Home Depot Vs. Lowe's Both giants have growing room, but one's a better value.
By Jim Frederick

(MONEY Magazine) – Every time I come here I'm just amazed," says Robert Sherwin, a filmmaker and film instructor, gesturing toward the throngs of do-it-yourselfers crowding the aisles of the Brooklyn Home Depot. It's a bright Sunday morning as Sherwin shops the orange aisles for a piece of particleboard to reinforce his son's bed. "I mean," he says, "the industriousness of the American consumer just blows me away." And no company has catered so well to that industriousness--or benefited as greatly from it--as Home Depot.

Home Depot's approach is straightforward: Open massive stores (110,000 square feet, on average) at breakneck speed (three a week) and stock them with every item a home-improver might need--about 45,000 a store. Oh, and keep prices low. In just over two decades, that formula helped the Atlanta retailer vanquish one competitor after another as it built a network of 770 stores in 43 states, Puerto Rico, Canada and Chile. The company now books $29 billion in annual sales, and its stock has rocketed 2,222% this decade, 6 1/2 times the S&P 500's return.

And Big Orange isn't finished yet. Its market is swelling steadily: With interest rates low and existing-home sales strong, analysts expect the $150 billion home improvement business to grow 6% a year. Home Depot is expanding faster: It will open 160 stores in 1999 and another 400 by 2002. And the company is seeking to extend its reach with newly unveiled efforts like its Expo Design Centers, aimed at the professional market, its Villager's Hardware chain of smaller stores designed for small towns and its recent move into Latin America. So Home Depot rides off into the sunset on its way toward total industry domination--end of story, fade to black, roll the credits?

Not so fast. Somebody forgot to bury Lowe's. Starting in 1989, the North Carolina outfit went on a $7 billion, big-box construction binge. A decade later, 80% of the company's 487 stores in 27 states are new (accounting for 90% of total sales) with 80 more planned for 1999. The average store size is now 89,000 square feet, up from 20,000 square feet a decade ago. And Lowe's has sped its western expansion with the $1 billion purchase of California-based Eagle Hardware. No mere copycat, Lowe's has tweaked the Home Depot formula by aggressively courting women shoppers with brighter, better-decorated stores carrying a full line of appliances--in contrast to Home Depot's scruffier, appliance-free, workshop-for-giants atmosphere. As a result, Lowe's has quintupled both total sales and earnings per share since 1989, averaging 29% annual profit increases over the past five years. And its stock has nearly kept pace with Home Depot's over the past two years, gaining 222% vs. 241% for its larger rival.

The two titans have largely avoided going head to head, with Home Depot targeting major metropolitan markets nationwide and Lowe's focusing on mid-size cities in the South and Mid-Atlantic. Two years ago, however, Lowe's began pushing into larger markets, starting with successful forays into Depot strongholds like Atlanta and Dallas. (Those cities now support 10 and 14 Lowe's stores, respectively.) Lowe's will continue to move into Home Depot territory. But analysts believe that rather than stealing sales from each other, the two chains, which now control 25% of the market, will prosper at the expense of mid-size outfits like Hechinger and Payless Cashways. The point, says Ronald Ognar, manager of Strong Growth fund, is that Lowe's has made it a two-way race where both can win. "The biggest will only get bigger," he says, "and each one could triple its market share over the next 10 years."

No one thinks Lowe's will challenge Home Depot's top-dog status anytime soon. Home Depot still generates 2 1/2 times the revenue, controls better than twice the market share, runs 300 more stores, adds more new stores annually and beats Lowe's on crucial industry comparisons like same-store sales and net margins. Even so, right now Lowe's looks like the smarter buy.

Here's why. As an innovative, dominant company in a fast-growing industry, Home Depot often commands a lofty price/earnings ratio. Lately, it has been trading at an extremely rich 45 times estimated 1999 earnings. Moreover, its P/E based on 1998 earnings is 60% above its average multiple over the past five years and double the S&P 500's P/E. That said, Home Depot is a prime long-term holding for growth investors, who should consider buying anytime it dips, say, 15% off its 52-week high.

At 33 times estimated 1999 earnings, Lowe's isn't exactly cheap either, but it's a better value than Home Depot, especially when analysts believe both companies will achieve long-term annual earnings growth of 20% to 25%.

"We want to own both," says Ognar, who has 1.6% of his $1.8 billion fund in Home Depot and 2.6% in Lowe's. "But Lowe's P/E multiple is 10 points lower than Home Depot's. That's a big differential, and that's why we've been buying Lowe's lately."

Courtney Smith, chief investment officer with Orbitex Management, a private money-management firm in New York City, also favors Lowe's. He began buying the stock in late 1997, and it now accounts for 5% of his growth portfolio. He also says he owns "a little" Home Depot. "Home Depot already is a tremendous company, but Lowe's is in the process of becoming a tremendous company," he says. "Lowe's has more upside."