While I typically view myself as a long-term investor, I also try to read the tea leaves and understand how a company’s fundamentals are shaping up. That way, I won’t be totally surprised when the company reports earnings. Sometimes, it makes sense to take signals appropriately and reduce a position you think is shaping up for failure.
This is a tough decision to make, but I think it makes sense to reduce CorePoint ahead of earnings. I say that based on the following:
Booking Issue Lingered: We know the booking “disruption” from Q2 has lingered in Q3. This literally means they are losing customers because they can’t book on the site. They said it on the call.
“On July 30, 2019, we gave notice to LQ Management that we believe there are several events of default under the management agreements relating to all of our wholly owned properties” – so they waited until one month into the quarter to serve a default notice…
“On our first quarter call, we noted we were seeing early indications of disruption, in particular, a decline in ADR from the transition and integration of our hotels to the Wyndham platform in April. Unfortunately, that has not yet abated, and July’s RevPAR on a comparable basis was down 5.2% with continued market share loss.” – so we know in July RevPar was down ~5% compared to -6% for Q2.
While this should be temporary, I think they clearly tried to signal that the impacts would linger.
Oil price and rig count is down: We know that CPLG has heavy exposure to Texas and the oil producing regions, which is why some look at oil as a proxy. As shown below, this does not bode well for improving results or an increase in guidance compared to Q2’19.
Hurricane Imelda: There is a chance that Hurricane Imelda had a significant impact on results. While not discussed as much as Hurricane Florence and Irene, Imelda caused significant flooding in Texas. We already saw what Hurricane damage did to CPLG before, so I am thinking it likely pressured results in some way (e.g. took some rooms of the table).
CPLG’s price has recovered: CPLG’s stock was at $10.9 before it reported its last atrocious quarter and now is at $9.7. While I think it is technically cheap, I also think the stock price will follow fundamentals. I think the chances are higher that I’ll be able to nab at a better price post-quarter.
How could I be wrong? Well, I am essentially trying to trade CPLG around earnings, which is usually a losers game. The company also could have resolved the booking issue much faster and that will improve their outlook. Lastly and more importantly, I think the story continues to be around the asset sales. With the stock at such a low p/BV, selling assets above book is very accretive. This is where I am the most concerned on reducing.
Unfortunately, I think this means guidance will have to be reduced from $155MM at mid-point. The company previously guided RevPar to be flat to up 2%, then revised it to down between 2.5% and 4.5%. That new guidance, while abysmal, banks on a recovery in the 2H that I just do not see happening.
Is management stepping in to buy stock? This could be a good signal of how the quarter was shaping up, how they view the prospects of the company, how fundamentals are moving etc.
Sadly, no. Only a director bought right after Q2 ($4,400 ain’t much) and I don’t see any other members of management stepping up.
Tax-loss harvesting is something I tend to think about after a strong year of equity returns. I find myself asking if I should reduce risk in some names or at least re-balance the portfolio. The problem is that this can create significant capital gains. That said, if you are like me, you probably have some investments that did considerably well this year and some that have done not so well (they generated losses). We can use those poorer performing investments to help offset our capital gains, reduce our taxable income, and even compound our earnings at a better rate, all things being equal.
My goal of this post to provide examples of tax-loss harvesting scenarios that will allow investors to not only understand the concept better, but also save money.
The basics are simple – an investor typically sells a stock or fund that has losses to offset another investment she is selling that will result in a gain. Let’s lay down the tax rules first so we’re all on the same page:
The short-term capital gain/loss is taxed at your income tax rate. Short-term capital gains can therefore be quite expensive. If you think it is fine to hold out for a year and a day, it might be worth it to do so. However, never let the tax tail wag the dog – if an investment could plummet, its best to take your winnings an move on.
An important thing to lay out in the beginning before we get into examples: short-term capital losses are worth more because they are taxed at the higher rate. That means they are best to apply to your short-term gains or long-term gains, rather than, for example, applying a long-term loss that is taxed at 15% to a short-term gain that could be taxed at 37%.
Example #1: Using capital losses to offset gains
Simple example. You have a $10,000 gain on ABC stock and also a $10,000 loss on XYZ stock. You sell ABC and XYZ to net each other out. Assuming a 15% tax rate, this saved the investor $1,500 (15% x $10k gain). Further, let’s say you take that saved income and earn 5% per year on it over 5 years (i.e. opportunity cost). That means you would also have an extra $414 after 5 years.
