Home improvement retailer Lowe’s (NYSE:LOW) is scheduled to announce Q1 results on May 21. After a strong last couple of years, the unusually cold months of January and February slowed down growth in the housing industry this year. In addition to bad weather conditions, higher mortgage rates and rising house prices somewhat deterred growth for the housing market. Sales of existing homes in particular, which form around 90% of overall house sales, were the most hit in the first three months of the year. However, rising mortgage and housing rates could be offset by higher consumer affordability going forward. Net sales for Lowe’s in the last quarter stood at $11.66 billion, an increase of about 5.6% over Q4 2012. This rise was boosted by addition of stores due to the Orchard store acquisition, and a 3.9% comparable sales growth. Excluding the impact of bad weather conditions in the tail-end of the last quarter, Lowe’s would have achieved 4.9% comparable sales growth. The company expects to achieve its highest comparable sales growth for the year in Q1, whereas the full-figure figure is anticipated to be around 4%. First quarter sales should rise as homeowners go about carrying out repair jobs due to the damage caused by the snow to driveways, roofs etc.
We have a $49.34 Trefis price estimate for Lowe’s stock, which is around 8% above the current market price.
Housing Industry Growth Stalls In March
Lowe’s business is dependent on the number of house sales, as new occupants spend on home improvement supplies and construction products and services. House sales in turn are influenced by factors such as housing prices, mortgage rates, and the general business environment that impacts job creation and incomes. With housing prices and mortgage rates remaining high, sales of existing homes declined from a seasonally adjusted annual rate (SAAR) of 4.87 million in December to 4.62 million in January, 4.6 million in February and 4.59 million in March.  In fact, sales in March represented a year-over-year decline of 7.5%. New home sales also remained low, and fell to a SAAR of 384,000 in March, from 449,000 in February.
The average interest rate on a 30-year fixed-rate mortgage this year has been 4.3%, up from 3.45% last year in April.  Lending rates have been on a rise since last year, fueled by the Federal Reserve’s announcement of reduction in bond purchases, which had kept the long-term interest rates low. High mortgage prices, coupled with high housing rates, are hurting consumer affordability. However, according to Blue Chip Economic Indicators, net disposable income is expected to increase by 2.3% this year, up from a small 0.7% growth in 2013.  Lowe’s focuses more on higher priced premium goods, as compared to its chief competitor Home Depot. With an increase in disposable incomes, consumers might switch to premium goods and thus boost Lowe’s sales. In addition, the unemployment rate in the U.S. has also fallen to 6.3% in April, down from 7.5% a year ago.  Creation of jobs should facilitate home sales, and in turn bolster home improvement sales. Although home sales in March were slow despite the commencement of spring, housing activity is expected to have picked up in April, bolstered by pent-up consumer demand. This could boost home improvement sales for Lowe’s this quarter.
Value Improvement Initiatives Could Boost Margins
Gross margins for Lowe’s improved by 40 basis points year-over-year to 34.67% in Q4 last year. Margin expansion due to favorable product mix and lower inventory was essentially offset by markdowns necessary to clear seasonal product and the company’s proprietary credit value proposition. Margin growth was primarily due to the company’s value improvement initiative, which boosted gross margins by 40 basis points last quarter. Lowe’s finished the first round of value improvement line reviews last quarter, and expects profitability to rise this quarter, as value improvement is now fully operationalized. The company suffered an erosion in gross margins by 84 basis points in 2011 and 2012 and is seeking to regain 2010 levels.
Value improvement should also support growth in sales to professional (pro) customers for Lowe’s this quarter. A considerable amount of process improvements and value improvement reset spends were directed to categories that have high penetration of professional customer sales. While professional customers account for about 35% of Home Depot’s sales, the figure for Lowe’s is close to 25%. The latter’s pro customer business saw higher comparable sales growth than the company average last year. Lowe’s will now relaunch LowesForPros in the second quarter, a dedicated online platform for purchase by professional customers. The company will aim to add incremental sales by capitalizing on the growth potential of the professional customer market, which is growing faster than the retail consumer market at present.Notes: