Is Lowe’s A Better Pick Over Home Depot Stock?
Home Depot stock (NYSE: HD) has grown by close to 38% since early February 2020 after the WHO declared the Coronavirus a global health emergency, while Lowe’s stock (NYSE: LOW) has gained about 67% of its value. Both home improvement retailers have benefited from the Covid-19 wave as customers spent more of their disposable cash on home improvement projects rather than on vacations or dining out. But is Home Depot stock appropriately priced compared to Lowe’s stock? We believe that Home Depot stock is overvalued compared to LOW stock, due to the notable mismatch in their current P/S multiples when compared with revenue growth and operating margins for the two companies over recent years. Home Depot’s P/S multiple of 2.5x is substantially higher than the figure of 1.6x for Lowe’s. Our dashboard Home Depot vs. Lowe’s: HD stock looks overvalued compared to LOW stock details the full picture based on revenue growth and operating margin – parts of which are summarized below.
1. Revenue Growth
While Home Depot still generates 1.5x more revenues than Lowe’s, the latter’s revenue growth was higher in 2020 (24% vs 20% for HD). Throughout the pandemic, Lowe’s outdid Home Depot in comparable sales and revenue growth, gaining on Home Depot’s top spot.
- Lowe’s comparable sales of 26.1% managed to surpass Home Depot’s comp sales of 19.7% in fiscal 2020. For comparison, comparable sales growth was recorded at 2.2% for Lowe’s and 5.2% for Home Depot in 2018. A similar growth trend was witnessed in 2019, where Lowe’s comps grew 2.6%, while Home Depot’s comps grew 3.5%.
- Of course, the odds of either retailer sustaining their recent levels of 20%+ growth, post-Covid, are slim. But both home improvement company’s have invested quickly and heavily to build out their digital capabilities to accommodate this demand surge during the pandemic. In fact, these capabilities could bring in customers even after the pandemic has run its course.
- The increase in remote working could be longer-lasting than expected, which will allow these companies to serve those customers looking to build and maintain a home office beyond the Covid crisis. In addition, as a consequence of the pandemic, more people are deciding that owning a home is a better bargain than renting an apartment – which means more business for home improvement retailers.
2. Operating Income
- Home Depot’s operating margin came in at 13.9% for the last twelve-month period 0f 2020, higher than Lowe’s operating margin which stood at 8.6%
- Over the last twelve months, the operating margin for Home Depot changed by -0.5 pp (percentage points) – worse than the change of 0.8 pp for Lowe’s. In fact, a similar trend was seen a year ago where the operating margin for Home Depot change was flat and Lowe’s saw a 3.0 pp growth.
- The expansion in Lowe’s operating margins was brought about by a decline of 370 basis points in selling, general, and administrative margins (SG&A as % of sales) from 24.4% in 2018 to 20.7% in 2020. On the other hand, Home Depot’s SG&A margins grew from 10.8% in 2018 to 18.5% in 2020.
The net of it all
In summary, the net advantage moves back to Lowe’s based on its higher revenue growth and better operating income growth in the current scenario as compared to Home Depot. While Home Depot is still more profitable, Lowe’s stock has performed better in 2020. Despite Lowe’s and Home Depot trading at an almost similar 2x projected 2021 revenue, Home Depot shares are trading at twenty-five times estimated FY 2021 earnings, and Lowe’s at twenty times the same estimates relative to projected earnings.
While HD stock looks overvalued compared to Lowe’s, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how the stock valuation for Home Depot vs. Quest Diagnostics shows a disconnect with their relative operational growth. You can find many such discontinuous pairs here.
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