Example #2: Repurchasing the sold shares & avoiding wash sales
If we build on Example #1, we should discuss the “wash-sale rule.” This rule prevents someone from selling a stock for a loss for taxes and then immediately buying it back. The IRS requires you to wait 30 days before you can buy it back.
Let’s say the price of XYZ stock is still $90 after we wait 31 days, so we buy it back at the same price we sold. Over the next 5 years, our analysis was correct and it appreciates to $150.
Good outcome, right? We have a $50k gain on our investment, less what we owe in taxes ($7.5k), but also have what we saved in taxes from Example 1.
So are we in a better position? What if we didn’t sell XYZ in the first place?
We would have owed $1,500 in taxes in Example 1 and would not have benefited from the $414 time value of money.
As you can see below, it paid off to take the loss, despite having a bigger taxable gain in 5 years from the sale date.
That said, the total amount saved isn’t really that great. Don’t get me wrong, I would take an extra $414 dollars if it fell from the sky, but there must be a way to improve these results.
Avoiding the wash sale rule
One type of loss that is harder to measure is the loss associated with being out of the market as you wait to buy the security back.
However, you can buy a fund or security that achieves the same goal of that security as long as it is not “substantially identical” to the existing security. For example, you could sell the S&P500 ETF and buy an actively managed large-cap fund and face no issues.
Therefore, you can still be in the market and benefit while you wait.
Example #3: Think Short Term
While I am sure most people here view themselves as somewhat long-term investors, it is important to think short-term when it comes to tax losses.
The tax code says that long-term losses first offset long-term gains and short-term losses offset short-term gains. Anything left over will go to offset other gains.
The LEAST tax efficient thing to do would be to use short-term losses to offset long-term gains. That is because the difference in tax rates can be around 15 percentage points. In other words, I could have used my short-term losses to offset a short-term gain that I owe tax on at a 35% rate. But instead I am using them to offset something I owe tax on at 15% rate.
The table below attempts to show this. I sell AAA for $10k gain and BBB for a $10k loss, saving myself from $2k in taxes. However, BBB was worth $3,500 in taxes, so I missed $1,500 dollars in tax savings.
Are European equities cheap? I keep hearing that European that they are cheap relative to the US at least. It follows then that because the US has outperformed so much over the past 10 years, there is bound to be a reversion to the mean. This chart is often thrown around with no real context other than lower P/E means great buy:
I wanted to break that down and test the hypothesis. I downloaded the holdings for the S&P500 (from iShares IVV) and the Eurozone equities fund (EZU). But before we go through that, check out the relative performance.
Bottom line: Europe has gotten its A$$ kicked.
But wait – this isn’t totally true. We can’t forget currency’s impact on performance. The dollar has strengthened massively (since the US is the best house in a bad neighborhood). Here is the hedged Euro performance. Not nearly as bad as some pundits might have you believe over the past few years…
So how do the companies that make up the index compare? Here is my simple pivot tables using the weighted avg to assess the relative forward P/E multiples.
Note: the amounts don’t add to 100% due to rounding plus a small amount of cash held in the ETFs.
As we can see, looking 2 years out the S&P trades at 20.8x earnings compared to 16.0x for Eurozone. That does indeed seem steep. What is driving it?
Several sectors stick out: Consumer Discretionary, Tech, Real Estate and Financials.
Why does Consumer Discretionary trade so much higher in the US?
One word: Amazon. The company is labeled as consumer discretionary vs. Tech. Watch what happens when I relabel Amazon as a tech company.
It drops precipitously! Given Amazon is such a big weight in the index, it has a dramatic impact on the sector. It is still high relative to Eurozone, but not crazy.
I personally thought that the US would rank higher in P/E solely because of Tech. And that does seem to be a big driver. Including Amazon, Tech weighs in at almost a quarter of the S&P500. If I include Facebook and Google (currently in the communication sector) it would be close to 30%!
While remnants of the tech bubble make this a concern, I would rather have these businesses than not and think they actually trade at reasonable valuations. They grow 20% a year and are secular growth stories while also requiring little capital to grow.
So another adjustment here, but we’re starting to parse out the large drivers here.
One reason for the high multiples in the US is REITs. These entities pay no income taxes and should therefore trade for higher multiples. However, that’s not the whole story. Think about the best businesses in the REIT space: oligopolies, contractual rent escalators, increasing demand each year… Yes the tower REITs.
