Two big earnings reports this week from Lowe's (LOW) and Home Depot (HD) are expected to offer more insight on the state of the economy. While Home Depot is generally considered the more prominent player, analysts are buying Lowe's as the more enticing stock story ahead of earnings.
Shares of both Home Depot and Lowe's have leaned into earnings week in the green, bouncing alongside the broader market as tech and consumer sector leaders, as well as rising yields, lead a widespread rebound.
While both stocks retain a "Buy" consensus rating among sell-side analysts, the Marvin Ellison-led turnaround story at Lowe's offers more upside in the near term, according to numerous research reports.
"Despite industry pressures, our credit card data remains positive for LOW, and we continue to prefer the Company over HD, given new management's focus on driving sales, as well as its lower valuation, Keybanc Capital Markets analyst Brad Thomas advised clients. "We see meaningful opportunity to improve operational efficiencies, sales productivity, and expense and capital spending diligence in 2019. While we still see LOW as more of a second-half story, we are encouraged to see our Key First Look Data show continued outperformance for LOW vs. HD in 2Q, albeit not to the same degree as we saw in 1Q."
He reiterated his belief that Ellison, who joined the company after a tumultuous tenure at J.C. Penney (JCP) in 2018, can indeed turn the company around as he has forecast.
With a notably lower forward multiple than Home Depot, improvements in key areas of comparable sales and gross margin could give shares a much more significant lift.
Given the dynamics of the turnaround and stock-specific catalysts to shares for Lowe's, many analysts prefer the isolated Lowe's from the macro-sensitive Home Depot. Further, the fear that remains on Lowe's lingering issues leaving the multiple lagging its peer could counter-intuitively provide the perfect catalyst for an earnings pop.
"Overall, we'd describe positioning as "complacent HD" (comp risk and FY guide cut expected but 2H intact), "fearful of LOW" (GM miss and guide cut)," J.P. Morgan Christopher Horvers said, summarizing the dynamic. "While it may sound crazy to go riskon in this tape on earnings, we prefer to go counter consensus with the risk-reward on the print higher for LOW."
He added that the margin miss and disappointing sales numbers in the first quarter have baked in much of the downside, with EPS estimates being reeled in by about 20 cents and same store sales forecasts falling slightly since June, making the stock pick not quite as risky as it might initially appear.
"In our view, given the low hanging fruit of higher seasonal and building materials in-stocks compared to the past two years and weather concerns that could be overdone given the Census report, we see the potential for a positive sales surprise," Horvers commented. "In our view, even a small miss is ok given valuation. Indeed, the shares trading at a 1x PE discount to the S&P on our 2019 EPS estimate (HD at a 2x premium) and, generally, given the duopolistic nature of the category, moat vs. Amazon (AMZN) , and lower rates, LOW should be at a premium."
Still, as issues persist in pursuing a revitalization means a positive earnings report is far from guaranteed.
"We can't argue for further valuation multiple expansion," Piper Jaffray analyst Peter Keith cautioned as he expressed doubts on the guidance that could be provided. "Valuation could expand for LOW, but the turnaround potential has become more murky."
Of note in recent weeks, thousands of employees were said to be laid off, adding concern for the more skeptical that the turnaround trajectory may be stalling.
"We remain surprised with reports of layoffs from early August, as we didn't think headcount reductions were in the cards to drive margin improvement," Keith said. "Certainly, margin recovery opportunity in 2020 from lapping first half pricing issues looks intriguing, but we look for more signs the turnaround is progressing appropriately."
He retained his "Neutral" rating on shares of both Home Depot and Lowe's, as he expects that the market needs to hear much more from both retailers before sparking any serious stock moves.
Still, even Keith's price targets for the two stocks place significantly more upside to shares of Lowe's, as valuation concerns leave Home Depot's price target below Monday's opening level.