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Lowe's Will Never Stop Improving and Remains a Strong Buy


NEW YORK (TheStreet) – "Never stop improving" is Lowe's (LOW - Get Report) motto and management understands what it must do to satisfy Wall Street's appetite for profits. The company has begun to lay the foundation.

The stock closed Monday at $50.45, up 1.8% on the year to date, besting the 0.26% decline posted by the home improvement sector. Rival Home Depot (HD)  has posted gains of just 2.7% in 2014. That's part of Lowe's problem.

You see, it doesn't matter how well Lowe's performs. The company will always be measured by how well Home Depot does. This is a pattern frustrated Lowe's shareholders know all too well -- analysts can't stop pulling out the measuring tape. Fairly or unfairly, that's Lowe's reality.

What I think is more important consider is the extent to which the U.S. housing market will continue to rebound. Unless investors believe another collapse is imminent there should be plenty of business for both Lowe's and Home Depot to prosper. This is not, however, how Wall Street is evaluation Lowe's.

With the stock trading at around $50 per share, Lowe's is valued at a price-to-sales ratio of 0.9. Consider, this is 50 basis points below the industry average P/S of 1.44. And 1.44 is exactly where Home Depot is priced at.

In my view, management's recent guidance, which includes 4% increase in same-store sales and a 65-basis point jump in operating margin, tells another story. Management expects to make the sort of growth and efficiency improvements that makes Lowe's a solid investment. On the basis of long-term revenue and margins expansion, these shares should be worth $55 to $60 in the next 12 to 18 months.

What's more, based on 2015 earnings estimates of $3.14, Lowe's price-to-earnings ratio drops to around 15, or 4 points below the industry average. Home Depot, on the other hand, commands a forward P/E of 16.34, roughly a full point higher than Lowe's. This is even though Lowe's is growing earnings at a faster rate (15.6% vs. 12.5%).This doesn't make sense.

The other thing is, Lowe's management projects to grow full-year revenue by 5% versus Home Depot's projected growth 4.7%. And when you factor Lowe's projected year-over-year earnings growth of 21%, compared to Home Depot's 17%, Wall Street will have no choice but to adjust for this discount.

So while I do love Home Depot's business and its prospects, there is still plenty of value in Lowe's. The company is in the midst of a significant store expansion. Aside from opening close to 80 new locations in 2013, Lowe's is rapidly expanding is footprint on the west coast. Management's $205 million deal last year for Orchard Supply gives Lowe's access to new urban areas in California.

Management is working quickly to extract value from this deal. To that end, the company's efficiency improvements in areas like logistics and cost management should spur long-term free cash flow and earnings. Not to mention the boost Lowe's may see from ongoing improvements in the housing environment and potential increases in minimum wage laws. All of which will help consumer have more money in their pockets to consider home-improvement projects.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

TheStreet Ratings team rates LOWE'S COMPANIES INC as a Buy with a ratings score of A+. TheStreet Ratings Team has this to say about their recommendation:

"We rate LOWE'S COMPANIES INC (LOW) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, increase in stock price during the past year, impressive record of earnings per share growth, compelling growth in net income and expanding profit margins. We feel these strengths outweigh the fact that the company has had generally high debt management risk by most measures that we evaluated."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • LOW's revenue growth has slightly outpaced the industry average of 0.3%. Since the same quarter one year prior, revenues slightly increased by 2.4%. Growth in the company's revenue appears to have helped boost the earnings per share.
  • The stock has risen over the past year as investors have generally rewarded the company for its earnings growth and other positive factors like the ones we have cited in this report. Looking ahead, unless broad bear market conditions prevail, we still see more upside potential for this stock, despite the fact that it has already risen over the past year.
  • LOWE'S COMPANIES INC has improved earnings per share by 24.5% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, LOWE'S COMPANIES INC increased its bottom line by earning $2.13 versus $1.68 in the prior year. This year, the market expects an improvement in earnings ($2.61 versus $2.13).
  • The net income growth from the same quarter one year ago has exceeded that of the S&P 500 and the Specialty Retail industry average. The net income increased by 15.6% when compared to the same quarter one year prior, going from $540.00 million to $624.00 million.
  • 35.50% is the gross profit margin for LOWE'S COMPANIES INC which we consider to be strong. It has increased from the same quarter the previous year. Regardless of the strong results of the gross profit margin, the net profit margin of 4.65% trails the industry average.

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