Looking for a stock that beats the market? If you are considering Lowe’s (NYSE:LOW) then you are likely on the right path. Over the last ten years, an investment in Lowe’s beat the S&P 500 by nearly a three to one margin, and that doesn’t include dividends.
Speaking of dividends, Lowe’s just raised its divvy by 31%. The company also has a five year dividend growth rate of nearly 18%, and the payout ratio indicates the dividend is safe and has room for growth.
However, shares of Lowe’s have fallen nearly 22% this year. Tough comps, and fears that the housing market will slow and that a recession may be on the horizon, are legitimate concerns for those considering an investment in any company in the specialty retail industry.
A Review Of Q1 Earnings
Lowe’s reported Q1 FY22 earnings on May 18th. EPS of $3.51 beat the $3.22 consensus. However, net sales of $23.66 billion fell short of analyst’s estimates of $23.76 billion and were below last year’s $24.42 billion.
The company also missed on same store sales. Analysts predicted a 2.5% decrease in comps, but Lowe’s reported a 4% drop from 2021.
Management blamed the somewhat disappointing results on cooler weather conditions, claiming some sales normally expected in Q1 will be realized in Q2. However, this rings a bit hollow considering that the day prior Home Depot (HD) reported a 2% increase in comps and raised its sales outlook.
Although a cursory review of Lowe’s results aren’t particularly impressive, as I perused the earnings call, I found a number of positive takeaways.
During the quarter, operating margin increased by 65 basis points. This is noteworthy in that a number of retailers this earnings season reported increased sales accompanied by plunging profits.
Investors also need to acknowledge that Lowe’s sales increased markedly in 2020 and 2021, thereby setting a very high bar for current earnings. Consequently, although U.S. comparable sales declined 3.8%, they are up 19.7% on a 2-year basis.
Lowes.com, sales also grew 2% in Q1. That follows 36% growth for Q1 21, and represents a two-year comparable increase of over 39%.
In the important Pro category, Lowe’s reported a 20% increase for the quarter on top of 36% comps last year. The increase in Pro sales is a factor in the 9.1% increase in the comparable average ticket.
Where Can We Find Growth?
I previously noted that last quarter Home Depot reported a 2% increase in comps versus Lowe’s 4% decrease. Lowe’s also forecasts flat comps this year, and Home Depot guides for a 3% sales gain in 2022. The performance gap is largely due to Home Depot garnering a much larger share of the Pro market than Lowe’s.
Pro’s tend to generate bigger tickets and are reliable, repeat customers. Aside from better comps, this also translates into bigger profit margins: HD has an operating margin above 15% of sales, while Lowe’s goal is to hit a 13% margin this fiscal year.
When studying these and other metrics, pundits commonly view HD as the better investment of the two. This means investors are willing to pay a premium for HD, resulting in a P/E roughly four points higher than that of Lowe’s.
Therefore, it might surprise some to find that over the last five years, shares of LOW are up about 150% while HD stock is up roughly 100%.
Yes, HD has a better all-around business model, but in some respects, Lowe’s is gaining ground.
Sales to professionals generate 25% of Lowe’s total revenue, less than Home Depot’s nearly 50% share; however, initiatives designed to increase the company’s Pro business resulted in 600 basis points of growth in Pro penetration over the past three years. That means Pro sales today are up over 31% over 2019. Last quarter, Pro sales outpaced DIY with sales growth of 20%..
One other really interesting data point, if we look at the Pro customers currently enrolled in our new MVP Loyalty Program and our credit program, they’re spending 300% more than Pro customers not enrolled. So it gives us a lot of confidence that our Pro growth is sustainable.
Marvin Ellison, CEO
However, the investment community is weighing how rising interest rates coupled with a possible recession will affect future sales for the home improvement industry.
The Outlook For The Home Improvement Market
For insights into the home improvement market, look no further than a study by Harvard University and the resulting chart below.
Of course, as investors, it is wise to be skeptical of academic studies, even those that come from the likes of Harvard. Furthermore, the chart reflects data gathered prior to Russia’s invasion of Ukraine and before inflation really raised its ugly head.
Nevertheless, the graph above shows remodeling activity is projected to remain robust throughout 2022. Are there other indicators that contradict or buttress this viewpoint?
A survey commissioned by Angi Inc addresses a number of factors influencing home renovations. (Note that references to younger generations allude to those that are 18 to 43 years of age while older generations are those 57 to 75.)
A survey of 1,000 U.S. millennial homebuyers found respondents bought homes needing more renovations than the buyers initially intended to consider. Of those studied, 56% of millennials bought a home requiring minor or major renovations. This is even though 42% of prospective home buyers want to purchase a fixer-upper rather than a move-in ready home.
Of those in the younger generation, 65% are more likely to remodel, and 56% remodel “before or immediately after moving in.” Younger homebuyers are also motivated to renovate to improve environmental sustainability.
Of the millennials surveyed, roughly 70% have budgeted $25,000 or more and nearly half intend to spend $50,000 on renovations.
Younger generations are more likely to engage in DIY projects, while 72% of younger and 42% of older homeowners started a DIY project recently.
Among the older generation, 59% have financed a home improvement project through a home equity line of credit.
Statements during the recent earnings calls provide additional evidence that the home improvement market still has legs:
…our Pro customers continued to shop to fuel their strong business demand. And our recent Pro surveys indicate that the majority of our Pro customers continue to report strength in their business and a full slate of projects for the year.
