Lowe’s Companies, Inc. (NYSE: LOW) may not need to outperform Home Depot (HD) to generate some impressive long-term gains for investors. On Monday, Bernstein upgraded Lowe’s stock from “underperform” to “outperform,” and analyst Brandon Fletcher says tax cuts, new activist board members and a strong home improvement market are a winning combination for Lowe’s.
Lowe’s has a primarily domestic business, which means it should get a big earnings boost from tax reform. Fletcher estimates that Lowe’s tax rate will drop from around 40 percent to as low as 25 percent.
In addition, he says two recently appointed board members may hold management’s feet to the fire when it comes to keeping selling, general and administrative expenses (SG&A) under control. On Friday, Lowe’s added two new board members after meeting with activist hedge fund D.E. Shaw, which has accumulated a more than $1 billion stake in Lowe’s.
“Now that Lowe’s has made some of the mistakes that are inherent in the first few attempts of SG&A reduction and has the focus of an activist investor on board that can hold management more accountable, we think Lowe’s may finally begin to make progress on SG&A reduction,” Fletcher says.
Finally, Fletcher says the U.S. home improvement business is booming. Lowe’s has consistently lagged Home Depot on most fundamental metrics, but Fletcher says that performance gap may soon close.
“We believe the barrier is primarily management, and we have been arguing that if Lowe’s ever gets a team together that can realize the efficiencies in a similar way to what Home Depot did, there’s a lot of upside,” he says.
Fletcher says both Home Depot and Lowe’s benefit from their near duopoly in home improvement, which gives them more pricing power than most other segments of the U.S. retail industry. He says pricing competition may be the single biggest threat to the U.S. retail sector in coming years.
One of the reasons the home improvement business is protected from the threat of pricing pressures is because it is relatively insulated from competition from Amazon.com (AMZN). Amazon has made large strides in home improvement, but Fletcher says service and shipping challenges make it a difficult market for Amazon.
Looking ahead, Fletcher says…
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