American Tower, Crown Castle and SBA Communications dominate the real estate sector. Arguably tech exposed as well, this is the big driver. In addition, they are investing heavily for growth and REITs tend to carry higher leverage. This means increased EBITDA but EPS can be pinched by interest in the short-term.
Last but not least… Financials. Look at where they trade in the US vs. Europe. More importantly, look at their relative weights. We all know the struggles of European banks due to (i) negative interest rates and (ii) weaker economies. Do I want to own those banks? Perhaps because some day their troubles will reverse… but for now, I’ll pass.
Bottom line: I don’t think Eurozone equities are THAT cheap. The further and further you peel back the onion, the more I want to buy the US vs. Europe. Is the multiple higher than Europe? Yes. Is it a concern how big tech has become in the US indices? Yes, but I also want to own those companies. As they continue to disrupt and change the way we do things, Europe’s older economy may be left holding the bag.
As one final comparison, here is what you are buying. In my view, missing secular growth and asset light businesses in exchange for “cheap” cyclical names (banks, Oil and Gas, Autos, Chems). I think the US will compound at a much higher rate going forward as well and should perform much better in a recession. If you think the US$ will depreciate or that we are headed for a tech crash, then sure, go with europe.
My firm recently began using Okta for security log-in purposes. In line with what Peter Lynch would recommend, when you hear about adoption of a product, go and check out their stock. Often times, Lynch would hear his children talking about a new toy, he’d buy the stock and profit as the rest of Wall Street caught up to the story.
While Okta is not a toy company, it is a hot topic for today’s investors. In my experience, I’ve seen Okta used as a security portal for employees in order to access the cloud where important files or information may be held. A benefit is that its simple to use and its multi-factor login creates a secure authentication process without multiple log-ins. For its customer platform, you and I may be logging in to JetBlue’s website and everything looks right, but behind the scenes Okta is powering the customer experience and making it secure.
The bull case for Okta is that as Cloud adoption grows, so will security needs. We’ve all seen and heard about data breaches in the past, so it will clearly be a big focus in the future.
Peruse any one of Okta’s filings and it is clear they are bullish on the cloud and what it means for them. In fact, Cloud is mentioned 285 times in their S-1 and they note, “According to International Data Corporation, or IDC, in 2016, the Cloud Software market is expected to be $78.4 billion and the Custom Application Development market is expected to be $41.2 billion. We believe that our platform is well positioned to address a meaningful portion of these markets.”
Notice they don’t say that is their addressable market. The fact is, it is likely a fraction of that, but undoubtedly it will be big. This growth has started to show in Okta’s numbers. In the FY ended Jan-2016, Okta did just $86MM in sales and in the LTM period Jul-19, they did $487MM. That is a 64% CAGR!
As expected, Okta’s growth has started to slow. It is simply impossible to sustain that rate forever. Analysts expect however that it will grow top line ~30% through 2021.
Getting to the valuation:
Let’s just say we think Okta can grow at a 30% CAGR for the next 7 years. Their GP margins, given it is a subscription model mostly, grow at high incremental rates. I will assume 88%. Given security is a constantly evolving business, I will assume that R&D is fixed as a % of sales, but roughly half of sales and marketing is fixed vs. variable (and grow at inflation) and G&A and back office are 75% fixed (likely an assumption, honestly).
What we see above is that if everything goes right and they grow at a massive rate, the company is still trading at 20x EBITDA 7 years from now…. I don’t see why I would buy this when Facebook is growing 20% a year and trades at just 10.5x 2020.
So what do you need to believe? I would have to say investors are banking on AT LEAST 40% top line CAGR with massive EBITDA growth (negative to $1.4BN) and that still only gets you to 10.7x EBITDA…. looking 7 years out. To me, this is crazy.
While Okta has some benefits of being “entrenched” in its customer base, I don’t think switching costs are that high. My firm used something before we moved to Okta… we could move again if we deem we are more protected or offered more for the same price. This is a constant occurrence in Tech and especially in cyber security… constant cannibalization and forming something new and better… often at the expense of incumbents.
I’ve been studying Bill Ackman’s portfolio and strong performance so far in 2019 and it seems the hedge fund manager is getting back to his roots. Gone are the shorts in Herbalife and aggressive long in Valeant, and instead he has waved in a new era of “high-quality, simple, predictable, free-cash-flow-generative businesses with formidable barriers to entry.” As shown in the slide below, it seems as if Ackman is positioning himself towards high-quality blue chip names. And not pictured, he added Berkshire Hathaway to the mix and existed UTX and ADP.
