Lowe’s Earnings Review: Strong Sales Growth On Higher Investment In Homes

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LOW: Lowe's logo
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Lowe's

Lowe’s (NYSE:LOW) reported solid third quarter results, fueling a 5% growth in its stock price just after the announcement on Wednesday morning. The company is the second largest in the U.S. home improvement retail space, behind Home Depot, operating 1,836 home improvement and hardware stores across the U.S., Canada and Mexico. Lowe’s was able to capitalize on the improving macroeconomic environment in the domestic market, with revenues rising 5.6% year-over-year to $13.7 billion in Q3 ended October. [1] As consumers look to invest more in their homes and take up remodeling projects, home improvement sales could rise further through the end of the year, heading into winter. In addition to a 4.5-5% top line growth for the full fiscal year, Lowe’s is looking to expand its operating margins by 70 to 75 basis points this year, and move closer to 9.7% operating margins by 2015. EBIT for Lowe’s last fiscal stood at 7.7%, and has improved to 9% in the first nine months of this fiscal year ending January. [2]

We have a $55 Trefis price estimate for Lowe’s stock, which is roughly 10% below the current market price. We presently estimate an 80 basis points expansion in the retailer’s operating margins by 2016 (fiscal year ending January 2017). However, if the figure rises by 200 basis points by then, or closer to 10% operating margins for the company, our price estimate for Lowe’s would increase by over 10% to roughly in line with the current market price.   

See our complete analysis of Lowe’s here

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GDP Growth And Home Price Appreciation Bode Well

After a rough initial few months of the year, when the U.S. economy remained weak amid unusually cold weather conditions, sales for home improvement retailers have picked up. After only a 2.4% top line growth for Lowe’s in Q1, higher consumer spending has boosted the retailer’s sales by 5.7% and 5.6% respectively in the second and third quarters. In fact, it was the first time in almost two years that comparable sales growth for Lowe’s (5.1%) was roughly even with that at Home Depot (5.2%). One of the reasons for this could be the data breach at Home Depot during the third quarter, which could have shifted some of the customer traffic to the nearby Lowe’s stores. But the key reasons why Lowe’s could continue this high sales momentum into the fourth quarter are a conducive business environment, home price appreciation, and holiday sales.

Lowe’s depends on home sales as new occupants spend on home improvement supplies and construction products and services. 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. [3] 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 through the end of the year, as customers are likely to look to purchase home improvement goods and equipment.

Home sales, in turn, are impacted by the economic environment and general business activity, and 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.

  • 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 over 97% of Lowe’s’ stores are located, fell to a six-year low of 5.8% in October. [4] 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. [5] As customers look to invest more in home improvement projects, Lowe’s could gain from additional business during Q4.
  • Mortgage Rates To Rise: According to Freddie Mac, the average rate for a 30-year fixed-rate mortgage fell to below 4% in mid-October, and is below the January levels of 4.5%. [6] Potential home buyers have looked to take advantage of the lowered borrowing costs, boosting home sales. Lending rates are expected to rise going forward, fueled by the Federal Reserve’s announcement of reduction in bond purchases, which had kept the long-term interest rates low. [7] The rates haven’t risen as aggressively as they did mid-last year when the Fed first announced its reduction in bond purchases. However, the average rate for a 30-year fixed-rate mortgage is expected to rise to 5.1% by the end of 2015, which could further prompt house purchases in the near term, consequently boosting home improvement sales.

Big Ticket Purchases Key To Lowe’s Growth

Revenues for Lowe’s rose on the back of a 2.6% growth in customer transactions and a 2.9% growth in the average ticket size this quarter. Big ticket purchases are boosted by a higher proportion of remodeling projects and professional (pro) customer sales. With improvement in the general business environment in the U.S., and falling unemployment rates, customers flush with cash could look to engage more in remodeling projects, prompting a higher average ticket size. This could consequently boost Lowe’s net revenues, even if the number of customer transactions increases at only a moderate pace.

On the other hand, pro sales, which form approximately 30% of the retailer’s net revenues, are growing faster than the net comparable sales growth for the overall company. The average pro customer spends around $2,000 at Lowe’s annually, and with an increase in such customers, the retailer could further improve its average ticket size. Pro customer penetration at 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 next quarter, which could be key for Lowe’s in expanding further in the professional customer market.

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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. labor market tightens, but wages still anemic []
  5. The U.S. housing market in 10 charts, wsj.com []
  6. 30-year fixed-rate mortgages since 1971 []
  7. historical 30-year fixed-rate []