Why Lowe’s Bought Orchard Supply and Is Eyeing Smaller Stores

In August 2013, Lowe’s (LOW) completed the acquisition of 72 Orchard Supply Hardware stores for $207 million in cash and assumed liabilities. The acquisition was made with the intention of capitalizing on the housing market (XHB) (ITB) growth in California, one of the largest housing markets in the US. The purchase raised Lowe’s sales by about $0.2 billion in fiscal 2014.

However, each Orchard store is much smaller than Lowe’s typical big box store. Orchard Supply stores are ~36,000 square feet each and serve densely populated urban neighborhoods. Products cater to the specific needs of each community and primarily consist of items like paint as well as backyard and repair tools and supplies. At the end of fiscal 2015, Lowe’s operated 71 of these stores in California and three in Oregon.

Lowe’s is also experimenting with the idea of rolling out other smaller format stores like City Center stores in other under-penetrated and high-density urban areas in the US. Due to the significant space requirement, home improvement retailers are typically located in suburban areas. Smaller format stores in urban areas may help Lowe’s address gaps in the market. Lowe’s has already opened two City Center stores in New York in 2H15.

Other big box retailers like Walmart (WMT) and Target (TGT) also have their own small stores catering to the urban populace. In fact, Walmart’s neighborhood market format stores have consistently reported better comps compared to the rest of its US retail brick-and-mortar footprint.

But Home Depot (HD), Lowe’s rival, has no plans of coming up with a small-format store, according to Craig Menear, CEO of HD. However, IKEA of Sweden has rolled out smaller stores in Canada, albeit for different reasons. The privately held retailer plans to use these primarily as fulfillment centers for its e-commerce business.

Orchard Supply stores represent a significant growth opportunity for Lowe’s to establish a presence in highly populated segments of the market. The company is looking at rolling out 40 new stores in the next three years.