Marvin Ellison, CEO, Lowe’s
…in surveys, our customers tell us that their homes have never been more important, and their intent to do projects of all sizes has never been higher. And our Pros say the same thing about their backlogs.
…we also have to listen to our customers, those same surveys where the Pro survey, there is also one with respect to consumer intent to do projects. Homeowner intent to do projects of small, medium and large sizes has never been higher than right now.
Richard McPhail, CFO, Home Depot
In my article from last March on Home Depot, Home Depot: Developments That Signal Long-Term Growth , I have a section that details trends that should drive long term growth for home improvement retailers.
In part, I cite home-price appreciation, a lack of affordable housing, increased existing-home sales, demographic trends, and the age of homes in the US, as just some of the factors fueling remodeling demand.
Pondering A Potential Recession
There is a great deal of chatter among investors regarding the possibility of a recession. What does history tell us about home improvement trends in general, and Lowe’s stock in particular, during recessions?
One point to consider is that Lowe’s CEO claims two-thirds of his company’s sales are non-discretionary. From roofs damaged by storms to stopped up drainage systems and more, there are some things that just gotta get fixed, no matter the state of the economy next Monday morning.
The next two charts, once again the result of studies by the Harvard Joint Center for Housing Studies, show how owners’ expenditures on home improvement projects vary over economic cycles.
The study determined that at the low point of the Great Recession, homeowners spent nearly one-quarter less on home improvement projects. When replacement projects are added to the mix, consumers spend 15% to 20% less.
Looking at Lowe’s stock, at its pre-recession peak in early 2007, it traded for a bit over $32 per share. At its nadir in 2009, it briefly fell to under $16 per share.
In the midst of the 2008-09 recession, the largest drop in sales Lowe’s recorded was roughly 5%, year over year; however, EPS fell from $1.86 in 2008 to $1.21 in 2010.
And here are some interesting stats regarding housing during the Great Recession. According to the U.S. Bureau of Labor Statistics, housing expenditures increased by 1.1% from 2007 to 2008, and fell by 1.3% in the following year. When one considers that the Great Recession was largely caused by a housing crisis, it is reasonable to construe that there would be a lesser impact on housing expenditures should a recession occur in the future.
The Manifest Strengths Of LOW
Lowe’s operates in a near duopoly with Home Depot. Consider that Menard’s, the number three competitor in this space, has 335 stores in 15 states. Contrast this with Lowe’s with 1,971 stores and servicing 230 dealer-owned stores in the US and Canada.
Lowe’s size also provides a competitive advantage. As a consequence, the firm has significant bargaining power. Some of the savings gained when negotiating with vendors are passed along to consumers. The nature of the company’s products also provides protection against e-commerce competitors.
With an addressable market of over $900 billion, and annual sales of $97 billion, there is significant room for Lowe’s continued growth.
Lowe’s owns 84% of its stores, some of which are on leased land. Lowe’s balance sheet values the company’s property at $19 billion.
The company has a long history of rewarding shareholders with double-digit dividend growth and a robust stock buyback program. In 2010 LOW had over 1.4 billion shares. Today the company has a bit over 639 million shares outstanding.
During the last quarter alone, Lowe’s repurchased 19.2 million shares.
LOW Stock Key Metrics
LOW currently trades for $199.63 per share. The 12-month average price target of the 19 analysts covering the stock is $246.00. The price target of the eight analysts that rated LOW following the last earnings report is $233.88.
Lowe’s trades for a forward P/E of 14.72x, well below the stock’s 5-year average P/E of 18.92x. In fact, it has been nearly a decade since Lowe’s sported a P/E ratio below 15x. Lowe’s has not traded at a P/E ratio below 14x since the Great Recession.
LOW has a 5-year PEG ratio of 0.74x. Lowe’s average PEG ratio over the last five years is 1.10x.
Lowe’s current yield is 2.10%. Lowe’s has a payout ratio of 26.08%, and a 5-year dividend growth rate of just over 17.98%
Last Friday, the company announced a dividend increase of 31%.
Lowe’s debt is rated Baa1/stable by Moody’s, and BBB+/stable with S&P.
Is Lowe’s A Buy, Hold Or Sell?
While the latest quarterly report was less than stellar, there are a number of trends exhibited by Lowe’s that warrant investors’ attention.
Digital sales at Lowe’s increased 151% over the past two years. Because 60% of online orders are picked up in stores, this often drives additional foot traffic.
Lowe’s had an operating margin of 9% in 2019. Management forecasts that metric will reach around 13% in 2022.
The company has increased its Pro business by 600 basis points over the past three years.
The trend toward remote work, the age of the housing stock, millennial household formation, and baby boomers’ preference to age in place, should serve as long-term tailwinds for home improvement.
When measuring P/E ratio and price to free cash flow, Lowe’s is trading at the lower end of its historical valuation.
I rate LOW as a BUY.
I’ll readily admit that I often struggle to determine whether a company should be rated as a buy or a hold. In the case of Lowe’s, the current valuation combined with a sound financial position, the fact that the company operates in a duopoly, a number of factors related to housing, which I believe will drive long term demand for the home improvement market, make this an easy decision.
While conducting research for this article, I added to my already large investment in Lowe’s. Should the share price continue to drop, I will gladly increase my position.