Getting Bearish On Depot and Lowe’s. More of the same from HD and LOW this quarter – absolutely blistering comps with no love from the market. This bullish ‘long the Home’ trade is getting razor thin. Nothing but red on my Home Improvement stock screen. With Depot, it put up an impressive 24% comp. Think about that…this is a company with a revenue base of $110bn last year, and it just comped 24%...that’s the equivalent of adding $26bn in net sales on an annualized basis. Not to be outdone, Lowe’s comped 30%, which naturally led to an 8% sell off in the stock as the headline EPS number was $1.98 – two cents shy of the consensus. The only way you put up a that kind of comp and miss is if the Street is simply sitting on sky-high expectations for both comp and flow through. But flow through was a problem for both retailers. Home Depot noted that it is permanently taking up wages for full-time and part-time hourly employees, a move it expects to cost around $1 billion annually. It will also make some temporary benefits offered during the ongoing coronavirus crisis, such as paid time off, permanent for these workers. LOW noted that it’s looking at $800mm in wage investments for the year. Add this to the wage pressure at TGT, WMT, TJX, BBY, Dollar Stores, Costco, and any other retailer that is putting up an outsized comp and is taking a temporary lift in sales and translating it into a permanent increase in comp for employees. Lowe’s cash flow was weak in the quarter – again – something you don’t want to see with a 30% comp. The rationale is that it massively improved in-stocks to meet demand, and why it’s more confident in predicting a 15-20% comp in 4Q. That’s nice, but hard to call a 1,000+ deceleration in comp bullish – even if we’re simply seeing mean reversion to the new normal. On top of that, Depot goes ahead and buys HD Supply for $8bn when we’re at the peak of the cycle. It’s using its tremendous cash position and premium valuation to fund the deal, which I get. But It’s almost as if HD’s CEO sees how the narrative will change – negatively – over 12-18 months and will need another leg of the story to talk about as it relates to creating value. Looking at the SIGMA position for both retailers, they’re rather similar – both in or near Quadrant 2 (The Sweet Spot -- sales outpacing inventories and margins improving). While that might seem bullish at face value, the likelihood of them staying in Quad 2 is extremely low, and any fundamental move out of Quad 2 is negative for the stock price. Be careful owning either of these names here. The market’s reaction to earnings appears to have gotten it right – but potentially more downside to come. Near peak valuations on peak earnings with less than a percent of the float short. I've had no skin in the game here, but based on our research thus far I’d be short. Adding both names to the bottom of our short bias list, and taking the research deeper on both HD and LOW…
