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Investment Overview for Lowe's (NYSE:LOW)
WHAT HAS CHANGED
- Changes in the last year - U.S. economy and housing markets
- Over the last year, Lowe's has continued to benefit from strong macroeconomic fundamentals. In 2014, the U.S. economy grew about 2% and unemployment rates reached record lows of about 6%. In spite of an upbeat economy, housing statistics remained slack in the year with existing home sales declining 2.9% (after growing by over 9% in 2013) and new home sales increasing just 1.6% (after growing by over 16% in 2013).
- However, Lowe's share price and performance, in general, continued to benefit from the phenomenal growth in housing markets in the previous years. Furthermore, the National Association of Realtors projects existing home sales and new home sales to increase at a whopping 31% and 13%, respectively, going into 2015, which could ensure sales for the retail giant.
- Changes in the last quarter - U.S. economy and housing markets
- In the last quarter the U.S. economy failed to grow as expected, but instead contracted 0.2% according to Commerce Department estimates. The deceleration occurred as a consequence of an appreciating dollar choking off exports, labor disputes on the West coast adversely impacting trade, declining oil prices leading to lower investments in the sector, and harsh winter weather choking off consumer spending.
- The slowdown in the U.S. economy at large, also exerted an impact on the housing markets in the earlier part of the quarter. The sale of existing houses, among the most important drivers for the home improvement industry, fell 4.9% in January to a seasonally adjusted average rate (SAAR) of 4.82 million, the lowest recorded since May 2014. However, it laster picked up, with existing home sales surging 6.1% to reach a SAAR of 5.19 million in March, the highest in 18 months. Given these developments, Lowe's under-performed analyst expectations with $14.1 billion in revenues in Q1. However, the revival in housing markets in the latter half of the quarter could ensure a stronger Q2.
Lowe's EBITDA Margin: declined from 14.5% in 2007 to 12.1% in 2009 due to increasing expenses, declining sales, and de-leveraging of SG&A expenses. The margins also suffered as Lowe's continued adding new stores despite weakening demand. In addition, there was pricing pressure as Lowe's was trying to increase its market share amid the weakened demand scenario, thereby taking a hit on profit margins.
In 2010, margins slightly improved to 12.5% as the company began implementing cost-cutting, supply chain optimization, and other efficiency initiatives. In 2011, margins declined to 11.4%, due to the "5% off every day" promotions by Lowe's for its credit card holders, other promotional activities, higher fuel expenses, as well as inventory costs and SG&A de-leveraging related to the closing of 27 stores and discontinued projects. In 2012, margins rose to 12% and further grew to 12.4% in 2013, boosted by benefits from the Value Improvement initiatives. Margins remained flat in 2014. Going forward, we expect the margins to improve over the Trefis forecast period, as Lowe's comps improve. There could be a 7% downside to our price estimate if long-term margins fall to 12%, if Lowe's offers more discounts and other incentives on products to compete on a pricing front. On the other hand, there may be a 7% upside to our price estimate if margins grow to 13.5% in the long run.
Lowe's is the world’s second largest retailer of home improvement products, after Home Depot. Through its more than 1,800 stores spread across the U.S., Canada, and Mexico, Lowe's offers a wide range of home improvement products and installation services to individual home owners as well as professional builders. In addition to the physical stores, consumers can buy these products through the company’s dedicated website.
Lowe's has deep penetration levels in the U.S. with a total of 1,840 stores at the end of 2014. It is also trying to increase its presence in Canada. Lowe's is keen to venture aggressively into Mexico's home improvement industry where it recently opened two stores. Lowe's main selling point is that it outshines its main competitor Home Depot in terms of in-store shopping experience for the consumers. This has forced Home Depot to upgrade its store environment and provide better customer service.
Lowe's business is vulnerable to the housing market and the recent slowdown has affected its sales to a great extent in the past three years. In the current slow economy, attaining historical high revenue growth rates seems very difficult to replicate in the near future.
The Plumbing, Electrical & Kitchen and Hardware and Seasonal products divisions are more valuable than Lowe's other divisions for the following reasons:
Plumbing, Electrical & Kitchen have a larger total market than the Hardware & Seasonal, Paint & Flooring markets
The Plumbing, Electrical, Kitchen and Appliances market size is more than twice the Hardware & Seasonal market and Paint & Flooring market combined. Consumers are more likely to buy home plumbing, electrical and kitchen products owing to their importance in their daily lives. For example, products like electrical lights, kitchen appliances, water pipes, wash basins, toilets, and showers are basic requirements for every household. These products become necessary for consumers to carry out repair projects. Lowe's occupies a much higher market share in the Seasonal & Hardware Tools category, compared to the Plumbing, Electrical and Kitchen division.
