The Lowdown on LOW Pricing

by Kyle Woodley | November 19, 2012 1:17 pm

For about a year now, there has been much wailing and gnashing of teeth at JCPenney (NYSE:JCP[1]) as former Apple (NASDAQ:AAPL[2]) mastermind Ron Johnson has steered the retailing ship into a glacier. And some of the nastiest curses have been reserved for one of JCP’s two primary changes — a pricing shift to “everyday low prices.”

Funny that. No one was complaining about EDLP today after Lowe’s (NYSE:LOW[3]) rolled out its Q3 numbers.

LOW shares are enjoying a hefty 6% jump Monday as the home-improvement retailer announced a 76% surge in profits off a 2% increase in revenues. All told, earnings per share of 40 cents and revenues of $12.07 billion beat Wall Street’s respective estimates for 36 cents and $11.93 billion. And Lowe’s even enjoyed a 1.8% improvement in same-store sales to boot.

Seemingly not weighing on Lowe’s was the company’s own turnaround to everyday low pricing, which the retailer previously warned could take several quarters to catch hold with consumers. While it might be argued that Lowe’s results might have been even better otherwise, EDLP certainly doesn’t seem to be causing the full-scale destruction plaguing JCPenney.

Does CEO Rob Niblock have something that the mastermind of the Apple Store doesn’t?

Yup. Positioning.

Anecdotally…

I’m not discovering cold fusion here when I say that it’s better to have five competitors than 5 billion. Simply put, Lowe’s has a huge advantage over JCPenney in that there are fewer fish in the water.

While the breadth of Lowe’s selection means that occasionally Walmart (NYSE:WMT[4]) or Lumber Liquidators (NYSE:LL[5]) will pose threats on certain goods, it’s basically a two-horse race against Home Depot (NYSE:HD[6]). Sure, you’ve also got your local stores, but by and large, it’s hard to compete on the sheer economies of scale LOW and HD enjoy.

Then there’s JCPenney. Even among large mall department stores alone, it’s up against Dillard’s (NYSE:DDS[7]), Macy’s (NYSE:M[8]), Saks (NYSE:SKS[9]), Sears (NASDAQ:SHLD[10]) and Kohl’s (NYSE:KSS[11]). And I’ll spare you the laundry list of specialty retailers that compete with JCPenney on one front or another.

More important, we should keep in mind the sheer difference in shopping culture between home-improvement retailers and apparel/consumer goods.

I brag to anyone who’ll listen about the ludicrous deals I find while Christmas shopping. There’s excitement in the hunt[12] when it comes to clothes. And all you have to do is walk out JCP’s mall entrance door to access a host of competing deals.

Not that people looking to furnish their deck or install home lighting aren’t frugal — they are, and considering the scale of the purchases, they should be — but there isn’t the same in-your-face sales barrage between Home Depot and Lowe’s trying to mercilessly undercut each other with bigger and bigger deals. So when Lowe’s changed its pricing strategy, yes, it got dinged (as previous quarters’ numbers can attest), but Home Depot’s own hybrid system of trying to have everyday low prices with occasional sales was never set up to deliver a knockout punch.

Too bad none of that really matters in the long run.

Housing’s on the Rise, If You Haven’t Heard

While the disparity between Lowe’s and JCPenney’s performance post-EDLP is interesting, it’s essentially a footnote compared to what really matters concerning LOW stock.

Lowe’s is benefiting from the exact same thing bolstering rival Home Depot — a resurgent housing market. HD has gotten plenty of attention for eating away at Lowe’s’ market share and beating the pants off LOW stock this year (and for good reason). But Lowe’s stock still is up 35% this year — more than triple the S&P 500.

Broadly speaking, when housing picks up, home-improvement retailers have more people to supply. Consider this three-year chart of the SPDR S&P Homebuilders ETF (NYSE:XHB[13]), HD and LOW:

[14]

While Home Depot has vastly outperformed the other two over the time period, the general trends across all three are very similar. The big exception is May of this year, when Lowe’s showed some initial pain from its EDLP plan — but after that, it got right back in sync.

Of course, if you’re backing the horse with the momentum, I’d be remiss not to point out this three-month chart of the same three picks:

[15]

So, Which Should You Pick?

You can call it a copout if you want, but I call it logical: Unless you’re working with a really small amount of capital, pick (or avoid) both, depending on how you feel about housing’s prospects going forward.

Home Depot and Lowe’s are two extraordinarily similar stocks whose businesses almost completely overlap … to the point where any outside competition would seemingly hurt one as much as the other. And looking at a broad swath of important metrics, there’s little convincing me otherwise.

	Lowe’s	Home Depot
Dividend Yield	1.87%	1.83%
Trailing P/E	22.64	22.39
Forward P/E	16.85	18.22
PEG	1.26	1.27
Price/Sales	0.72	1.27
Beta	1.19	1.03
Cash/Share	$2	$1.72
Debt/Equity	64.77	60.96
FY14 EPS Growth	+22%	+14%
Short % of Float	1.3	1.3

The one number that stands out there is next fiscal year’s projected earnings growth, but remember, Home Depot is working off much better numbers from this year.

Picking Lowe’s vs. Home Depot seems almost futile unless you really think one is set to absolutely decimate the other, and considering Lowe’s seems to be recovering from EDLP, I don’t see that disruptor yet.

So rather than picking one or the other, decide whether you think American housing will continue to recover … and by proxy, whether the home-improvement retailers will continue riding on its back (it should). You get protection with HD should Lowe’s pricing strategy end up flopping, and you have protection with LOW should it work.

Of course, neither helps you if housing falls off a cliff. But that’s a story for another day.

Kyle Woodley[16] is the Assistant Editor of InvestorPlace.com[17]. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @IPKyleWoodley[18].

Source URL: https://investorplace.com/2012/11/the-lowdown-on-low-pricing/

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