Key Issue 1: Confidence in comp guidance for the back-half of the year
Management has given 2015 guidance of 4.0% - 4.5% comps for the full year. Some investors have concerns over this number, as it implies an acceleration in trends when looking at the 2-year stacked comps (see red box in the chart below). What would drive such a strong acceleration in underlying sales trends? The belief is that strength in the housing market will be the biggest driver of the comp acceleration, as home prices continue to increase and turnover remains robust. Additionally, LOW has several other initiatives, including a growing online site and an emphasis on the pro customer (detailed later) that should drive sales gains. However, some investors still have concerns over these numbers. The company was only able to comp 5% and 4% in 1Q and 2Q with much easier comparisons. Will they be able to still comp in the 3.5% - 4.0% range with comparisons that are 300-500 basis points higher?
Key Issue 2: Confidence in margin guidance for the back-half of the year
Similarly, LOW has also guided to an acceleration in margin trends in the back half of the year. Guidance of 80 - 100 bps of margin expansion for the full year implies a fairly significant margin acceleration after just ~55 bps of margin expansion in 1H. Management has outlined several key drivers that they believe will allow them to achieve this guidance: 1) less mix shift from appliances, which are lower margin sales, 2) easier comparisons due to appliance promotion and high incentive comp from one year ago, and 3) a benefit from its private label credit card agreement in 4Q. Even with these tailwinds, LOW would be achieving a level of profitability expansion that they have not seen since 2Q13. As a result, some investors have doubts about how achievable these targets are.
Key Issue 3: Closing the HD/LOW Gap
Numerous analysts believe that a significant portion of the comp gap between HD and LOW has been due to HD's increased weighting towards the pro customer. Recall that the pro customer represents more than half of the industry spend in the home improvement market (think about the ticket size and the number of times a customer might call a contractor whenever they need something fixed in their home rather than doing it themselves). Roughly 40% of HD's sales are weighted towards this customer as opposed to ~30% for LOW. LOW has a number of initiatives to close that gap, including: 1) improving product assortment specifically towards pros, 2) relaunching lowesforpros.com, 3) emphasizing better customer service towards pros through their AEPs (account executive proservice). If LOW is able to execute on these initiatives, they may be able to close the gap between themselves and HD. However, HD has outperformed LOW since 2Q10 (for 20 quarters), and as a result, it remains to be seen if these efforts will gain traction.
Key Issue 4: Invest in HD or LOW?
As the two largest home improvement companies with exposure to the same industry tailwinds, and as the two primary competitors in a tame oligopoly industry, investors often ask which company to invest in. HD appears to be the more stable bet, as they have consistently outperformed on revenue trends. However, it also trades at a higher multiple of 21.4x NTM EPS. In contrast, LOW is more inexpensive at 20.1x NTM EPS and offers higher EPS growth. If one can become comfortable with its guidance (the key question), LOW appears to be the better bet with higher upside.
