Lowe’s Earnings Review: Spring Sales Boost Q2 Results, But Slow Q1 Weighs On Full-Year Outlook

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LOW: Lowe's logo
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Lowe's

American home improvement retailer Lowe’s (NYSE:LOW) reported strong spring and summer sales on August 20, boosting the company’s Q2 results. Net sales grew 5.7% year-over-year to $16.6 billion, similar to the increase seen by Home Depot (NYSE:HD), Lowe’s primary competitor, during the period. [1] However, around 100 basis points of this top line growth was incremental, contributed by Orchard Stores, a neighborhood hardware and backyard store chain acquired by Lowe’s in August last year. [2] While Lowe’s’ sales in the first half of the year rose 4.2%, Home Depot’s sales grew 4.4%. This suggests how Home Depot could have further widened its lead over Lowe’s in the U.S. home improvement market. As of 2013, Home Depot and Lowe’s held 27.2% and 18.4% value shares in the domestic market respectively. Given the slow Q1 sales due to rough weather conditions, Lowe’s lowered its full-year sales guidance to 4.5% growth, down from 5% estimated previously. However, this means that sales in the second half are expected to have a solid growth of roughly 5%. This increase is expected to come from the anticipated income and employment growth, and appreciation of home prices, as the domestic housing industry regains momentum.

We have a $50.24 Trefis price estimate for Lowe’s stock, which is roughly 4% below the current market price.

See our complete analysis of Lowe’s here

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Macro Conditions Improve To Boost Demand For Home Improvement Goods

Lowe’s’ business is impacted by the number of house sales, as new occupants spend on home improvement supplies and construction products and services. Macroeconomic factors are starting to favor growth in this market, as seen by the increases in home sales in the second quarter. Hurt by the overall slowdown in economic activity, along with high lending rates, 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. [3] 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. However, following the first quarter, house sales have picked up in the U.S. Existing homes sales improved in April, May and June to reach a SAAR of 5.04 million, which is the highest sales figure since seen in October last year, although 2% lower than June 2013 levels.

Following tepid growth in the first quarter of the year, the domestic housing market seems to be regaining momentum, supported by declining lending rates and unemployment rate, and improving consumer affordability.

  • Following a negative 2.1% contraction in the U.S. GDP in Q1, the country’s GDP returned to positive growth in the second quarter, increasing by 4%. [4] In particular, personal consumption expenses rose 2.5%, with spending on durable goods increasing 14% percent, compared with only a 3.2% growth in Q1. Consumer spending could continue to improve in the latter half of the year and translate into higher sales for Lowe’s.
  • According to Freddie Mac, the average rate for a 30-year fixed-rate mortgage declined to 4.13% in July from 4.43% in January and 4.37% in July last year. [5] Potential home buyers have looked to take advantage of the lowered borrowing costs, boosting home sales. Lending rates had previously been on a rise since the first half of last year, fueled by the Federal Reserve’s announcement of reduction in bond purchases, which had kept the long-term interest rates low. [6]
  • Home sales are also impacted by the general business environment that affects job creation and incomes. The U.S. unemployment rate fell to 6.1% in June, the lowest rate since recession started in September 2008. [7] Although the unemployment rate rose slightly to 6.2% in July, the figure is still much lower than the 7.6% rate in July last year. This bodes well for the housing industry as job creation would facilitate income growth and consequently also support home sales. In addition, with job stability, consumers might also look to increase spending on home improvement products.
  • Rising house prices are closely associated with consumer affordability. After decreasing by more than 30% during the recession, home prices picked up momentum in 2012-2013, rising to within 20% of the peak 2006 levels. [8] Home Depot, the main competitor for Lowe’s, expects home prices to grow by 6% in 2014, which although lower than the rise in 2013, reflects steadily growing incomes, affordability and consumer demand. While during their peak in 2006, home prices were almost 40% overvalued, as compared to metrics such as cost-to-rent and incomes, the domestic housing industry remained 4% undervalued based on the same fundamentals at the end of last year. According to Home Depot, home prices appreciated around 5-6% in the first half of the year.
  • Despite increases in existing home sales, new home sales fell to a SAAR of 406,000 in June from 442,000 in May. However, housing starts jumped almost 16% in July to an annual rate of 1.093 million units, while home construction was up 22% through July. [9] Higher rates of construction could mean that builders are confident of an uptick in new home sales going forward. In addition, although house sales are still lower than previously estimated by retailers, home sales might grow later in the year in anticipation of the Federal Reserve’s move to increase short-term interest rates in early 2015.

Lowe’s Will Hope To Gain From Higher Pro Sales Going Forward

With economic conditions starting to support home improvement sales, Lowe’s will also aim for professional (pro) customers to contribute higher to its top line. Why the pro customer base is crucial for Lowe’s is because it forms around 30% of the retailer’s net revenues, and is growing faster than the retail consumer market at present. In the first quarter, comparable sales growth for the pros business was three times the company average, and remained higher than the company average in Q2 as well. Pro applications increased 23% in the second quarter, but overall pro penetration for Lowe’s still lags that of Home Depot’s, which generates over 35% of its net sales from the pro business. Lowe’s relaunched LowesForPros during the second quarter, a dedicated online platform for purchase by professional customers, in a bid to further expand into the growing professional customer market. The site is presently being tested with a select group of pro customers and will release for a broader base by the end of the year.

Growth in pro customer sales should also boost the company’s average ticket size in the coming quarters, as these customers typically have bulk purchases per transaction. The average ticket size in the quarter stood at $65.65 for Lowe’s, whereas the figure for Home Depot was $58.43. [10] Lowe’s focuses relatively more on higher priced premium goods, as compared to Home Depot. With an estimated increase in disposable incomes, consumers might switch to premium goods and thus boost Lowe’s sales going forward.

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Notes:
  1. Lowe’s 8-k []
  2. Lowe’s earnings transcript []
  3. New and existing home sales, U.S.“, National Association of Home Builders []
  4. U.S. GDP growth rate []
  5. 30-year fixed-rate mortgages since 1971 []
  6. historical 30-year fixed-rate []
  7. U.S. unemployment data []
  8. What’s ahead for 2014 housing market []
  9. U.S. housing starts up sharply in July, wsj.com []
  10. Home Depot 8-k []