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ON THE HOMEFRONT

Lowe’s, Home Depot battle for market share heats up

BY DEBRA HAZEL

For home centers this should be the best of times. Millions of Americans have taken advantage of record low mortgage rates in recent years to buy homes. Still others have refinanced older loans to free up disposable income for home improvements, or even to buy second houses. A shaky stock market has further encouraged people to invest in real estate.

But whether these are in fact the best of times for home centers depends on whether you are The Home Depot or Lowe’s Home Improvement.

Wilkesboro, N.C.-based Lowe’s, the industry’s No. 2 chain, is riding high. Its earnings for fiscal 2002 totaled $1.47 billion (up 43.8 percent from 2001), on $26.5 billion in sales (up 19.8 percent). Comparable-store sales, meanwhile, were up 5.6 percent for the year.

And the company has taken the media spotlight by expanding from 295 smaller stores (30,000 square feet and under) in 1989 to more than 850 larger ones (averaging about 115,000 square feet) in 40 states today. Lowe’s plans to open more than 120 stores in 2003, including 60 in the New York metropolitan area, which is now dominated by Atlanta-based industry giant Home Depot. Overall, the company aims to launch 300 new superstores by mid-2005.

“We need to move into the markets where the money is,” Lowe’s Chairman and CEO Robert Tillman told attendees at ICSC’s New York Idea Exchange & Deal Making in December.

This is the latest headache for Home Depot, the industry’s largest chain. Granted, Home Depot posted record numbers last year, with net earnings of $3.7 billion, up from $3 billion in 2001, while total sales rose 9 percent to $58.2 billion. But same-store sales were flat for the year, and the chain has struggled in other ways. Its stock price closed at $23.11 per share on Feb. 27, well below its 52-week high of $52.60 per share, and the company earned the distinction of being the worst performer on the 30-member Dow Jones industrial average last year.

Besides all that, and total results for the year notwithstanding, in February Home Depot reported a 3.4 percent fourth-quarter profit decline. The chain has lowered its profit projections for 2003, behind a $4 billion plan to open 200 new stores, renovate 250 existing ones, invest in new systems and hire 40,000 sales associates in an effort to stay competitive.

“We have embarked on a transformation of The Home Depot from a young, decentralized business toward a more mature and balanced company with predictable and sustainable growth potential,” said CEO Robert L. Nardelli in a written statement at the time the plan was announced. Nardelli was appointed to succeed founders Arthur Blank and Bernard Marcus.

Part of Home Depot’s problem has been that as a much larger company, it has less opportunity for the kind of exponential growth it experienced through the 1990s. The chain now operates more than 1,300 U.S. Home Depots, 52 Expo Design Centers, one Floor Store, three Landscape Supply stores and more than 100 units in Canada, Puerto Rico and Mexico. This maturity is at the heart of its stock woes, observers say.

“Home Depot has over 1,200 stores right now and has penetrated the United States,” said David Campbell, a retail analyst at Davenport & Co., a Richmond, Va.-based investment bank. “Now it has started to run into a saturation problem and a lot of management turnover [as] its founders retired.”

Some have criticized Nardelli, a former General Electric Co. executive, for focusing more on cost-cutting than merchandising. Product purchasing has been increasingly centralized, giving store management less freedom. But that plan has, to a degree, paid off. CFO Carol B. Tomé announced in January that she expects earnings to grow between 21 percent and 23 percent this year, largely because of centralized purchasing, expense control and a $2 billion share repurchase program.

Now, though, the chain is spending to update its aging store base, which will cost it some. According to Nardelli, 26 percent of the existing units are now at least seven years old. The company will dedicate about $250 million this year to remodeling.

“It’s pretty clear that we need to make significant investments in our existing stores, and we’re increasing our investment by almost four times what we invested last year,” Nardelli told analysts in January.

Home Depot also plans to expand its tool rental centers, adding these to 200 existing stores for a total of 800 this year. And Home Depot, like Lowe’s, continues to increase its offerings of such appliances as irons and coffeemakers.

But the Southeast-dominant Lowe’s can still enter new regions, particularly because it locates in smaller markets than in the past. At one time, Tillman said, Lowe’s required its markets to have 100,000 or more residents, whereas today it builds superstores in markets one-third that size.

Another possible factor in Lowe’s favor, at least at first glance, is its determination to market to women, as contrasted with Home Depot’s dedication to contractors. Lowe’s units are airier and more open, with brighter ceilings and more space given to decorating items. The shift in focus began in the late 1980s, Tillman said, when the chain realized that women make 94 percent of all home furnishings decisions and 91 percent of all decisions regarding the purchase of a house.

“The three largest economies in the world are American females, the nation of Japan and American men,” Tillman said at the December ICSC show. “In addition, single women buy homes at twice the rate of single men.”

It was largely to appeal to women that Home Depot opened its higher-end Expo format, which is geared more to them and designers than to contractors. Yet Expo has been a financial disappointment, because it is being perceived as too expensive for its target audience, an idea exacerbated by the weak economy, observers say. As a result, the company has cut expansion plans for the format, opening only two new stores this year. Home Depot has also retargeted Expo’s demographics down from a $75,000 annual income to $50,000. In fact, the chain said at the January analyst meeting that it intends to market not to a particular gender, but to anyone interested in home improvement.

Home Depot says its decision is vindicated by a Forrester Research survey that indicates that women constitute about 45 percent of the customer base at each chain. More than 7,000 households were surveyed by mail in July and August 2002, and the shoppers at both chains were surprisingly similar.

“I’ve never seen anything like it,” said Forrester’s Christopher Kelley, who analyzed the survey, about the similarity of the data.

“It was gratifying to see that we’re reaching our target market,” said Home Depot spokeswoman Karen Powers. “It did mean a lot to us that we’re doing it right.”

Lowe’s says it sees no reason to introduce an Expo of its own, because its stores already appeal to women.

“Heaven forbid,” Tillman said, when queried at the ICSC New York show in December. “If you have one format that does both, why would you split the two? Everyone that’s tried that format, [it] hasn’t worked. It’s very labor

intensive, and people visit the stores, but don’t buy a lot.”

For their part, developers seem not to see any distinctions between the two chains, leasing to them based on which one happens to be expanding in that particular market.

“The overlap of stores is not as extreme as other people perceive it to be,” said Daniel Hurwitz, executive vice president of Developers Diversified Realty Corp., Cleveland, which leases to both chains. “When a home improvement use makes sense for a project, we offer it to both Home Depot and Lowe’s.”

But Home Depot should be careful about its expansion, warned Kelley.

“If you live in an area where The Home Depot is strong and suddenly Lowe’s comes, you’ll see a shift in some of those dollars,” Kelley said. “That’s the challenge Home Depot has going forward.”

The chains themselves believe there is still much room for growth in an extremely fragmented market, however. Home Depot and Lowe’s combined have only 20 percent of the overall market, said Tillman, compared with Wal-Mart and Target’s near-total dominance of the discount business.

“The top two players have such a small market share that the upside is staggering,” Tillman said.

And home improvement product sales are expected to average 6 percent annual growth between 2003 and 2007, according to a December 2002 study by the Home Improvement Research Institute, a Tampa, Fla.-based nonprofit organization that tracks home improvement sales; and Waltham, Mass.-based research firm Global Insight.

“The measure of human needs was once food, clothing and shelter,” Tillman told attendees at the December New York Deal Making. “Now, it’s food, shelter and clothing.”

Consequently, developers are eager to have these kinds of stores.

“Home improvement stores are a vital component of our mix,” Hurwitz said. “We value our relationship with both Home Depot and Lowe’s.”

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