Jeremy Glaser: I'm Jeremy Glaser with Morningstar.com. The home improvement retailers have been some of the hardest hit during this recession. I'm here to discuss Home Depot and Lowe's results with retail analyst Brady Lemos. Brady, thanks for joining me.
Brady Lemos: Thanks for having me.
Glaser: What in these results was surprising to you this quarter?
Lemos: In this quarter, Home Depot actually outperformed Lowe's on a same store sales basis. That was the most surprising. We think a lot of it had to do with the fact that Lowe's product mix has more appliances, they have a higher average ticket, and I think in this environment that was negatively reflected in Lowe's results.Read Full Transcript
Glaser: Do you think that this is a permanent shift, that Home Depot is going to be doing better than Lowe's going forward, or do you think that this is just a one time blip?
Lemos: We think this could be the case for the next couple of quarters, simply because we believe customers are certainly cutting back on their expenditures. What we are seeing is that items priced below $50 are actually holding up well, actually increased quarter over quarter, whereas the big ticket items that are struggling in this environment. If that trend continues - and we think it will - we think Home Depot has a slight advantage over Lowe's. Over the long term, however, we do think that Lowe's has a slight competitive advantage in that we believe consumers prefer shopping their stores. They have better customer service, and we think, over the long term, that's a competitive advantage.
Glaser: When do you think those high ticket items could come back?
Lemos: We're not expecting it this year. We think same store sales are going to decline in the high single digits this year and that would be the fourth straight year of negative same store sales growth. It's fairly remarkable for these retailers that have been performing so well historically. So next year, in 2010, we think comps are going to be flattish. The following year, we do think we're going to see some sort of rebound. And again, even after that rebound, we don't think store productivity is going to be anywhere near the store productivity these retailers achieved during their peak in the mid-2000s.
Glaser: Given the negative sentiments surrounding these stocks, that these high ticket items really don't seem to be coming back, four years of declines, a housing market that maybe has been approaching a bottom but is still in pretty dire straits - do you think the valuations of these companies reflect those headwinds? Or do you think that they're fairly priced?
Lemos: We think that both Home Depot and Lowe's look pretty undervalued at the current market valuation. We think that certainly has to do with the environment that we're facing. They're both very tied to consumer spending and also the housing environment. I don't think too many people think those are going to improve any time soon, so I think those negative sentiments are reflected in the share prices.
Glaser: So which of the two, if you were thinking about buying one of the retailers, do you think would be the best buy right now?
Lemos: Over the long term, we think they both have scale advantages, other competitive advantages, so we like their prospects over the long term. We think both are going to gain market share over regional players, hardware stores, Sears hardware, lumber yards and retailers like that that don't have as strong a balance sheet to withstand a long-term recession. Between the two, we do like Lowe's a little bit better simply because we think consumers prefer shopping their stores. Historically, they've had higher same store sales growth. They've gained share at a much quicker rate and we think they have a lot more room to grow, not only in the United States but Canada and Mexico, where they just recently entered.
Glaser: So, where do you think that your analysis could be wrong? That we think that these are really undervalued right now, but what's an event that would catch you off guard or would make you think the companies are worth much less than we think they are?
Lemos: If the housing market continues to decline... What we've seen is a deceleration in same-store sales, declines in some of the hardest hit markets, California, Florida, et cetera. If we continue on that trend, which is what we're expecting - in other words, they'll be lapping easier comparisons month over month, quarter over quarter - we expect that prediction to continue. If somehow that reverses, California market becomes even weaker - which again would be weak comps on top of four years of weak comps - that would certainly impact our thesis.
Glaser: OK, great. Thanks so much for talking with me today, Brady.
Lemos: Thank you.
Glaser: I'm Jeremy Glaser with Morningstar, thanks for watching.