Tuesday brought a couple solid reports from the consumer discretionary sector (XLY). Home Depot (HD), which we think is a better operator than peer Lowe’s (LOW), posted an impressive comparable-store sales increase during the third quarter, while Dick’s Sporting Goods (DKS) showcased a strong high-teens pace of top-line expansion in the period.
Our reasoning behind Home Depot’s operating superiority relative to Lowe’s is worth repeating. For starters, the most important metric to judge a business is return on invested capital (ROIC), or the amount of earnings (before interest) that a firm generates divided by the amount of capital that it must hold in the business in order to generate that earnings stream.
Return on invested capital is not a pure accounting-based measure such as revenue or earnings per share. Instead, return on invested capital assesses the efficiency of the earnings power of a business, and non-GAAP adjustments with respect to the capital structure (leases, etc.) and other items are made to improve comparisons across companies. ROIC is a superior measure than either return on equity (ROE), which can be impacted by financial leverage (debt), or return on assets (ROA), which can be impacted by non-operating cash on the balance sheet. On this yardstick, Home Depot stands head-and-shoulders over Lowe’s. Home Depot is targeting return on invested capital of ~27% by 2015, while Lowe’s target is ~17% by that time.
In Home Depot’s third-quarter report, the firm showcased comparable-store sales growth of 5.2% thanks to a 5.8% comp in the US. We would expect Lowe’s comparable-store sales measure to be slightly lower than Home Depot’s if recent trends are any indication. The world’s largest home improvement retailer revealed net earnings of $1.5 billion, or $1.15 per diluted share, during the period, which compares to $1.4 billion, or $0.95 per share, in the same period a year ago. Diluted earnings per share grew by more than 21%.
Looking ahead, Home Depot confirmed its fiscal 2014 sales growth guidance of ~4.8% and its diluted earnings per share guidance of ~$4.54 per share, the latter which management expects to be bolstered by share repurchases. The firm is trading north of 21 times current year earnings, and while this isn’t preposterous, it means the company isn’t cheap either. At nearly $100 per share, Home Depot traded under $30 as recently as mid-2011. Its stock has been a fantastic performer.
In other news today, Dick’s Sporting Goods, the largest US-based full-line omni-channel sporting goods retailer, posted third-quarter results. Net sales during the period leapt 9% thanks in part to consolidated same-store sales increases of 1.1%, which was roughly in-line with the company’s guidance calling for 1%-3% expansion. Dick’s posted earnings per share of $0.41 in the period, which came in at the high-end of the previously-guided range of $0.38-$0.42 per share. Golf and hunting sales were the only weak spots in the period, as the balance of Dick’s business showcased a solid 4.6% comp increase.
Though many are calling the quarter mixed, we liked it. The company opened 24 new Dick’s Sporting Goods stores in the period, and its e-commerce penetration advanced to 7.3% of total sales, compared to 6.5% in the third quarter of last year. Dick’s, like Home Depot and Lowe’s, is somewhat resistant to online discount retailers. As with home improvement items, sporting goods are generally preferred to be evaluated in the store before purchasing. We think this dynamic makes the business models of home improvement retailers and sporting goods giants more immune to encroaching online competition. Still, no firm is completely sheltered from the proliferation of e-commerce.
Looking ahead, Dick’s expects a same-store sales increase of a similar magnitude in the fourth quarter of 2014 as that of the third quarter as it anniversaries a strong 7.3% comp in last year’s period. The company expects non-GAAP earnings per share in the range of $2.75-$2.85 for the full year. At nearly $48 per share, shares of Dick’s are trading at ~17 times current year’s earnings, a much more palatable multiple than Home Depot’s. However, Home Depot is executing at a higher level, as comparable-store trends and ROIC measures indicate.
All in, we like Home Depot, Lowe’s, and Dick’s Sporting Goods, and we think their results speak to the health of consumer discretionary spending. We won’t be rushing to add any of them to the newsletter portfolios, however. We think there will be a better time to consider them in the months and years ahead.
Related Firms: BGFV, CAB, HIBB, LL, ELY