There are a lot of reasons to like Lowe’s Companies, Inc. (NYSE:LOW) stock at the moment. And that hasn’t always been the case. LOW stock traditionally has underperformed that of its key rival, Home Depot Inc (NYSE:HD). Even excluding HD’s higher dividend yield, investors in HD stock have received about 30 percentage points more return over the last five years than their counterparts in Lowe’s stock.
But LOW stock may be positioned to outperform HD stock — and the market overall — going forward.
Lowe’s stock has a number of catalysts in its favor at the moment. With a bit of cooperation from the housing markets, LOW stock should be one of the better-performing large-caps over the next few years.
Strong Quarter and Year for LOW Stock
Lowe’s stock jumped 9.5% after the company’s first-quarter report in early March, and with good reason. Results were strong across the board. Adjusted earnings-per-share of $0.86 crushed consensus expectations of $0.79, and increased a sharp 46% year-over-year. Even considering some likely help from better weather in key markets, that’s a huge earnings increase for an established company. Full-year adjusted EPS rose 21%, with same-store sales up 4.2%, including a 5.1% jump in Q4.
Admittedly, Lowe’s same-store sales in Q4 were a bit below those of HD, but the gap is smaller than it has been of late. Meanwhile, guidance for 3.5% comps looks possibly conservative, and Lowe’s expects to turn those revenues into a 16% increase in earnings per share — even with FY16 (ending January 2017) having an extra week, and thus a tougher comparison. And it certainly appears that Lowe’s stock has room to grow considerably beyond just next year.
Can Lowe’s Stock Outperform HD Stock?
Looking forward, there are a number of multi-year catalysts behind LOW stock. The gap between Home Depot and Lowe’s in terms of revenue seems to be narrowing. Home Depot outperformed LOW stock by 200 bps for the full year, but just 70 bps in Q4. The nature of incremental margins are such that if Lowe’s can grab a few more dollars from its rival, its earnings should expand nicely.
Meanwhile, the housing cycle seems to imply a tailwind for both LOW stock and HD. Housing starts numbers have been solid so far in 2017, and renovation activity appears to be picking up as well. Both bode well for sales to not only do-it-yourself individual customers, but the large-volume commercial clients that drive a good chunk of Lowe’s revenue.
And there’s one more, somewhat hidden, catalyst: The continuing decline of Sears Holdings Corp (NASDAQ:SHLD). Sears competes with Lowe’s in both hardware and appliances. And the revenue being shed by that struggling company — both through store closures and declining same-store sales — has to go somewhere. Sears (not including Kmart) saw revenue decline by $1.5 billion in its most recent fiscal year. Some of those lost sales will make their way to Lowe’s.
In fact, one analyst has estimated a 50-plus basis point tailwind to comparable sales for both Lowe’s and Home Depot each year from Sears’ struggles. And with the decline at that retailer not likely to end any time soon, if ever, that benefit should persist for some time.
Bottom Line on LOW
And yet, Lowe’s stock is priced very reasonably. LOW trades at about 15x its FY17 guidance of $4.64. In comparison, HD trades at over 18x its guidance and a two-turn premium on an EV/EBITDA basis, as well.
If Lowe’s can narrow the growth gap — as it has done of late — the valuation gap between LOW stock and HD should narrow in turn. A 19x multiple plus the 1.7% dividend paid by Lowe’s stock implies about a 9% return over the next year. Any outperformance, or strength in the industry as a whole, puts total return into the double-digits on a percentage basis.
And I’d expect some outperformance this year — and perhaps a rising tide for both HD and LOW in terms of earnings and multiples. Consumer confidence is up. Home builders are optimistic. Few, if any, retailers have the same protection from e-commerce and Amazon.com, Inc. (NASDAQ:AMZN).
Lowe’s stock is near an all-time high, but hitting $100 by 2018 hardly seems an outrageous expectation. A 19-20x multiple — up modestly due to rising optimism — and $5+ in 2018 EPS gets the stock into the triple digits.
That’s a 20%+ return in as little as a year, and that’s worth paying attention to. And so is LOW stock.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.