Home improvement retailer Lowe’s (NYSE:LOW) has completed the acquisition of Orchard Supply Hardware (OSH) for $205 million. Under the deal, Lowe’s has gained ownership and control of the majority of Orchard Supply’s assets, including 72 stores. However, it has also assumed responsibility for payables owed to nearly all of Orchard’s supplier partners. 
Orchard Supply had earlier filed for Chapter 11 bankruptcy protection after being weighed down by years of declining sales, an overcrowded California market and massive debt which it inherited from its parent company Sears Holding Corporation. ((Lowe’s to purchase Orchard Supply assets, The Deal Pipeline))
The bid looks like a smart move by Lowe’s to counter competition in the lucrative California real estate market from Home Depot, the nation’s biggest home improvement retailer. Home Depot has more than twice the number of stores as Lowe’s in California and they are located strategically, giving the company better access to consumers. ((Lowe’s bid for California chain could be used as model in Canada: analyst, The Globe and Mail))
Lowe’s Rationale For The Acquisition
The housing market in the U.S. is on a rebound. This is due to positive consumer sentiment as well as mortgage rates at near record lows. According to the latest data available from the National Association of Home Builders, the sales of new homes have been surging every month and reached 500,000 in June. The sales of existing homes continue to be strong as well. Also, according to research firm IBISWorld, the $164.4 billion housing market is expected to rise by an average of 3.1% annually in the next five years. ((Home Sales Data, National Association Of Home Builders))
The California market is booming in particular, especially because of its enormous population. Here, Lowe’s has only 110 stores out of its total 1,750 North American stores while rival retailer Home Depot has 233. Home Depot enjoys a further advantage as it is located in areas with high population density. OSH is also present in high-density, prime locations in California and has 89 of its 91 stores located in this state alone. In one fell swoop, Lowe’s can get access to OSH’s prime real estate properties without having to spend the time and a huge amount to build a presence on its own.
In the second quarter this year, Lowe’s reported net earnings of $941 million, a y-o-y increase of 26%. Sales for the quarter rose 10.3% to $15.7 billion. In comparison, Home Depot’s earnings for the quarter stood at $1.8 billion compared to $1.5 billion in Q2 2012, an increase of nearly 22.8%. Also, its net sales for the quarter stood at $22.5 billion, an increase of about 9.5% over Q2 2012. ((Lowe’s Q2 2013 8-K, SEC))
Furthermore, Lowe’s reported same-store sales rise of 9.6% in the second quarter after a dip of 0.7% in the previous quarter compared with the 10.7% and 4.3% boosts recorded by Home Depot. ((Home Depot Q2 2013 8-K, SEC))
Clearly, Lowe’s has lagged behind Home Depot in taking maximum advantage of the economic recovery currently underway, and one of the factors for it is Home Depot’s strong performance in the California market.
The Way Forward
OSH’s stores will be allowed to retain its brand name, management team and employees and will operate as a standalone business. Lowe’s management thinks that OSH’s business has the potential to grow and high debt is the only major factor inhibiting its viability. The OSH stores are known for providing an intimate feel to consumers so Lowe’s is probably keen to avoid tinkering too much with their operations.
We have a $41 Trefis price estimate for Lowe’s stock.Notes: