’s $5 billion in cash on the books and a solid $5.2 billion in free cash flow so far this year.
Here’s my problem: Home Depot is way too expensive. At $123, it’s trading at 21 times fiscal year 2015 earnings. Home Depot deserves a premium for its free cash flow and its brand, but I cannot justify a P/E ratio greater than 14.
Lowe’s
Lowe’s delivered revenues of $17.33 billion for the quarter, up 4.49%, and comps jumped by 4.29%. Earnings for Lowe’s was $1.13 billion ($1.20 per share), an increase from $1.04 billion ($1.04 per share).
Lowe’s also used share repurchases to goose its EPS higher.
For the first six months, revenues increased 5% to $31.5 billion. Net income was $1.8 billion, up from $1.65 billion, which was a jump of 7.9%. While net margins climbed 25 basis points to 6.5%, it still lags Home Depot’s, which are far superior at 9%.
Lowe’s stock is at $73 and trades at 22 times 2015 earnings of $3.30. But even with a 20% premium tacked on for brand and cash flow, Lowe’s only should trade at 11 to 12 times earnings.
As important as home improvement is to the economy – and these two home improvement stocks are category killers – I like a wide moat as far as risk goes. There’s just no reason to pay 50%-80% more for a company that it is worth.
When the market corrects, you’ll get hammered.
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