Stocks Of The Day: Lowe's and Home Depot

Lowe's and Home Depot are the two dominant home improvement retailers. After a lovefest with Lowe's a decade ago investors have taken a liking to Home Depot in recent years. Home Depot has greatly outperformed over the past few years and investors are once again getting ahead of themselves. Home Depot is trading at a 25% premium to Lowe's based on expected 2012 free cash flow. Over the years the balance of power has see sawed between these two retailers. I don't believe that either retailer has a built in advantage that justifies such a large premium.

I believe that there is a catalyst in place that will significantly close the valuation gap. Yesterday on the Lowe's conference call Lowe's said:

Our guidance assumes approximately $4.5 billion in share repurchases for 2012, spread evenly across the 4 quarters.

The market cap of Lowe's is $34 billion, meaning that Lowe's is guiding to a repurchase that amounts to 13% of shares outstanding this year. I believe that should do the trick in closing the valuation gap. At a minimum I believe my downside is protected in that the gap should not widen given this enormous buying.

I have been long Lowe's and short Home Depot for over a half a year. I have watched a 10% profit disappear into what is now almost a 5% loss. My catalyst all along has been an aggressive Lowe's repurchase, which they have been guiding towards all along. Unfortunately, they were not following through with actual aggressive buying.  This guidance is now clear as day and has prompted me to increase my position.