As a segment, home improvement had the highest expectations among hardliners. Housing data points were largely supportive during Q1 and the market got more comfortable with the idea that the recovery is real and is gaining steam. But supplier commentary was somewhat mixed with outdoor-related categories weaker. Who is right: housing data or suppliers?
How did the hardliners perform?
The Home Depot, Inc. (NYSE:HD), a well-known supplier of home-decoration products, has been a pure play on the performance of the housing market. The company delivered a solid Q1 beat, especially considering the unfavorable weather in many markets. Managing through difficult weather comparisons, the company prudently controlled expenses to drive 132 bps of EBIT expansion and produced solid 28% EPS growth on a year-over-year basis.
Despite the fact that The Home Depot, Inc. (NYSE:HD)’s comp of 4.3% decelerated sequentially by 260 bps on a two-year stack, the company’s top line is expected to accelerate throughout 2013 given its strong internal momentum and a developing external tailwind in housing. Home Depot raised full-year guidance from 3% to 4% (growth in revenue), and the EPS guidance was raised by $0.15, or 4.5%. Moreover, in the conference call management claimed that the company’s comps accelerated in April after a difficult March.
On an overall note, as the year progresses we should see improving results from The Home Depot, Inc. (NYSE:HD). The company is a well-managed, best-in-class retailer whose cyclical tailwinds have yet to be fully realized. Any sales headwind that the weather presented in select categories (e.g., gardening) should be recouped, not lost. The external tailwinds in housing and Hurricane Sandy rebuilding efforts remain. Moreover, Home Depot is expected to continue to aggressively return capital to its shareholders through share repurchases and dividends.
Home Depot vs. another player
Results for Lowe’s Companies, Inc. (NYSE:LOW) were pretty much in line with the consensus estimates, but continue to trail Home Depot. That was expected as The Home Depot, Inc. (NYSE:HD) is executing better, catching up in appliances, has more Sandy exposure, and has more exposure in recovering markets. It is not important for the company to narrow the comp gap; what is important is for Lowe’s is to show progress toward its 3.5% comp goal for the year, and to do that while improving the gross margin. If there was an item of concern in the quarter, it was gross margin, as the company failed to meet the Street’s estimate (which was an expected rise of more than 10 bps in the margin).
To date, management has made important progress on end caps, product-line reviews, resetting key parts of the store and moving to ‘everyday low prices guaranteed.’ These efforts do not come without pain, as one can ask Ron Johnson (former CEO of J.C. Penney Company, Inc. (NYSE:JCP)), and the benefits do not always occur in a straight line. The Street continues to like the setup going forward.
What is the setup? Some 28% of the stock is projected to be repurchased over the next three years. Moreover, housing and weather are likely to give strong tailwinds to results beginning in Q2. Many of the initiatives that Lowe’s Companies, Inc. (NYSE:LOW) is investing in will take time to pay off, but they will pay off eventually. A major competitor is reducing its footprint in the space and of course, the cicadas are beginning to emerge. In a press release, the management discussed improved results in April and May, as expected, and commentary on this strength and support for a higher gross margin should continue to send the stock higher.
On an overall note, this stock has been, and should remain, rockier than the orange-blooded competitor, but there is no reason to believe that there can’t be two winners in this space.
A forerunner
Masco Corporation (NYSE:MAS)’s earnings release gave the market an indication that the comps would decline for both The Home Depot, Inc. (NYSE:HD) and Lowe’s Companies, Inc. (NYSE:LOW). Masco discussed temporary top-line headwinds like unfavorable weather and delayed tax refunds for big-ticket items that it faced in the first quarter. In fact, pure plays on the housing sector like Scotts Miracle-Gro Co (NYSE:SMG) and Whirpool made similar comments.
For Masco Corporation (NYSE:MAS), while North American sales grew 5.5% in Q1, accelerating sequentially on a two-year basis by 85 bps, the company posted weaker-than-expected performance in paint. Sales growth in Masco’s decorative architectural products segment (predominantly Behr paint, The Home Depot, Inc. (NYSE:HD)’s exclusive line) was -0.5%, missing consensus sales expectations by 4.6% as the management noted “weather negatively impacted core paint-business comparables.” Last year, the segment experienced 15.7% growth in Q1 due to favorable weather.
However, as weather improves, so should Masco Corporation (NYSE:MAS)’s sales. Importantly, Masco said on its earnings call that sales were up in the mid-teens thus far in April.
Final word
After a relatively weak Q1, Q2 is expected to come in strong given positive commentary on April sales trends. Holistically speaking, The Home Depot, Inc. (NYSE:HD) is a good company to invest into given its efficient management team and a bright capital allocation plan for the future. And this is what makes it a better choice as compared to Lowe’s Companies, Inc. (NYSE:LOW). However, that doesn’t mean that I am not bullish on Lowe’s. The company’s rapid share-repurchase program along with tailwinds from the housing recovery will help the stock to move up.
Zain Abbas has no position in any stocks mentioned. The Motley Fool recommends Home Depot and Lowe’s.
The article 2 Hardline Stocks to Buy on a Housing Recovery originally appeared on Fool.com.
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