Lowe’s Pre-Earnings: Steady Housing Growth To Boost Lowe’s Q3 Growth

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The second largest company, behind Home Depot, in the American home improvement market, Lowe’s (NYSE:LOW) is scheduled to announce its third quarter results on November 19. With increasing consumer spending in the domestic market over the last few months, buoyed by improving macroeconomic conditions, we expect Lowe’s to deliver solid sales growth this quarter. Earlier in this quarter, the retailer lowered its full year outlook to 4.5% sales growth from previously estimated 5% growth on account of only a sluggish 2.4% top line growth in Q1, when a slow U.S. economy and unusually harsh weather conditions marred customer spending on home improvement goods. However, following a 2.1% contraction in U.S. GDP in Q1, the country’s GDP returned to positive growth in the second and third quarters, increasing by 4.6% and 3.5%, respectively. [1] Falling unemployment rates, rising builders’ confidence and increasing number of housing starts- all bode well for the U.S. housing market, and in turn, are likely to boost customer spend on home improvement goods and equipment.

Lowe’s’ top line expanded by 4.2% in the first half of this fiscal year ending January 2015, and the company needs around 5% growth in the second half to meet its full-year target. Given the solid growth in consumer spending, and strengthening housing market, the retailer might even beat its target sales growth, similar to what was seen at Home Depot this quarter. Home Depot and Lowe’s are the two largest home improvement retailers in the U.S., together accounting for almost half the market sales. Despite an anticipated slowdown in sales due to the data breach, Home Depot reported a strong 5.4% year-on-year revenue rise in Q3, beating analyst expectations, as the overall demand for home improvement products remained strong in the U.S. across all categories.

We have a $50 Trefis price estimate for Lowe’s stock, which is roughly 4% below the current market price.

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See our complete analysis of Lowe’s here

Why We Expect High Demand For Home Improvement Goods

Lowe’s depends on home sales as new occupants spend on home improvement supplies and construction products and services. In turn, home sales are impacted by the economic environment and general business activity. Through key indices such as unemployment rates, interest rates and home prices, we gauge trends in the housing market, and consequently, the home improvement market.

  • Existing And New Home Sales Rise: Following the first quarter, home sales have picked up in the U.S., with existing home sales reaching a seasonally adjusted annual rate (SAAR) of 5.17 million in September, the highest sales figure in over twelve months, and also higher than the overall adjusted figure of 5.07 million for 2013. [2] New home sales also rose to a SAAR of 467,000 in September, the highest in over a year. Increases in new and existing house purchases during the last few months could mean more business for Lowe’s this quarter, as customers likely looked to purchase home improvement goods and equipment.
  • Unemployment Rate Falls: Home sales are also impacted by the general business environment that affects job creation and incomes. The unemployment rate in the U.S., where almost 97% of Lowe’s’ stores are located, fell to a six-year low of 5.8% in October. [3] This bodes well for Lowe’s 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.
  • Home Prices Rise: Rising house prices are closely associated with consumer affordability. The U.S. housing industry has picked up from the lows of 2010-2011, but the growth rate this year has slowed down in comparison to last year. However, this might not be a serious cause for concern. Although slower than 2013 levels, home prices have grown by around 5% this year. [4]

Sales To Professional Customers Could Drive Growth

With an uptick in general business activity, sales to professional (pro) customers could increase for Lowe’s and boost the net top line growth this quarter. The pro customer base is crucial for Lowe’s because it forms approximately 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 pro 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. We expect Lowe’s to gain from an extended reach in the professional customer base this quarter.

Orchard Stores To Boost California Sales In Q3

Lowe’s acquired Orchard Supply Hardware, a neighborhood hardware and backyard store focused on paint, repair and the backyard, in August 2013. As a result, Lowe’s’ store count increased by 72 new units, and Orchard stores represented 2% of the net sales in 2013. In addition, the acquisition of Orchard stores is expected to strengthen Lowe’s’ presence in the Western state of California, where both Home Depot and Sears have a significant presence. Home Depot had a massive 232 stores in the densely populated California state at the end of 2013, more than double the store-count for Lowe’s in the state.

As Orchard stores are primarily located in California, Lowe’s could boost its sales in the Western part of the country, given the improved economic conditions and higher pro sales expected due to the housing recovery, after a rough early part of the year. Lowe’s could also grab additional market share in the region, especially from Home Depot. California is the largest sales market for Home Depot, and before the Orchard acquisition, approximately 6% of Lowe’s revenues came from California, compared to over 10% for Home Depot. [5]

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Notes:
  1. U.S. GDP growth rate []
  2. New and existing home sales, U.S.“, National Association of Home Builders []
  3. U.S. labor market tightens, but wages still anemic []
  4. The U.S. housing market in 10 charts, wsj.com []
  5. Why Lowe’s is losing the housing recovery to Home Depot, businessweek.com []