Home improvement retailer Lowe’s (NYSE:LOW) released its Q3 earnings results on November 20. Earnings for the quarter stood at $499 million, a gain of nearly 26%. Net earnings were propelled by top-line growth as a result of the steady recovery in the U.S. housing market driving consumer appetite for home improvement products. The company’s net sales for the quarter stood at $12.96 billion, an increase of about 7.3% over Q3 2012.
Based on its solid performance and outlook for the balance of the year, Lowe’s raised its sales expectations. It now expects sales to be up by approximately 6% year-over-year with a rise in comparable store sales of approximately 5%. Earlier, Lowe’s had anticipated sales and comparable store sales to increase 5% and 4.5%, respectively. 
Despite posting solid results and upgrading its outlook for the year, Lowe’s was not able to outperform Home Depot. The latter reported a year-over-year same store sales growth figure of 7.4% for the third quarter, while Lowe’s same store sales grew year-over-year by 6.2% only. The same store sales metric is a key parameter to measure a retailer’s health because it excludes results from stores which may have been recently opened or closed.
We have a $43 Trefis price estimate for Lowe’s stock, which we will revise shortly based on the latest results.
Housing Market Recovery Boosts Sales
The housing market recovery continued in the third quarter of 2013, spurred by strong consumer confidence and low mortgage rates. New home sales rose were 390,000 in July and 421,000 in August while the data for September is yet to be reported. Sales of existing homes continued to be strong year-over-year. The National Association of Realtors is expected to report existing home sales data for September shortly, which may provide further boost to Lowe’s stock price. The reason that sales of new as well as existing homes benefit Lowe’s is the spending on home improvement by new occupants. 
Even though mortgage rates increased in October, Lowe’ is sanguine about the prospects of a continued housing market recovery. The company expects stronger job and income growth, improving household financial conditions and the lagging benefit of the recovery in home buying to be key drivers of growth going forward.
Lowe’s net sales in Q3 2013 were around 7.3% higher year-over-year and reached $12.96 billion. The main sales drivers in the third quarter were macroeconomic in nature – primarily declining unemployment, increasing home occupancy rates, higher rates of home construction and spending as well as new home sales.
The company’s comparable same-store sales (comps) increased by a healthy 6.2% over the quarter. This increase was driven by growth in the number of transactions as well as the ticket size of each transaction. Progress on these fronts was a result of an enhanced sales and operations planning process, value improvement, product differentiation and store labor investment. ((Lowe’s Q3 2013 Earnings Conference Call, Seeking Alpha))
Lowe’s also said that its ProServices business, which serves contractors and other professional customers, continued to perform very well. However, its relatively smaller share of this market in comparison to rival retailer Home Depot will ensure that the latter continues to outpace Lowe’s in terms of sales growth. Professional customers account for about 35% of Home Depot’s sales while the figure for Lowe’s is close to 25%. It is difficult for Lowe’s to catch up with Home Depot on this front because the latter has more stores in metropolitan areas where the professional customers are generally based. 
Interestingly, Lowe’s has been making some efforts to overcome its real estate disadvantage vis-a-vis Home Depot. It purchased the Orchard Supply Hardware (OSH) stores in California for $205 million in the third quarter. Home Depot has more than twice the number of stores as Lowe’s in California and they are located strategically, giving the company better access to consumers. The California market is booming in particular, especially because of its enormous population. OSH is also present in high-density, prime locations in California and has 89 of its 91 stores located in this state alone. In one fell swoop, Lowe’s has gained access to OSH’s prime real estate properties without having to spend the time and a huge amount to build a presence on its own. We will examine the performance of Lowe’s in California next quarter when the results from OSH are included for the first time on a full-quarter basis. ((Lowe’s Companies Completes Acquisition of 72 Orchard Supply Hardware Stores, MarketWatch))
Margins Remain Strong
Gross margins for the third quarter were 34.58% of sales, an increase of 26 basis points over Q3 2012. The rise in margins was driven mainly by value improvement which caused an increase of approximately 52 basis points.
The improvement in margin was offset to some extent by Lowe’s credit value proposition program, which impacted gross margin negatively by approximately 14 basis points. This program offers customers a choice of 5% off everyday or promotional financing mix. It helps Lowe’s comparable store-sales figures by attracting more customers, but takes its toll on the cost structure.
In addition, competitive pressures in the market impacted the level of appliance promotions, which reduced gross margins by an estimated 10 basis points. Finally, the mix of products sold hurt gross margins modestly.Notes: