Lowe’s Will Benefit From Uptick In Spending But Strategy Still A Problem

by Trefis Team
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Home improvement retailer Lowe’s (NYSE:LOW) will report its Q3 earnings results on November 19. The results are not expected to be very different year-over-year as the company is still in the process of implementing a shift in its business strategy. It is moving away from the discount-and-sales business model to its original “everyday low prices” model after the former failed to boost its performance. The strategy shift process is one reason why Lowe’s is not expected to benefit much from the nascent U.S. housing market recovery currently underway.

Hurricane Sandy may have benefited Lowe’s to some extent as people stocked up on items like generators, flashlights, plywood and pumps in anticipation of the storm. But we doubt that the company would put a figure to it given that the full effect is likely to be felt over the next few months as reconstruction and repair work takes place.

The aborted attempt to take over Canada’s largest home improvement retailer Rona came as a major setback this quarter. Lowe’s had to give up in the face of strident opposition from Rona’s board as well as politicians in Quebec province where Rona is based. Opposition from politicians made it extremely difficult for Lowe’s to mount a hostile takeover battle. The failure came as a setback to Lowe’s intention to expand beyond the saturated U.S. market. Rival retailer Home Depot (NYSE:HD) already has a sizable presence in Canada with 180 stores as compared to 31 of Lowe’s. The only way Lowe’s could hope to out-compete Home Depot in Canada in a short period of time was through inorganic growth.

See our complete analysis of Lowe’s here

The Canada Fiasco

Lowe’s failure to acquire Rona for $1.8 billion was partly due to the bad timing of its takeover proposal, which we think was a strategic oversight. Quebec, where Rona is based, was about to go in for elections. Politicians from opposition parties came out strongly against the proposal by adopting the economic nationalism stance. This, according to us, left no choice for politicians from the ruling party who adopted the same line and even mandated the government’s investment arm Investissement Quebec to weigh action to counter the offer. Underscoring the strong local factor, Quebec’s largest pension fund Caisse de dépôt et placement du Québec announced that it had boosted its stake in Rona to 14% from 12.18%. Rona’s board too spurned Lowe’s by declaring that the takeover offer was not in the best interests of the company or its shareholders.

Rona has a complex, differentiated network of small and big stores which bear little resemblance to the uniform big-box stores that Lowe’s already operates in North America. It would have taken time for Lowe’s to figure out how to operate in this format effectively. In view of this, we think that Lowe’s can derive some positives out of the whole affair. The most pressing issue for Lowe’s is competition in the United States and it can go back to focusing its efforts on that.

Lowe’s earned $747 million in Q2 2012. That was down from $830 million a year ago by nearly 10%, and shows that the U.S. market needs to be paid attention to.

Will The Housing Market Recovery Benefit Lowe’s?

The housing market is in the midst of a nascent recovery and home improvement retailers are expected to benefit from this in general. The Federal Reserve Bank’s resolve to keep interest rates low through its endless mortgage security purchase program is expected to provide a major boost to the housing market. However, customers who have become used to seeing frequent discounts from Lowe’s may now see no reason to go there if there are no discounts. Customer behavior might adapt to this change in the long term, but until that happens, rival retailers like Home Depot are expected to eat into Lowe’s business. [1]

Impact Due To Hurricane Sandy

Bad news on the weather front means good news for home improvement retailers. Hurricane Irene had a positive impact on sales for both Home Depot and Lowe’s in the previous year with the provided upturn spread over a surprisingly long period of time as recovery from the disaster was slower than expected. Home Depot, in its Q3 earnings conference call, estimated Irene related sales at $360 million, spread over two quarters. A similar effect may be estimated for Sandy, which has caused more damage to property (estimated $20 billion) than Irene had ($16 billion). This is likely to drive demand in the short run, providing a much needed boost to top-line growth. [2]

Competition From Home Depot

With efforts focused on better service, technology support and store remodeling, Home Depot has historically outperformed the sector, taking away market share from Lowe’s in a still mixed housing market, by making its operations and supply-chain more efficient. Lowe’s year-over-year growth figures have been dwarfed by Home Depot’s for six quarters now. The last quarter was the fifth consecutive quarter that gross margins narrowed for Lowe’s. This shows that Lowe’s has not been able to reduce costs like Home Depot has managed to.

We have a $33 Trefis price estimate for Lowe’s stock, 5% ahead of the current market price. We will revise our estimates if necessary once the third quarter earnings results are declared.

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Notes:
  1. Home Depot vs. Lowe’s: It’s No Contest, InvestorPlace []
  2. Home Depot Earnings: Housing Recovery And Cost Discipline Boost Results, Trefis []
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