home-improvement-stocks

Two huge trends have made the home-improvement sector an attractive place to invest. The housing sector was already humming, as speculators continue to buy up distressed properties and turn them into rentals. Add in low oil prices and cheaper gas prices, and consumers have additional money to make that home improvement they’ve been waiting on.

Together, they help explain the huge quarters and years that The Home Depot (NYSE: HD) and Lowe’s Cos . (NYSE: LOW) just reported.

Here comes the numbers. Then we’ll assess which stock might be the better purchase for your portfolio. I think you want to own one of these in a long-term diversified portfolio. Even during the financial crisis, the companies held up pretty well, thanks to strong balance sheets.

Lowe’s had sales of $12.5 billion for the fourth quarter, up 7.6%, and comps increased at a 7.4%. By “comps,” I mean comparable-store sales. Most retailers are happy with mid-single digits, yet Lowe’s came in at a number that is outstanding for this sector. It shows business is very strong.

EPS for Lowe’s stock was $450 million or $0.46 per share, up from $306 million or $0.29 per share. That’s a 50% year-over-year (YOY) increase and just astoundingly strong.

For FY14, Lowe’s sales were $56 billion, up 5.5%. EPS for the fiscal year was $2.71 per share, up from $2.14, or 27%.   Name other companies with that kind of growth, especially in retail. You won’t find many.

The balance sheet is looking very, very good. Lowe’s has $ 945 million in cash, and $ 10.8 billion in long-term debt that only costs a little over 5% in interest.

Home Depot beat earnings estimates, with sales of $19.2 billion for the fourth quarter, up 8.3%, and comps also did very well, up 7.9%. Home Depot’s EPS was $1.29 billion or $1 per share, up from $1 billion or $0.73 per share. That wasn’t quite as strong as LOW, but who’s complaining about a 37% YOY increase?

For FY14, Home Depot sales were $83 billion, up 5.5%, with comps up 5.3%. EPS for was $4.56 per share, up from $2.76, or 25%, almost the same as Lowe’s.

Home Depot also authorized an $18 billion share repurchase program, boosted its dividend by 26% to $0.59 per share, and expects EPS of $5.14 in FY15, up 13% after including repurchases.

Home Depot has $1.7 billion in cash, and almost $17 billion in long-term debt that costs a little over 5% in interest.

So we have two great situations here, although Lowe’s balance sheet is prettier with about 40% less debt. Still, when you generate billions in free cash flow each year, it doesn’t make paying down that debt terribly difficult, if need be.

Lowe’s stock is at $74.40 and trades at 22.5x FY15 earnings estimates of $3.28. However, analysts expect 18% long-term EPS growth, and I give companies a 10% premium if they are a world-class brand name (it is) and 10% premium for its annual free cash flow of $4.1 billion. I therefore consider fair value to be 21x, or $68. So although it is technically overvalued at this price, it isn’t by much, and I give more leeway to growth stocks. I think Lowe’s is a buy.

Home Depot stock is at $116.32, and trades at 22x FY15 earnings. It is expensive considering analyst estimates of 15% long term EPS growth, but I give it a 10% premium for being a world-class brand name and 10% premium for its annual free cash flow of $6.8 billion. So I would consider fair value to be 19x, or $100, based on FY15 estimates of $5.26 per share. It’s more expensive compared to Lowe’s, but again, with a growth stock, I give it leeway. I think Home Depot is also a buy.

There’s no bad choice here. Both companies will be around for a very long time. I suppose Lowe’s appears to have more potential capital appreciation given that it is not as expensive, and has higher longer-term earnings growth estimates.

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Published by Wyatt Investment Research at