As a quick aside, this strategy is puzzling to me. For a hedge fund manager to be buying huge, blue chip stocks… it just seems odd. Perhaps it is due to his view on the business cycle and these investments, with good balance sheets, will perform fine in good or bad economic times. However, they also are now mostly consumer discretionary businesses. Maybe he is bullish on the consumer 10 years into an expansion? Odd indeed.
In this post, I am going to examine Lowe’s which Ackman’s fund, Pershing Square, now has a ~$1bn investment. This is an age old question. We have two companies in a big industry. Everyone knows their names… why and how do you pick one over the other?
Ackman’s thesis seems to rest on Lowe’s “closing the gap” with Home Depot. Ackman even says Marvin Ellison, the Lowe’s CEO announced in May 2018 who is an ex-Home Depot executive, was his top pick for the CEO job.
As such, I will be examining Lowe’s in comparison with Home Depot and also determining if there are any structural differences between the two companies. In essence, I will see if Ackman’s thesis has merit. I hope to finally tie that into valuation. Because so much of this report will be comparing the two building product juggernauts, this might as well be viewed as a report on both Home Depot and Lowe’s.
Lowe’s history dates back to the early 1920’s when it opened its first hardware store in North Wilkesboro, North Carolina. In anticipation of dramatic increase in construction following WWII, Jim Lowe (the son of the original founder) and his partner Carl Buchan began focusing on hardware and building materials. Following some years’ operating together, the two disagreed on focus and Jim Lowe split with his partner to focus on grocery (and started Lows Foods grocery chain) while Buchan operated Lowe’s.
The company expanded in the Southeast. After Buchan died in the early 60’s, his executive team took the company public with 21 stores.
In the 1980s, the company suffered against Home Depot and the big-box retail concept. Home Depot was formed in just the late 1970s and early 80s with the home-improvement superstore concept. Their first stores were built in spaces leased from JC Penney in Atlanta and began branching out in the southeast US. By 1989, Home Depot surpassed Lowe’s in annual sales.
Lowe’s resisted this big-box format, mainly arguing that Lowe’s served smaller, rural communities where a big box chain doesn’t make much sense. However, it eventually did succumb to pressures. Today, Lowe’s has ~2,000 stores and ~209 million square feet of store space and does ~$72BN in sales. Home Depot, in contrast, has 2,289 stores, ~240 million square feet, and ~$110BN in sales. More on these comparisons later.
Lowe’s and Home Depot operate in what is estimated to be a $900BN market. With $72BN in sales, this means Lowe’s has less than 8% market share while Home Depot has ~12%.
However, I will say it is unclear to me what this market size estimate includes. Obviously, the housing market is huge and the market that Home Depot and Lowe’s serve must be big given the size of their respective sales ($180BN combined). But if they’re including everything within home improvement, the addressable market is likely much smaller for the duo. They will never truly displace the lumber yard. Nor should they. That is a low margin, commodity business. Home Depot in the past as alluded the market is more like $600BN, which makes more sense to me.
The customer base is split in DIY (do it yourself) and DIFM (do it for me) customers as well as professional contractor customers. I think we can all understand the DIY / DIFM customers well. These people are doing repairs on their home and come into Home Depot or Lowe’s for a certain tool, toilet, door, window, flooring, etc. Lowe’s and Home Depot serve as a one-stop shop for them.
Contractors on the other hand are a bit different. This is the segment Lowe’s is now aggressively targeting. As noted at Lowe’s investor day in 2018,
“[Our] final focus area will be intensifying customer engagement. At the core of this objective is winning the Pro. We have a tremendous opportunity to grow this portion of our business. This is a customer that is very important because the typical Pro spends 5x as much as the average DIY customer.”
We will discuss this in more detail later on, but I can see the challenge of this sector of the market. Time is money for a Pro and when they need something, they need to go to one place. That is why specific building supply stores and distributors exist. Not necessarily for one stop shop of everything (cabinets and windows in the same purchase), but more like, “You need plumbing products for that job? Head to Ferguson. Need HVAC products? Head to Watsco.” There are also showrooms around the country to sell tile, flooring and cabinets specifically for the pro channel. For example, Fastenal, Grainger, Ferguson, HD Supply, Watsco each have a niche they are targeting in the Pro segment.
It makes sense why Home Depot and Lowe’s would target this customer. If a pro stops in to buy one product and then decides to throw a hammer, some fasteners, adhesives, and paper towels in the cart as well, that is all upside to Lowe’s.
