It's always interesting to compare and contrast HD vs. LOW, but this quarter, the diversions are not quite as severe as the market suggests. Two Takeaways: Though the market could care less, 1) this is the first time in years that the 2 companies share similar slopes in SIGMA (P&L/Balance Sheet triangulation. 2) LOW actually looks better on paper than HD.
The market is painting HD as the hero and LOW as the goat. One beat and guided up, the other missed and guided down. While LOW’s comp of (-3.3%) was so much weaker than Depot’s (-0/6%), AND the underlying trendline (2, 3-year) also underperformed, check out the directional moves in our SIGMA (below). Nothing to take from Depot here. It printed a better quarter. Period.
These two companies have been duking out differing inventory strategies for a while, ‘stack it high, let it fly’ vs. ‘lay it low, let it flow), as well as the case regarding square footage growth vs. risk of increased cannibalization. All-in, we think that LOW usually wins that argument from a return on capital perspective. But that's longer term.
Above all the noise out there, there's something that clearly caught our eye.
Simply put, this is the first time in years that both of these companies shared a similar slope in SIGMA trajectory. What does this slope (down and to the left) mean? Aside from resembling a slider, It means that on the margin, both companies had a build in inventories relative to the top line AT THE SAME TIME profitability eroded ON THE MARGIN.
We’ve always said that these SIGMA charts don’t necessarily give us all the answers, but they do ensure that a) we’re asking the right questions, and b) we get a glimpse into how management teams trade off their P&L vs. their balance sheet in a given environment. The very simple take-always in looking at this chart are…
1) Given the nearly identical slopes for the two since well before the recession, we’ve gotta call this out as meaningful. We don’t like to call a trend based on one data point – but ignore this one at your own risk (especially on a day like today where housing data came in weak).
2) While the slopes of the lines are the same, their positioning is different. Depot is in what we call the ‘Danger Zone.’ That’s where margins are up, but inventory is building. The likelihood of a stock going up as it enters this quadrant (and stays there for one more, subsequently), is below 20%.
3) On the flip side, LOW is resting in what we call ‘Clean Up Mode.’ That’s where margins are off, but the company is actively doing so to keep the balance sheet whole. The risk for LOW is that it continues its current slope. If that’s the case, then there’s a better than 90% chance that the stock will go down. But if it keeps itself clean and can ‘start over’ with its product flow heading into summer, we’d be surprised if HD continued to outperform LOW.