Lowe's Is Improving on Its Success

NEW YORK (TheStreet) -- When it comes to home-improvement stores, there's always been a domestic battle between Lowe's (LOW) and its larger rival Home Depot (HD). There's no shortage of opinions on which company is better.

Over the past several quarters, the scales have tipped in the favor of Home Depot. But that's not because Lowe's has lumbered around. Its stock is down 5% for the year to date, as of Friday's close of $47.06, while the S&P 500 is down over 12% for the same period.

In terms of market share, Home Depot is the clear-cut leader. But even with Home Depot's edge in areas like merchandising, cost management and logistics, Lowe's stock has outperformed its rival by decent margins. The company's slowly narrowing the gap because management adheres to Lowe's slogan, "Never stop improving."

Lowe's recent $205 million acquisition of Orchard Supply (OSH) is a perfect example. This deal was aimed at expanding Lowe's urban footprint in areas like California. To that end, given the modest improvements we've seen in the American housing recovery, Lowe's is poised for both solid expansion and improved same-store sales. This is the metric that tracks the performances of stores that have been opened at least one year.

In that regard, I believe too much has been made about the company's perceived struggles. I'm not suggesting that Lowe's has been a standout. But I've been impressed from the standpoint that despite headwinds, the company has always delivered on the bottom line. This is something I expect to continue when Lowe's announces fourth-quarter and full-year results on Wednesday.

The Street will be looking for 31 cents in earnings per share on revenue of $11.69 billion. These figures represent a 20% and 6% jump in earnings and revenue, respectively. By contrast, analysts predict a 6% increase in profits for Home Depot. This is while the company is projecting a 2% decline in revenue. Investors ignore this sort of disparity when debating this rivalry.

As strong as this quarter is expected to be, I'm curious to see if Lowe's can sustain the uptrend in margins it has demonstrated over the past couple of quarters. With poor results coming out from Wal-Mart (WMT) and other retailers, blaming the winter weather for sluggish performances has become the trend.

To the extent management can post higher margins to demonstrate the sort of operational leverage the Street craves, the stock should respond well. By "operational leverage" I'm referring to, say, a double-digit basis point a jump in gross margin. Only then will investors buy into management's initiatives to improve operational efficiency. Investors want to see the dividends -- but Lowe's has already proven this.

Don't forget, Lowe's is coming off a solid November quarter that produced more than 7% revenue growth. This beat the consensus estimate handily. Even more impressive was that same-store sales advanced 6.2% year over year. With the company generating (on average) over $7 million in revenue per store, management made every bit of that traffic count.

What this means is management knows how to squeeze out strong profitability from each store location. So although it's still premature to say Lowe's has leapfrogged Home Depot in terms of size and operational efficiency, the Street should credit management for its work to close the gap. But don't assume the company is content with second place.

All told, I don't see any noticeable weaknesses in the company's current status. There is always room for better merchandising situation and improved cost structure. But there isn't a retailer that is ever satisfied with these areas. In that regard, given Lowe's strong comps of late, Michael Jones, the company's new chief merchandising officer has pushed the right buttons.

Again, this is not to say Lowe's should suddenly take its foot off the gas pedal. We should agree, however, that this race with Home Depot is much closer than previously thought.

At this point, Lowe's is the better investment. With the Orchard deal in hand, management seems more willing to take the sort of risks necessary to return long-term value to shareholders. This supports a valuation of $55 to $60 in the next six to 12 months.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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