Comparison – How do Lowe’s and Home Depot Stack up?
Now that we’re starting to get into their differences, I’d like to provide a simple breakdown first of Lowe’s and Home Depot’s stats. I think this is where it becomes clear that their performance differential is stark, despite seemingly similar store count.
Clearly, Home Depot has similar store count, but is much more productive. Home Depot has 14% more stores, but 50% higher sales, 140% higher EBITDA, and incredible return metrics on invested capital, despite spending about 2x as much per store.
What about like-for-like sales comparisons?
As shown below, Lowe’s was performing well against Home Depot up until the financial crisis. Since that time, Home Depot has been eating Lowe’s lunch.
This is more clearly seen by looking at the two-year stack (that is, comparing the last two years sales growth rate together). Coming out of the crisis, Home Depot took a strong lead and has since maintained it.
If we look at the drivers of Lowe’s sales since 2010, we can see in the chart below that in the past few years, most of the growth has come from larger average ticket sizes, while transaction growth (or volume) stalled.
At the same time, Home Depot has had a good mix of volume and pricing gains. To me, it looks as if share shift is clearly demonstrated in the last two years, where Home Depot is reporting stronger transaction growth to Lowe’s negative comps.
Rationale for the Underperformance?
Lowe’s called out some of the reasons for under performance here:
“We took a hard look at the current state of our stores. We saw that customers were very excited to come to Lowe’s. And therefore, our traffic growth was quite strong. However, frequent out of stocks led to poor conversion, lower transaction growth and a frustrated, disappointed customer. We have terrific associates who know this business well and give their all each and every day to find solutions for our customers. But we also saw that we made it difficult for those associates to do their job. Lack of process, procedures and clear direction made their work inefficient. Complex, outdated point-of-sale systems require too much time and training to navigate, leaving our dedicated associates scrambling and long lines of customers waiting. In effect, the staffing models placed too many hours in associate and tasking activities and not enough in selling activities.
In addition, the company called out the lack of focus on the Pro.
“We had also fallen out of step with the Pro. They had been a lack of focus on the depth of inventory, the right pricing and the products that they expect. In fact, we lost some critical brands years ago because there was a focus on margin rate rather than the understanding and responding to the comprehensive needs of that important customer. We also found that our online assortment was lacking with a significant SKU deficit versus the competition.”
Home Depot has had much more success with Pros recently vs. Lowe’s. On Home Depot’s Q2’18 call, they stated that Pro penetration is ~45%, while Lowe’s stated it is ~20-25%.
Why does the Pro matter? Home Depot stated in 2019 that they were going to dispell a myth: the Pro is not higher margin than DIY. The margin mix of products is similar. However, they spend much more when in the store. Home Depot also stated that “the Pro represents nearly 40% of sales but only 4% of customers.” Therefore, you have more inventory turns in the big box store and you are much more productive.
I think another reason why Lowe’s stores lag Home Depot’s and lag in serving Pros is geography. Lowe’s stores lag in the high density population areas, which are Pro heavy. Instead, I think they have more locations in more “rural” areas which is heavy DIY. Household incomes of these denser population areas are also higher on average, which means they have more to reinvest in their homes and renovate.
Why did Lowe’s outperform pre-crisis? I think Lowe’s stores where in areas which were likely impacted by the real estate bubble. As the bubble grew, the city sprawl grew as well and the values of homes on the outskirts of town also witnessed strong growth (at the time). This translated into higher sales for Lowe’s at the time. When the bubble popped, these areas were more heavily impacted.
This is speculation on my part, but let’s compare some stores in areas. Note: this is completely anecdotal, but what I am trying to gauge is Home Depot’s density in city centers (where population is theoretically higher) compared to Lowe’s. I also pulled up some smaller cities to compare store count. It’s one thing if you have the same store count, but it is another if one competitor has 10 locations in Houston and another has none there, but does 10 in Des Moines. With a big box store you want to be serving as many people as possible in a day.
Below is Boston. You can see some Lowe’s stores are peppered outside of the city, but no real ones serving the actual city. Contrast that with Home Depot on the right – more stores dead inside the population zone.
The next is Houston. This time, Home Depot has many more stores serving the 4th largest city in the US, both inside and outside.
Next is Oklahoma City. Home Depot and Lowe’s looked roughly well matched. However, Lowe’s has 11 locations there, including one outside of town. Home Depot has 9. Does it make sense for Lowe’s to have the same number of locations in Oklahoma City as it does in Houston, when Houston has 4x the population?
