Summary
- The junior member of a home improvement retailing duopoly, LOW is being transformed under new leadership.
- LOW's turnaround has parallels with that of UPS, with both following a "better, not bigger" strategy of increasing profit margins.
- My bullish thesis is that LOW is far enough along in its turnaround that it may deserve the same TTM P/E as HD, or even a higher one.
- The basic rationale for this thesis is that LOW has lots more low-hanging fruit to pick, whereas HD is mostly optimized.
- That Wall Street is somewhat skeptical of LOW's ability to approach HD's level of excellence is a point of view I am willing to bet against.
An uptrend for the right reasons
The large sales and EPS beat in its Q2 represented the 5th consecutive EPS beat for Lowe's (LOW), so the degree of the beat was the main surprise. In the bigger picture, what has been happening should in my view continue to drive LOW's share price closer, and perhaps equal to or above, that of bigger peer Home Depot (HD). HD has been generating alpha versus the S&P 500 (SPY) since my first article on it, Home Sweet Home Depot: $200+ Within 2 Years?, written in May 2017, when HD was $156 (versus $268.55 at Friday's close).
I ended my ownership of HD in late February this year when I got heavily into cash and also into bonds as I saw the COVID-19 mess coming to smash the SPY like a big freight train. As I returned to stocks, I found that the long-serving CFO of HD was going to run (and now has become CEO) of UPS (UPS), and also saw that LOW had a large P/E discount to HD with new management that was delivering the goods. So, I went back into the home improvement sector with LOW rather than HD, in the $125-130 range and have added on pullbacks into strength, most recently within the past week at and below $160.
My core bullish thesis is that LOW is likely to emulate HD, improve its operating efficiency, and make good use of the COVID-19-related tailwinds helping both members of the duopoly.
I think what we are seeing is a stock moving with an appropriate dose of caution, allowing the new buyer a reasonable expectation of beating the SPY for some years to come, as operational improvements allowed LOW to benefit bigly from recent trends and will let it beat expectations going forward.
Before getting to some numbers, a brief discussion of my UPS article shows a theme that is recurring with LOW.
Turning around a big player rewards shareholders over time
The old Abby Joseph Cohen metaphor of the US economy as a slowly-turning supertanker also applies to large companies that have lost a step or two on the efficiency scale, and now need to speed up or fall victim to Amazon (NASDAQ:AMZN). This is the basic message from my bullish Sept. 13 article, UPS: New CEO, New Strategy To Deliver Sustainable Alpha.
Under CEO Carol Tome, HD's very long-serving CFO until last year, UPS is now operating under the "better, not bigger" philosophy. However, trends in e-commerce and the probable longer-term growth of its B2B markets mean that some growth is baked in the cake so long as the company increases its competitiveness. UPS has returned about 5% in the past two weeks since that article, and I remain overweight this stock. Earnings estimates for UPS for 2020 and 2021 remain in an uptrend, and my expectation is that the "better, not bigger" mantra will allow this stock's breakout from a multi-year trading range to continue providing alpha for UPS shareholders.
We will learn more details of how UPS plans to transform its operations as the months and years roll by.
With LOW having its change agent in place since 2018...
