Earnings Preview: Home Depot, Lowe's Look for Housing Comeback

Home Depot (HD) and Lowe's (LOW) are scheduled to report fourth-quarter earnings a day apart next week, and investors are hoping for a positive one-two punch from the home-improvement retailers.Home Depot, the country's largest hardware chain, is expected Tuesday to post fourth-quarter earnings of 16 cents per share, down 15.8% from the year-ago period, according to Thomson Reuters' analysts consensus. Second-place Lowe's goes first on Monday, and analysts are expecting 12 cents per share for the fourth quarter, a 9% improvement above the same period in 2008.

Home Depot had been suffering from a number of internal issues even before the recession. Then, home-improvement retailers got hammered by the housing crunch even before the rest of retail suffered. Their professional business, selling materials to contractors, froze as soon as foreclosures began to rise and construction projects were abandoned. Then their consumer business went down the drain as homeowners lost their jobs or their home-equity lines of credit, and put improvement projects on hold.

The hardware chains reacted by cutting operating costs and focusing on small projects such as paint and plumbing. Those had a better chance of attracting cash-strapped homeowners looking to improve the homes they couldn't sell. The stores boosted their in-store classes and online tools for do-it-yourselfers, stocked up on lower-priced materials, paint and gardening tools, and moved the marble and gold-plated bathroom fixtures off the sales floors to the special-order catalogs.

Those moves started to pay off in the third quarter, as consumer confidence began to make a comeback. Lowe's reported good sales of flooring and appliances to homeowners who'd begun taking on more mid-size projects. Home Depot's forecasts have remained more glum, but management has noted that the volume of small transactions rose in the third quarter, and sales appeared to stabilize in the markets hit first by the housing crisis, such as California and Florida.

Home Depot Gets Martha, Lowe's Goes to Mexico

Investors have become more positive on both companies recently, as sales of both new and existing homes appear to have bottomed out. It's a straight line from more new construction and remodeling to larger sales of materials and appliances, so any sign that the housing crunch is easing is good news for home-improvement stocks.

Oppenheimer upgraded both hardware chains just ahead of their earnings reports, moving Home Depot to outperform and restating the same rating for Lowe's while raising its target price on that stock to $32 from $28 per share. And investor George Soros, who made big waves in the sector last year by investing in several retail companies, upped his stake in Lowe's during the fourth quarter.

Analysts will want to hear progress reports on initiatives both chains announced last fall that are coming online in the first quarter. They will want some sales and margin guidance for the new Martha Stewart Living line of house and garden products, which is due to launch in March at Home Depot. The company signed a deal with the domestic guru just as her Kmart contract with Sears Holdings (SHLD) expired last year.

And investors will want a progress report on the new Lowe's stores in Mexico, which it is opening as part of a plan to focus its expansion on under-served urban markets in the U.S. and new markets abroad. Lowe's opened its first Mexican stores, two locations in the city of Monterrey, on Feb. 8, and has a joint venture with Woolworth Group to open stores in Australia and New Zealand starting in 2011. While Home Depot has a presence overseas in Mexico and China, until now, Lowe's international holdings consisted of 16 Canadian stores.

Holidays Aren't Hot in Hardware

Investors will be looking at sales figures closely, wondering when they will become good, rather than merely less bad than before. Despite the winter's inclement weather, hardware store sales were down 6.3% in January, according to the Commerce Department. Home Depot has forecast sales for 2009 will be down 9%, while Lowe's had projected fourth-quarter sales will be flat.

The hardware stores don't get as big a bump during the fourth quarter as other retailers, who make most of their profit for the year from holiday sales. Construction is slow in the dead of winter, and most holiday hardware sales are inexpensive decorative items, so while the stores do a brisk business in Christmas trees and extension cords, they don't rake in outsize profits over the holidays.

Still, investors will be watching the sales and margin figures for signs that both hardware chains have set a foundation to deliver profits while they wait for the economy to give them a boost. For Home Depot, a good fourth quarter could be a sign that it has straightened out its house and will be able to deliver profit growth in the recovery. For Lowe's, a good quarter could be the start of a renewed effort to leapfrog over its biggest rival.
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