Saturday, August 23, 2008

Home Depot vs Lowe's

Too many investment decisions are made with a blind bias towards choosing the company with the most market share. But profitability is what investors should be looking for, not market share. In this article by Todd Sullivan, he suggests that to avoid losing market share, Home Depot desperately needs to invest all its savings into remodeling old stores to get the stores on par with Lowe's. It's quite possible that this would increase profitability, but the argument is unconvincing, as it relies on no profitability data whatsoever.

In this article, we examine the data between these two companies in order to determine the relative strengths and weaknesses of these two home improvement retailers, in order to give us hints into what each company could be doing better.

Because Home Depot is much larger than Lowe's, on the revenue side it makes sense to compare these retailers on a sales/sqft basis. In this article on Build-a-Bear, we showed a chart listing the sales per square foot of several retailers. Here is that chart reproduced below, but isolating for the two home improvement behemoths:

Of course, this is only the sales side and doesn't necessarily transform into profitability. After all, it's quite possible that Home Depot is selling the same goods as Lowe's, but for cheaper, and therefore making a smaller profit on each sale. So let's take a look at the companies' gross margins:

Indeed, we do see (from the gross margin percentage) that Lowe's is able to mark-up its products more than is Home Depot, somewhat making up for the lower sales numbers. Nevertheless, we still see (above) that Home Depot makes a larger gross profit per square foot, after taking into account their higher sales per square foot.

But we're not done here. If Home Depot advertises more than Lowe's, or spends more on training or giving their stores visual appeal, they may still prove to be less profitable, so let's take a look at general, administrative and depreciation expenses as a percentage of sales: last fiscal year, these expenses represented 24.2% of sales for Home Depot, and 24.9% for Lowe's.

The result, all said, is that Home Depot actually makes a few bucks more per square foot than does Lowe's. Now, this was just an initial glance at the two companies, and is far from perfect. Being the larger company, Home Depot should benefit from economies of scale, but as Lowe's catches up in size, we may see their margins improve. Also, being the older company, Home Depot may be benefiting from having better locations, which will cost them on lease renewals in the future or tie up capital for owned locations. Furthermore, we haven't even begun to consider the capitalization structures of these companies in order to determine whether shareholders are getting the best bang for their buck.

However, at least it's a start. This is far better than jumping to conclusions on anecdotal data that Home Depot must spruce up all its stores, improve its lighting, better train and better pay its employees. Home Depot's plan of closing its least profitable stores, slowing down new store openings, and refurbishing certain stores could result in better profitability without the huge overhaul that many are calling for. We'll find out soon enough!

Disclosure: Author has a position in both HD and LOW


Anonymous said...

I'm not sure what you mean when you call Home Depot "the older company", But Lowes, as a company, is much older. Lowes was founded in 1946, went public in 1961, and began trading on the NYSE in 1979, the same year HD opened their first stores.

Saj Karsan said...

You're right, Anon, the use of "older" is not clear. But since HD has many more stores, while Lowe's is playing catch-up, many of HD's stores have been around longer, which is the context I refer to.

SteveNTexas said...

Do you have any opinion on whether each will expand? I live in Rockport 30 miles north of Corpus Christi. Lowes is 6 miles away in Aranasas Pass. HD has two in Corpus.

Does that give them enough market penetration or would you think they may add a store in our town of 11,000?

IS there anywhere where these companies list sales per store?

SteveNTexas said...

Is there anywhere where one can find sales per store?

I'm wondering if either company is planning to expand to my town of Rockport TX, there's a Lowes 7 miles away in Aransas Pass and two HD's and a Lowes in Corpus Christi 32 miles ( but no traffic issues-just 32 min away).

I don't think our town of 10,000 would be a good market that hasn't already beeen penetrated by both but one never knows how they think?
Do you?

Saj Karsan said...

Hi SteveNTexas,

Considering the state of the housing market, I wouldn't expect any meaningful expansion from these companies.

They don't list the sales of individual stores, but to get an average you can divide total sales by number of stores.

Anonymous said...

Bar graph is a bit misleading. At first glance it makes lowes looks like a drop in the bucket.

Anonymous said...

My take is that HD is in major need of a makeover! Tired looking stores, associates wearing those awful dirty, tattered and paint splattered aprons needs to go. In this regard HD is losing ground to crisp looking, much better Lowes. HD are shelf pilers, Lowes are merchandisers, better assortment planners with much greater presentation skills with brighter and more inviting stores.

Dean Booso said...

I am a bigger Home Depot fan. They have better lumber, and you can get nice discounts for seconds wood and broken bags of landscape materials. I used to shop at both, but t had customer service issues at Lowes, so switched to mostly Home Depot.