Lowe’s Earnings Preview: A Strong U.S. Housing Market To Propel Sales

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Lowe’s (NYSE:LOW), America’s second largest home improvement retailer after Home Depot (NYSE:HD), is scheduled to announce its fiscal fourth quarter and 2015 financial results on February 25. In the past year, the stock price climbed almost 56% to register a 52-week high of $73.95 on February 21. In Q3, sales grew 5.6% year-on-year to reach $13.7 billion, driven by higher comp sales and positive performance in the ProServices business. Lowe’s is looking to expand its operating margins by 70 to 75 basis points this year in addition to a 4.5-5% top line growth for the full fiscal year to move closer to 9.7% operating margins by 2015. [1] Post a rough first quarter with a modest 2.4% top line growth, amid unfavorable weather conditions in the U.S., home improvement spending picked up with Lowe’s registering a 5.7% and 5.6% increase in sales in the second and third quarters, respectively. We expect Lowe’s to have leveraged the improving prospects in the U.S. economy and the housing market to meet its fiscal year targets.

See our complete analysis of Lowe’s here

We have a $55 Trefis price estimate for Lowe’s stock, which we will update post the earnings release.

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Higher Activity In the U.S. Housing Market To Steer Growth For Lowe’s

Lowe’s business is highly correlated with activity in the housing market, with existing home sales being one of the most important drivers for the industry. This is because existing homeowners usually make home improvements before putting a house up for sale. This is usually followed by further changes made by new homeowners. After the first quarter, home sales have picked up in the U.S., with existing home sales reaching a seasonally adjusted annual rate (SAAR) of 5.25 million in October, the highest sales figure in over twelve months. [2] Furthermore, new home sales also increased to a SAAR of 481,000 in December, the highest recorded in over a year. The higher activity in the housing market could propel demand for home improvement spending in the quarter.

The level of activity in the housing market is highly correlated with the general macroeconomic landscape, which looked positive in the three months. After contracting by 2.1% in the first quarter, GDP in the U.S. grew at 4.6% and 5% in the second and third quarters of 2014, respectively, to register an eleven-year high. [3] Although GDP grew slower at 2.6% amid weaker business spending and a wider trade deficit in the fourth quarter, consumer spending in the U.S. continued to increase from $10,999.50 billion in the third quarter to $11,114.90 billion in the fourth quarter backed by falling gasoline prices, leaving people with more discretionary income. [4] Furthermore, unemployment rates also declined to hit a six-year low at 5.6% in December. This bodes well for Lowe’s as job creation would facilitate income growth and stability to support spending on home improvement products.

A Growing Professional Customer Market Could Drive Revenues

A consequence of an improving economy and falling unemployment rates has been a growing number of customers flush with cash looking to undertake remodeling projects. The higher proportion of remodeling projects and professional (pro) customer sales resulted in a 2.6% growth in customer transactions and 2.9% growth in average ticket sizes last quarter for Lowe’s. In this quarter, we expect the positive macroeconomic scenario to continue contributing to higher pro sales, which currently account for 30% of the net revenues, slightly behind that at Home Depot at 35%. The relaunch of LowesForPros, a dedicated online platform for purchase by professional customers in the second quarter and a continued focus on product categories such as lumber and building material, mill work, rough plumbing and electrical, and tools and hardware, which constitute the highest “Pro penetration,” could expand this segment for Lowe’s. [5] The average pro customer tends to spend approximately $ 2,000 at the retailer annually. Hence, an increase in this customer base could also positively impact average ticket size in the quarter. [6]

How Does Lowe’s Stack Up To Home Depot ?

A final consideration is how the two big names in the U.S. home improvement industry compare. Both Home Depot and Lowe’s have done exceedingly well since the recession with the respective stock prices growing approximately 260% and 195% since 2010, to outdo the growth in the S&P 500 index. Given the continued optimism in the U.S. economy in general, and the housing markets in particular, the stocks could continue growing at a fast pace. Furthermore, both companies have taken initiatives to target pro customers — Home Depot through the launch of its same-day delivery platform called “Home Depot Delivers,” and Lowe’s through the consolidation of its “LowesForPros” platform, which could have a positive impact on both customer transactions and average ticket size. [7]

While Home Depot has a higher slice of revenues in the market, a number of factors could put Lowe’s in better stead going forward. Firstly, since the former Chairman Frank Blake’s time, Home Depot aimed at driving revenues through productivity gains, by improving existing store sales rather than opening new ones. In the past year, Home Depot opened only three stores, in comparison to six home improvement and four hardware stores by Lowe’s. While productivity increases are good news, it tends to be constrained beyond a point. Furthermore, business investment also took a back seat since Home Depot initiated a share buyback program worth $7 billion earlier in 2014, which has been financed mainly through debt and operating cash flows. While this helps achieve positive results for investors, a large proportion of EPS growth coming from productivity gains and share buybacks may not bode as well as that coming from revenue gains. Second, is the matter of the massive data breach at Home Depot, which compromised credit and debit card details of almost 56 million customers last year. This could have resulted in moving customer traffic towards Lowe’s to narrow the gap in comp sales growth between the two retailers from 0.9% for Lowe’s via-a-vis 2.6% for Home Depot in the first quarter, to 5.1% vis-a-vis 5.2% in the third. [8] Furthermore, Home Depot stands at the threat of incurring significant expenses in terms of “legal help, credit card fraud, and card re-issuance costs” in spite of their $100 million insurance cover, which could also put Lowe’s on better grounds in the future. ((Home Depot Q3 2014 10-Q, SEC))

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Notes:
  1. Lowe’s earnings transcript []
  2. “New and existing home sales, U.S.”, National Association of Home Builders []
  3. United States GDP growth rate []
  4. United States Consumer Spending []
  5. Q3 2014 Earnings Call Slides []
  6. Lowe’s Earnings Review: Strong Sales Growth On Higher Investment In Homes []
  7. Home Depot: Four Factors To Watch Out For In 2015 []
  8. Capital Return Driving Majority Growth []