Although these home improvement retailers are experiencing a boom, the current recession will not last forever.
Being an industry leader is valuable. After all, companies with dominant market share tend to generate huge profits in their niches, along with faster sales growth.
This is true even during cyclical economic downturns. The home improvement industry is experiencing that right now.both home depot's (HD -1.29%) and lowe's (low -1.44%) Business is currently shrinking as consumers scale back real estate spending. But Home Depot gave several reasons in its recent earnings report to make investors more optimistic about its long-term outlook. Let's take a look at some key factors that make stocks of industry leaders stand out as better buys.
1. Stable demand trends
Both companies reported a 2% drop in same-store sales for the sale period that ended at the end of July. A closer look at Home Depot's demand trends reveals some positive signs of strength.
For example, customer traffic decline improved to a 2% decline from a 5% decline in the previous quarter. Home Depot has seen more demand flow through its online sales platform, with shoppers willing to spend on smaller projects in areas like plumbing and outdoor gardening supplies.
The win here almost completely offset the decline in big-ticket projects such as consumer electronics. And without the sharp drop in lumber prices, average spending would have been about 2% higher (rather than flat). Yes, the industry is seeing lower spending levels. But Home Depot, as it has in all previous economic downturns, has responded well to the challenge.
2. Economic victory
Home Depot's two core financial metrics reflect the company's leading position in the industry. The first is profit margin, which last quarter was more than 15% of sales. In mid-August, the company confirmed its outlook for operating profit to exceed 14% of full-year sales. Lowe's is targeting his 13.4% to 13.6% profit margin.
Low Operating Margin (TTM) Data by YCharts
Home Depot's return on invested capital (ROIC) is also higher than its smaller rivals. Both retailers' metrics have deteriorated in recent quarters due to a combination of weak sales and rising interest rates, but Home Depot's ROIC for the quarter was more than 40%, while Lowe's was close to 30%.
ROIC is a good metric for investors to follow because it reflects management's ability to efficiently allocate incremental capital. Home Depot has a proven track record in this regard, including using low-interest debt to help fund aggressive stock buybacks.
3. Check price
Home Depot's stock has underperformed its smaller peers in 2023, making its valuation slightly more attractive by comparison. Now, from three times his annual sales during the pandemic, he can own this industry giant with 2.2 times sales. In contrast, Lowe's stock is trading at 1.5 times sales. Home Depot's dividend yield is 2.5%, compared to Lowe's 2%.
Some investors may like Lowe's stock here simply because of its discounted valuation. The company is also making progress in closing the performance gap with Home Depot in key areas such as sales growth and profitability. Further gains here could bring Lowe's valuation closer to that of its peers.
But Home Depot has dominated in these categories through many economic booms and busts. Perhaps it will bring the industry out of this doldrums, as it has in previous recoveries. Fundamentals such as an aging housing stock and favorable demographic trends will support economic recovery. “We are bullish about the future of this market,” CFO Richard McPhail said on a recent conference call. Investors should be similarly bullish about Home Depot's stock's long-term prospects.
Demitri Kalogeropoulos holds a position at Home Depot. The Motley Fool has a position in and recommends Home Depot. The Motley Fool recommends Lowe's Companies. The Motley Fool has a disclosure policy.
