Lowe’s is starting to nail it

May 6, 2013, 12:34 PM UTC

Warren Koontz, 51, does his best to tune out the noise of Wall Street and instead discern a company’s “true value,” which he calculates with a heavy emphasis on discounted cash flows. As a co-manager of the $1.6 billion Loomis Sayles Value Fund, he has used this approach to deliver a 9.9% return over 10 years, compared with 7.9% for the S&P 500. One recent target: shares of the “other” home-improvement company, Lowe’s.

1. It’s the right time for Lowe’s

Lowe’s stores often sit farther from population centers — where recoveries start — than Home Depots. So HD benefited first from the housing turnaround, helping to explain why its stock has waxed Lowe’s. Now the recovery has begun boosting the smaller company. Homeowners are once again taking on the big projects — say, redoing a kitchen — that Lowe’s specializes in. Those are “much more profitable than buying a gallon of paint,” says Koontz, who expects stronger 2013 revenue growth than the 4.9% that Lowe’s anticipates.

2. The company is building smarter

Lowe’s has tempered its frenetic growth strategy, says Koontz. During the downturn, the company opened about 40 stores a year, despite warnings that it would hamper profits. “They wanted to put their footprints out there,” Koontz says. In late 2011, Lowe’s reversed form, closing 20 underperforming locations and committing to only 10 to 15 new stores a year. The wiser spending helped increase profits 6.5% in 2012, compared with a drop of 8.5% in 2011, and it gives Lowe’s more cash to invest elsewhere.

3. Some clicks with the bricks

Lowe’s has focused on online sales in recent years, launching MyLowes.com, which allows people to design their homes and keep track of paint colors and room dimensions before entering a store. The company also teamed up with high-end providers like Valspar Paint, and now sells a professional line of colors found only through Lowe’s. Says Koontz: “They are saying, ‘We have it. They don’t.’ ” With only 1.5% of Lowe’s $51 billion in yearly revenues coming from online sales, Koontz says, there’s plenty of room for growth.

4. It’s cheaper than Home Depot

At $38, Lowe’s stock has jumped 39% since Koontz first bought it in mid-August 2012. (He now owns 592,000 shares.) At that point last summer, Koontz projected the shares would rise to $41, with an “upside possibility” of $53. With a forward price/earnings ratio of 16.6, compared with 19.3 for Home Depot, and a $5 billion stock-repurchase plan to be completed over the next two years, “if we continue to talk about a gradually improving economy,” says Koontz, he thinks the higher target could be within reach.

This story is from the May 20, 2013 issue of Fortune.

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