Can Mexico Deliver Growth For Lowe’s and Home Depot?

What’s the perfect recipe for a housing boom? Most would agree that it’s a strong economy, cheap lending rates, and a growing, property-hungry middle-class. And that is precisely what spells ‘big bucks’ for Lowe’s (NYSE:LOW) and Home Depot (NYSE:HD), who have made it their business to support new construction and home improvement with a wide variety of home improvement products – ranging from plumbing to flooring to kitchen appliances.

See our complete analysis of Lowe’s here

Now we all know the way the US is these days – lending rates might still be cheap, but it’s becoming harder and harder to fuel any significant recovery. Sure, the housing market seems to be improving – but it’s more of a limp than a sprint right now. Moreover, the market is overly saturated – the landscape is dotted with retail chains with price competition imposing an ever increasing pressure on margins. Lowe’s and Home Depot are discovering that there it is difficult to drive top-line growth. Working on ‘softer’ differentiation such as customer service is one option. Improving the online presence is another.

The business improvement for the two in the US is mostly a game of working on the bottom line – getting smarter with inventory management, putting a halt to store-related capital expenditure. The US scenario is typified by two companies’ latest, third quarter financials – low sales growth (in the region of 2-4% for both companies), coupled with a significant jump in net profits (76% for Lowe’s). Having said that, we must also mention that Hurricane Sandy offers the two companies hope for a short-term spike in earnings in the coming quarters.

So where do Lowe’s and Home Depot turn to for some top-line sizzle?

Mexico. The country checks out on all mentioned parameters for housing growth. The country is South America’s second largest economy, and is expected to grow faster than pacy Brazil for the second consecutive year in 2012. Lending rates are at 10%, down from 13% three years ago. Home loans grew by more than 10% over September 2011- September 2012. The country is expected to add around 14.6 million homes over the period 2010-2040, leading to a real scramble between the nation’s leading lenders for a slice of this rather enticing pie. ^[1]

Home Depot has 100 stores in the country (its 100th was flagged off recently in November). This is up from around 60 in 2009. Lowe’s, meanwhile has a rather limited international presence at the moment, with only 2 stores in the country.

Going forward, we expect the two companies to continue investing heavily in the region. Lowe’s, which has a markedly lower footprint in Mexico than Home Depot, starts off with a distinct disadvantage.

A new market – does this mean new risks?

Well, there is always the chance that Lowe’s and Home Depot could repeat China in Mexico.

Home Depot has all but pulled out of the Chinese market after setting up as many as twelve stores in the country in 2009. The reasons are a bit complex – ranging from a downturn in the housing market in the country to a failure to launch in the market due to cultural reasons. The Chinese are not very big on buying home improvement items directly from stores and working on their projects on a do-it-yourself (DIY) basis. Nor could Home Depot really connect with the rather fragmented market of professional contractors in the country who usually manage home improvement projects for individual consumers. There is always the risk that the oversight of such cultural factors might flare up again in Mexico. Going by the Home Depot’s performance so far in the region, however, we may safely assume such risks are at best marginal. ^[2]

The key point worth noting is that when we talk about Mexico driving either Home Depot or Lowe’s top line, we are taking a very long-term perspective. Well over 90% of either companies revenues and stores are still within the US. The two companies’ performance in the next couple of years will be directly impacted by the US housing market – irrespective of how fast the growth is in Mexico. Nonetheless, investors for both Home Depot and Lowe’s can take heart in the fact that there is still a lot of scope in the international arena.

We have a Trefis price estimate of $36 for Lowe’s stock, which is in line with the market price.

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1. “Mexico’s Banks Target Wealthy in Booming Home Market: Mortgages“, Bloomberg, November 2012 [↩]
2. “Home Depot’s big box plans for China lost in translation“, NBCNews.com, September 2012 [↩]