Lowe's: Rhymes with grows
Stock Spotlight: Home improvement retailer has posted astounding numbers over the past several years, but does the stock already reflect this?
By Rob Kelley, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) - Rising interest rates are supposed to be bad news for home improvement retailers. Higher rates should lead to a slowdown in the real estate market, and in turn, fewer visits to stores such as Lowe's and Home Depot.

But shares of Lowe's (Research) have more than held their own since June 2004, when the Federal Reserve began hiking rates. Its stock has climbed 17 percent, outperforming the S&P 500 and archrival Home Depot (Research). Lowe's has been expanding without pause, averaging a new store opening every three days over the past three years, and taking Home Depot head on in major markets.

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When Lowe's releases earnings on Monday, analysts expect the company to report earnings per share of 94 cents, a 27 percent increase from a year ago. And sales are expected to grow nearly 20 percent to $11.8 billion.

But there are concerns: investors fear that the Fed's 16 rate hikes may finally start to have an impact on sales and that more rate hikes could put a further damper on growth. Home Depot reported Tuesday that its retail sales grew at a less-than-expected 5.7 percent in the first quarter and its stock was punished as a result.

In addition. Home Depot has slowed new store openings recently, spurring discussion of how close the home improvement retail market is to being saturated.

How do these trends bode for the future of Lowe's?

Rate hikes haven't slowed Lowe's

The state of the housing market is worrying investors. High home turnover equals high remodeling spending. But what happens when people stop looking to sell their homes and just sit tight?

Although existing home sales actually rose slightly in March, real estate observers think rising mortgage rates will soon cause sales to slow... especially if the Fed keeps boosting short-term rates.

But Michael Cox, an analyst with Piper Jaffray, said that Lowe's can keep growing at a healthy rate no matter what Fed chair Ben Bernanke does.

"We argue that consumers staying in their homes longer spurs the remodeling cycle," says Cox. "A slowing new home cycle could in fact provide a nice lift for remodel activity, particularly in the way Lowe's stores have been expanding into the remodeling services market."

Another big factor for the sector is hurricanes, which boosted sales of basic building supplies last year. And according to Bear Stearns analyst Chris Horvers, Lowe's is still seeing demand from people looking to rebuild their homes following last year's devastating hurricanes in the Gulf Coast region.

"Hurricane sales give a pretty long tailwind to the industry," he said. Insurance claims can take some time to come in, and the repair process is ongoing.

Remodeling the market

Even if a housing slowdown doesn't hurt Lowe's, some investors wonder whether there's room for many more home improvement stores. A decade ago, Home Depot and Lowe's had 900 superstores combined. Today, they have more than 3,000.

How long can this expansion tear keep going?

"I think we're close to a saturation point," said Cox, pointing to how Home Depot has opened new stores at a slower rate than Lowe's during the past few years.

But Horvers believes the industry probably won't reach a saturation point until 2010. Lowe's management apparently agrees. It plans to open 150 new stores a year for 2006 and 2007. Home Depot, on the other hand, is adding about 70 a year.

Analysts add that Lowe's has another powerful thing going for it - a better customer experience than Home Depot - which allows it to sneak into markets that Home Depot has already penetrated. Morningstar analyst Anthony Chukumba points out that 70 percent of Lowe's stores are within 10 miles of Home Depot locations.

"Lowe's has succeeded... because they have cleaner stores, better customer service, and they're easier to navigate," said Chukumba. As such, Lowe's same-store sales growth, which measures revenue increases at stores open for at least a year, grew by 6.1 percent in its last fiscal year. Home Depot's same-store sales increased by just 3.8 percent.

And even as the U.S. market begins to mature, Lowe's now has it sights set on international expansion. The company will open its first Canadian store in 2007 and Chukumba said the move makes sense for Lowe's. Still, it won't be easy. Home Depot already has 141 stores in Canada.

Gotta go to Lowe's

So is it worth buying Lowe's stock? The company is currently trading at 15.1 times its projected 2006 earnings, a significant premium to Home Depot, which has a price-to-earnings ratio of 12.5. But a premium is probably warranted since analysts expect Lowe's annual profits to increase at a faster rate than Home Depot's for the next few years.

Horvers adds that Lowe's is actually trading a discount to other similarly growing retailers such as Best Buy (Research) and Bed Bath & Beyond (Research). The reason is because investors are concerned about whether Lowe's can hit its sales and earnings target if the housing market slows.

There hasn't been any proof that rising mortgage rates are keeping people away from home improvement stores though. U.S. spending on remodeling grew 4.3 percent in 2005, according to the Harvard Joint Center for Housing Studies.

With that in mind, Chukumba thinks the future looks promising for both Lowe's and Home Depot. He said that until the home improvement retailers reach market saturation, they both should keep taking market share from mom-and-pop stores.

"Both companies have huge competitive advantages," says Chukumba. "They have brand name recognition, major leverage with suppliers, and room to grow, and that's what's really driving this sector."

And if Lowe's can keep opening new stores at an aggressive pace for the next few years and continue to thrive even when encroaching on Home Depot's turf, then this stock should could continue to be a winner...regardless of what the Fed does for the remainder of the year.


Defiant Home Depot = worried investors. Read the full story here.

Home Depot builds up buyback. Read the full story here.

For a complete look at Stock Spotlight pieces, click here.

Analysts quoted in this story do not own shares of Lowe's. Piper Jaffray has a banking relationship with Lowe's but the other analysts' firms have not done banking for Lowe's. Top of page

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