Home improvement retailer Lowe’s (NYSE:LOW) is scheduled to release its Q4 earnings results on February 26. Compared to the previous quarters in 2013, the performance of the housing market was a bit disappointing in the fourth quarter so Lowe’s may report only slightly higher year-over-year quarterly sales. On an annual basis, we expect the company to fall a bit short of its growth targets which were revised upwards at the end of Q3.
Lowe’s looks to have positioned itself well for higher demand for homes and home-related products. Its total sales rose by about 7.3% year-over-year in Q3 2013 and we expect sales to be higher on a year-over-year basis in the fourth quarter as well even though the increase in percentage terms may be moderate. In addition, the company’s gross margins in the previous quarter rose by 26 basis points from Q3 2012, primarily due to a favorable 52 basis point impact from its Value Improvement initiative. It was offset to some extent by an unfavorable impact from its credit value proposition program. We expect a further improvement in gross margins in the fourth quarter. ((Lowe’s Q3 2013 8-K, SEC))
We have a $46 Trefis price estimate for Lowe’s stock, which will be revised once the earnings results are out.
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Effect Of The Housing Market
The housing market recovery continued in October in the fourth quarter of 2013, spurred by strong consumer confidence and low mortgage rates but a slowdown occurred in November and December. New home sales rose were 463,000 in October, 445,000 in November and 414,000 in December. Sales of existing homes dipped compared to levels observed in Q2 and Q3. The reason that sales of new as well as existing homes are important for Lowe’s is the spending on home improvement by new occupants. 
We believe that Lowe’s stock price suffered in January and February because the housing data for November and December were released at this time and came in weak. However, this setback may just be temporary in nature. The U.S. has experienced an especially severe winter this time and we think that it may have been a major factor influencing the housing market activity in the fourth quarter as business activity levels dipped in general. It is safe to assume then that home improvement projects also got deferred. If so, we may see some pent-up demand resulting in a boost to Lowe’s sales in the first couple of quarters in 2014.
Promotions May Temper Margin Gains
In the third quarter, Lowe’s gross margins increased by 26 basis points from Q3 2012. The benefits from the company’s “Value Improvement Plan”, which aims at making Lowe’s stores more efficient through better inventory management, was offset to some extent by factors such as higher sales penetration of the company’s proprietary credit value proposition. This program offers customers a choice of 5% off everyday or promotional financing mix.
This proprietary credit program helps Lowe’s comps by attracting more customers, but it takes a toll on profitability. Going forward, we expect the company to make slow but steady gains in margins as the ‘Value Improvement’ plan progresses.
Notable Business Developments
Lowe’s demonstrated its Iris suite of home automation products at the Consumer Electronics Show (CES) at Las Vegas in January. The company seems to be betting big on this segment as the next catalyst for growth by competing on innovation rather than just retail sales of other manufacturers’ products. 
With rapid advances in technology and growth in wireless connectivity, the idea of smart homes is increasingly gaining hold. This is not merely for convenience but also energy efficiency. Customers can save a lot on their energy bill with a little upfront investment and a small recurring service charge. As the nation’s second largest home improvement retailer paying special attention to in-house innovation, we think that Lowe’s is poised to capture this space quite well.
Lowe’s announced a partnership with the Seattle-based website Porch.com in January that connects home improvement services contractors to homeowners. The employees at Lowe’s stores across 139 locations in Seattle, North Carolina and South Carolina will now be able to recommend such service providers to customers who ask for advice. 
Even though the financial terms of the deal haven’t been disclosed thus far, we think it is likely that Porch will pay a fixed annual fee or a commission based fee to Lowe’s. The deal will certainly benefit Lowe’s in other ways as well such as attracting more customers. Home Depot, Lowe’s main rival in the home improvement market, already has an in-house service called Redbeacon which connects homeowners to contractors. The partnership with Porch could help Lowe’s offset Home Depot’s advantage to some extent.
What We Will Watch Out For
We are interested in knowing if our hypothesis about the cold U.S. weather dampening housing sales and home improvement sales is true. Therefore, we will look at sales numbers for the fourth quarter and watch out for the management’s comments in this regard.
We will also look out for the financial terms of the deal with Porch.com to incorporate it in our model and any management comments regarding Lowe’s strategy for growth in the home automation segment. We would like to hear the management’s assessment about the size of this market and Lowe’s market opportunity.Notes: