U.S. Markets open in 6 hrs 28 mins

Home Depot and Lowe's: A Tale of Two Cities

Motley Fool Staff, The Motley Fool

As earnings season winds down, Motley Fool Industry Focus podcast host Jason Moser and guest analyst Asit Sharma analyze the most recent quarters of home-improvement competitors Home Depot (NYSE: HD) and Lowe's Companies (NYSE: LOW). Continuing a familiar pattern, investors endorsed Home Depot's earnings while panning the report issued by Lowe's. To find out why Lowe's is stumbling but may rebound, and why Home Depot remains a compelling investment opportunity, simply click below!

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

More From The Motley Fool

This video was recorded on May 28, 2019.

Jason Moser: Let's take a quick look here at the quarter in home improvement. Two companies you and I follow pretty closely here, Home Depot and Lowe's. Seems like it was a bit of a tale of two cities, so to speak. Home Depot with a good quarter, rather tepid market reaction. Lowe's, not a bad quarter, but it wasn't good enough, and the guidance was a little concerning, and the market's really been selling the stock since then. What stood out to you between the two as far as the disparity here?

Asit Sharma: You know, Jason, these two companies were some of the first companies that I covered with you several podcasts ago. I remember us talking about Home Depot just being in a great position to optimize good business, and Lowe's being in a turnaround phase. And yes, the guidance was weak from Lowe's. The stock is down about 16% since reporting last week.

What stood out to me is that the market investors were expecting higher earnings. Lowe's had sales of $17.7 billion. That was a growth rate of 2.2%. And comparable sales looked great. They were up 3.5%. But the company's diluted earnings per share of $1.31 plus that outlook that you talked about really unnerved investors. Investors feel like, with this top line growth, the company by now should be turning out more bottom line profit. But it's not easy to turn around a business which has subpar systems. This is something that CEO Marvin Ellison, since he came on board, has preached, that the company has outmoded processes for tracking inventory, for pricing, for keeping up with cost escalations, even sales associates don't have great technology in terms of mobile devices they can use, which they're currently upgrading. So what you're seeing is, it's not so easy to turn spaghetti into higher margins. I think that many people are perhaps missing that this is going to be a several-quarter exercise for Lowe's still.

I'll give you one example in merchandising. The company has had a huge turnover, I think they have replaced two out of three top executives in the last several quarters. And their merchandising systems, the ones that they keep track of in order to be able to, in real time, move pricing when their cost escalates, those still aren't up to par. This quarter, CEO Ellison said, "Look. We had costs go up on us from raw materials increasing, but our system could not communicate quickly enough for us to adjust pricing. It's part of the reason why our margins went down." This is not a great situation, but it's a good problem to have. I'd like to point out that being cognizant of the core issue in an organization is the first step toward getting better.

I personally think Home Depot is probably still the better buy, but don't ignore Lowe's. It's not necessarily on a long downhill slope. This is just the tough work of getting your ship back in order. What are your thoughts on the two quarters?

Moser: There's no question that Marvin Ellison has a multiyear project on his hands. It's not going to be an easy turnaround. And I think he's doing the things that need to be done. It's never easy when you're having to do that in the face of a competitor that continues to perform well. I think with Home Depot, clearly, they're separating themselves when you look at things like big ticket comp sales, sales that are over $1,000, that was up 4% for the quarter. But I think when you look at where Home Depot is really shining, it's with the pro customer. That pro customer now represents close to half of overall revenue. They're building a very robust rentals business from that as well. Just to show you some of the math behind that, several years ago, they may have rented tools to one out of 10 or so of their professional customers. Now that number's closer to one in four. Building a robust rentals business, and that certainly results in those professional contractors buying more stuff from your stores as they come and rent those tools that they need to use on an ongoing basis.

I mean, you can see where Home Depot's really executing. You can see where Lowe's really needs to get some work done. But to your point, it's not like Lowe's has been a bad investment. Over the last five years, the stocks have essentially tracked one another. You stretch that out to 10 years, Home Depot separates itself a little bit. But, again, it's not like Lowe's has been a bad investment. Assuming that Marvin Ellison is on the right path here, I think there are reasons at least to be hopeful. But if you're looking for the no-brainer in the space, yeah, my money goes to Home Depot 10 times out of 10.

Asit Sharma has no position in any of the stocks mentioned. Jason Moser has no position in any of the stocks mentioned. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.