Next is Indianapolis. To me, it is the same story as Oklahoma City. You can argue now that Lowe’s will be better positioned as these other, smaller regions grow, but it is questionable how they’ve allocated capital in the past at least (we can open a store in Houston, or one in Indianapolis – which do you pick?).
Ok last one to test the bubble thesis. South Florida was blasted by the housing bubble due to very high speculation activity in these areas. Let’s check out the store count:
Are the differences structural?
I think the differences in margin are not structural. However, I do think that turning a ship with nearly $80BN in sales is not easy and will not happen quickly. There may be taste changes that Lowe’s will have to overcome (didn’t have the product before, why should the Pro trust you now) and the investments may take some years to play out.
So what is Lowe’s doing to close the gap?
Clearly, it seems Lowe’s knows it needs to target the Pro. After an internal review, they discovered that there was inadequate coverage of Pro by their staff. The staff was busy with documentation work during peak hours and missed serving Pro staff. Time is money.
It does seem simple on paper: if they can be price competitive, have the right brands and quantities, and be consistent with service, I think that will help close the gap.
Again, however, I think this can only improve so much due to geographic differences.
On the profitability side, the company said that its payroll systems are antiquated and not prepped for changes in demand by department. Outside of COGS, store payroll is the company’s largest expense and they definitely spend more than Home Depot does on a per store basis (see EBITDA margin difference in table at beginning of this post). At the same time, they will be adding sales staff to support the Pro segment. The company’s goal is for the savings from one to fund the other.
They also noted they will focus more on “high velocity” SKUs in stock. Historically, they focused more on inventory dollar position versus inventory turns. If you are turning your inventory quickly – you are making more money. This seems like retailing 101 so hopefully is a quick fix.
As shown below, Lowe’s thinks it can improve sales per sq ft by ~10% over 2018 levels (and 8% over LTM Q1’19). By having better SG&A leverage, they think this will translate into 12% operating margins, or ~300bps higher than today and ROIC will improve dramatically.
In addition, Lowe’s is expanding its leverage target from 2.25x to 2.75x EBITDAR in order to free up cash flow for the equity.
This all seems to be a tough and a bit of a stretch. While $370 / sq ft is still behind HD, I try to detail my view on earnings if this were all to happen. I can see how you would get 110bps of margin expansion all being equal, but the company is also talking about investing in additional supplies, new technology, additional sales staff… all to support the Pro and help close the gap. That will cost something and doesn’t appear reflected in their goals.
However, as I look at consensus estimates, this isn’t totally priced in either. Street estimates show EBITDA margins expanding to 12.2% from 10.6% by 2021, so still high but not giving full credit. There is some doubt in the numbers which is good. It still seems rather optimistic to me, however.
Is it reflected in the valuation?
If I pull a list of comps for Lowe’s, I of course need to look at Home Depot, but I also need to show other defensible retail. I view the Home Depot and Lowe’s duopoly as similar to the auto repair stores. The customer service and experience drives customers back to their stores and there is some moat that Amazon will have trouble crossing. That said, if you don’t have the part in auto retailing, you lose the sale. Seems rather analogous to our discussion here.
Dollar Tree and Dollar General also remind me of HD and Lowe’s. Two formidable competitors that serve a niche part of the market. Finally, I also think Walmart, TJX, Ross Stores and Target need to be included as they are retailers known for their powerhouse supply chains and ability to survive in a tough retail environment.
In each case, Lowe’s screens as pretty cheap. But given what we know, would you buy Home Depot vs. Lowe’s?
Unfortunately, it is too simplistic to just compare multiple of earnings or EBITDA. We have to also take into account ROIC. Lowe’s is currently around a 12% ROIC while Home Depot is ~25%. If we were to run a DCF on these two companies and assumed they grew at the same rate and had similar WACCs, the one with the higher ROIC would clearly receive the higher multiple. Here is a brief summary with made up numbers:
Now compare to company 2…
If you then factor in that Home Depot has been crushing Lowe’s in growth, you have the formula for a much higher multiple that is warranted. Lowe’s is just trying to close the gap, but during this time, Home Depot won’t be standing still. It could reinvest more in new projects that extend its runway.
In sum, I think that Lowe’s has a formidable competitor. While I like that they realize they were asleep at the wheel and have a former HD exec running the ship now, I am a bit afraid that HD will still be pulling away while Lowe’s is trying to catch up. I want to root for the underdog, but I’d probably put my money on HD outperforming Lowe’s.