By James Hyerczyk
Earlier this week, Home Depot (HD) reported a 12 percent increase in second-quarter earnings. The company gave credit for this jump in earnings to an improving housing market. As the housing market was improving, customers were buying more big-ticket items such as appliances. Additionally, the company cited increased demand for home improvement materials as another reason for increased earnings. Finally, a cut in expenses also helped improve the company’s bottom line. With the housing market expected to remain stable into the end of the year, company officials expect this trend to continue.
Lowe’s (LOW) is set to report its second-quarter earnings results on August 16 before the stock market opens. Expectations are for this stock to show similar results as Home Depot (HD). One area that analysts will be focusing on is the results of the company’s price cutting strategy implemented originally late last year. Analysts are looking for earnings of 70 cents per share on revenue of $14.44 billion.
While Home Depot has moved steadily higher this year except for a few breaks triggered by concerns about Europe, Lowe’s has been under pressure since reaching a top at $32.29 in April 2012. The reason for the decline in the stock price from $32.29 to $24.76 on August 2 was the company’s move to increase leverage by raising $2 billion in the bond market. In mid-April, the company sold five-, 10- and 30-year debt reportedly to raise funds to finance stock repurchases.
Now that 10-Year Treasury Notes and 30-Year Treasury Bonds have begun to rise, it looks as if Lowe’s debt strategists may have come close to picking the bottom of the intermediate to longer-term debt markets. With cash in hand, Lowe’s may begin to purchase its own stock according to regulatory filings in a move that is expected to last until 2015 when it is scheduled to complete its $4.5 billion stock repurchase plan.
With the company effectively putting a bid under the market, share prices may be underpinned, meaning that increased earnings could lead to the start of a fresh rally. Two-days before Lowe’s is expected to report its earnings, the stock is already showing a slight advance versus Home Depot. On July 30, Home Depot closed at $52.18. On August 15 the close was $55.00 representing a gain of 5.40%. Lowe’s closed at $25.37 on July 31 and as of August 15 was trading at $26.83 or an increase of 5.75%. If the company’s earnings beat expectations then coupled with the possibility of a stock buyback, the percentage gain may increase over the near-term.
Since both stocks are reacting to the same fundamentals, the fact that Lowe’s is leveraged to buy back its shares, the stock may increase at a faster rate than the shares of Home Depot over the near-term. Since the price spread between the two stocks has reached a key retracement area, this chart pattern may be sending a signal to investors that Home Depot is overpriced relative to Lowe’s at least over the short-run.
Since bottoming at the height of the economic crisis in October 2008 at $17.05, Home Depot has rallied sharply higher, reaching a high of $55.34 on August 15. A comparable company, Lowe’s bottomed with the major indices in March 2009 at $13.00, before reaching a high in April 2012 at $32.29. The spread between the two stocks reached a low of $1.50 in December 2008 and is currently at $28.17.
In December 1999, the spread between the two stocks reached an all-time high at $53.81. Based on the range of the spread from $53.81 to $1.50, a key retracement zone has been created at $27.66 to $33.83. As of the close on August 15, the spread was trading slightly better than the lower or 50% level of the retracement zone. Often the test of a retracement zone leads to the start of a short-term correction. In this case, it may mean that Lowe’s stock is poised to outperform the stock of Home Depot.