What Do The Home Depot and Lowe's Earnings Mean for Our Portfolio?
There's a far superior investment to benefit from larger remodeling activity
For the first time since the October 2022 quarter, Lowe’s and Home Depot both reported positive same-store sales growth.
“Our results this quarter were once again better than expected, as we continue to gain traction with our Total Home strategic initiatives,” said Lowe’s Chief Executive Marvin Ellison. “We remain confident in the long-term strength of the home improvement industry, and we are equally confident in our strategy to capitalize on the expected recovery.”
After two years of negative comps, the post-COVID normalization, interest rate cycle not supporting a high level of large remodels, things are stabilizing. Excess demand has now faded fully, which means that the overall home improvement industry should return to positive comps over the next year(s). One of the drivers is expected to be a gradual improvement in average ticket after a period of disinflation or even deflation.
Yesterday, we put on an options position in Lowe’s, following Home Depot’s solid report and investors reacting favorably. Given that the implied volatility in Lowe’s options hadn’t come in, the short-term premiums were inflated. It was not a free lunch, but the setup was highly attractive.
Relative to Home Depot, Lowe’s is more cheaply valued because of different channel and product mix, but that should only bode well for cash returns to shareholders: more buybacks are being done at lower multiples. In fact, its board authorized a new buyback program of 15 billion USD last December. A lot of dry powder…
In the past quarter, Lowe’s bought back 1.4 billion USD of its own stock. Free cash flow was solid at 7.7 billion USD in FY24, which is an attractive yield relative to its market cap of 136-140 billion USD.
Just like Home Depot, Lowe’s experienced a favorable weather and hurricane impact. Looking ahead, though, both players aren’t upbeat about the trends in remodeling/housing, which could provide a nice kicker if and when things turn for the better.
In any given year, roughly 90-95% of home improvement demand is coming from homes that aren’t turning over with 60-70% in maintenance related items. Put another way, the business is discretionary to some extent with higher turnover needed to drive more demand, but within that basket, the more defensive categories like paint (Sherwin-Williams) should continue to perform well.
Nonetheless, at 19-20x NOPAT, slower-growing but very shareholder-friendly names like Home Depot and Lowe’s are more like staples with a not so favorable return outlook. That’s we like a far superior investment with:
35% ROIIC (based on current reinvestment need, inflation-adjusted incremental invested capital) on tangible assets, 7 times its nearest peers’;
mid single-digit market share globally, with >40% of the business now coming from North America;
high-forties percent ROI on growth expenses that are reflected in its P&L (marketing, sales/professional support functions);
NOPAT per share growth of mid-teens percent for the nexts several years vs. close to zero percent growth for other players;
an EV-to-NOPAT valuation of 18.0x for FY26 and close to 15x for FY27.