Smaller market size but greater market share than the Building Materials, Lumber & Millwork segment
Though the Building Materials, Lumber & Millwork market is twice the size of the Plumbing, Electrical & Kitchen market, it is a very fragmented market and Lowe's currently captures only around 4% of it. In comparison, Lowe's share in Plumbing, Electrical & Kitchen goods is about 12% and in Seasonal & Hardware Tools is close to 40%.
Consistently trailing Home Depot in terms of comps
In 2013, Home Depot outpaced Lowe's in terms of same store sales growth due to significant improvements in service levels and efficiency, as well as a more successful pricing strategy. While comparable sales for Lowe's rose by 4.8%, the figure for Home Depot stood at 6.8%. Although the figure narrowed down in 2014 with 5.3% for Home Depot against 4.3% for Lowe's, larger comp growth for Home Depot could further decrease Lowe's market share in the coming years. In late 2011, Lowe's had decided to move away from promotions to everyday low prices to establish itself as the retailer offering the most competitive prices. However, Lowe's sales continue to struggle more than they already would have in a depressed housing market as customers continued to seek discounts, particularly for discretionary and big-ticket purchases. Home Depot has been grabbing market share from Lowe's due to better pricing models.
MyLowes and emerging competition from online retailers
Online retail has been an emerging threat to the market share of brick and mortar home improvement retailers like Home Depot and Lowe's. For this reason both companies have made significant investments in their online strategies, including small acquisitions, and improvements in the web experience for their customers.
Lowe’s has been trying to turnaround its game with its improved online sales platform 'MyLowes,' newly launched smartphone apps, and its new campaign 'Never Stop Improving' which replaces the older "Let's Build Something Together" one. The online tool 'MyLowes' will allow customers to manage their home improvement projects from conception and planning to execution via extensive interactive content and state-of-the-art technology. Customers can view and manage room-by-room profiles of their homes and experiment with different styles virtually. Lowe's expects 'MyLowes' to help it regain market share through improved customer engagement with customized and personalized offerings.
Professional remodelers, general contractors, repairmen, small business owners, and tradesmen form the professional (pro) customer market, which is growing faster than the retail consumer market. Pro customers generate over 35% of Home Depot's sales, compared to 30% for Lowe's. For 14 consecutive quarters, comps for Pro offerings surpassed the company average. In its earnings call transcript, Lowe's has indicated a number of steps to leverage this and drive sales further among Pro customers.
In 2014, the company initiated a "beta test" for LowesForPros.com, a dedicated online platform for purchase by professional customers. After proving to be successful among pilot customers, the company plans to make the platform available to all pro customers starting Spring 2015. This could further hone their presence among the Pro customers going forward.
Lowe's smaller international footprint
Lowe's international presence (outside the U.S.) is limited compared to Home Depot. While Home Depot operated 292 stores outside the U.S. in 2014, Lowe's had only 47 stores. After Canada, Lowe's entered into Mexico's home improvement industry by opening two retail stores in February 2010 and scaling up to five in 2012, eight in 2013, and ten in 2014. The company has 37 stores in Canada. The company has now planned that about one-third of Lowe's anticipated store growth over the next five years will be in Canada and Mexico.
Lowe's is also in a joint venture with Woolworths (an Australian retailer chain) to open hardware retail stores in Australia. Lowe's is a one-third owner of the JV. The venture opened its first seven stores under the name "Masters" in 2011, and operated 49 stores in the country, as of June 2014. The JV plans to add 10 to 15 stores each year.
Do it Yourself (DIY) activity will drive the home improvement industry growth in the near future
Until the housing market situation in the US improves, more buying action is anticipated from DIY customers. Repair & maintenance of small house projects will dominate DIY activity. The North American Retail Hardware Association (NRHA) forecasts that plumbing & electrical products will be a major part of consumer spending in the near future. The spending will come mainly from DIY consumers who will demand more selection and information & service from the retailers.
Shift in consumer preferences will impact traditional range of home improvement products
A survey from NRHA suggests a change in the buying patterns among U.S. home improvement consumers. People are no longer loyal to only products made in the U.S. Consumer demand is driven more by price and quality. Consumers may find foreign products which are better suited to their needs more appealing than products made in the domestic market. Another observable trend is the shift in consumers toward buying green or eco-friendly products such as water saving flushes and electricity saving appliances.
Aging baby boomers will increase Do it For Me (DIFM) customers in the US
With the change in U.S. demographics due to the aging of the 77 million baby boomers (representing 28% of the U.S. population, and accounting for 77% of all financial assets), Trefis expects an increase in Do it For Me (DIFM) customers. This is good for retailers, such as Lowe's, as they can reap additional revenue by providing installation services, unlike in the case of Do it Yourself (DIY) customers.
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How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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