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Investment Overview for Lowe's (NYSE:LOW)
WHAT HAS CHANGED?
- Lowe's steps up Canada operations with the acquisition of RONA
- Lowe's has completed the acquisition of the Canadian home improvement retailer RONA, which will give the company more presence in Canada, and narrow its sales gap with Home Depot in the country to less than a billion dollars.
- The acquisition, valued at $2.4 billion, will not only add approximately $3 billion to Lowe's top line, and 496 stores in Canada, but it is expected to give the combined company an established platform to further boost sales in the Canadian home improvement space.
- In particular, Lowe's big-box outlets will now have the company of RONA stores under different banners and in different sizes. Having both larger and smaller outlets gives Lowe's an advantage as some customers are seen preferring the latter. In comparison, Home Depot has superstores in Canada. This reflects Lowe's strategy of becoming a more customer-centric business. Lowe's has been focusing on making itself more customer-centric for the non-expert — a potentially weak spot for Home Depot. This could help Lowe's gain more Do-It-Yourself customers and help it differentiate itself from Home Depot.
- In addition to the inorganic growth from the direct addition of RONA to Lowe's, the combined company is expected to benefit from more brand awareness in the country, helping it grab more market share in the nearly $35 billion Canadian home improvement market going forward.
- Changes in the last year - U.S. economy and housing markets
- Over the last year, Lowe's has continued to benefit from strong macroeconomic fundamentals. In 2015, the real GDP of the U.S. grew about 2.4% and unemployment rates reached record lows of about 5%. Housing continues to be a bright spot in the economic growth story for the country. Home prices are expected to increase 5-6% in 2016, a sign of growth in the housing industry. This could also boost home improvement sales.
- Lowe's' share price and performance, in general, has continued to benefit from the phenomenal growth in housing markets in the previous years, and steady growth in recent times.
Lowe's EBITDA Margin: declined from 14.5% in 2007 to 12.1% in 2009 due to increasing expenses, declining sales, and de-leveraging of SG&A expenses. The margins also suffered as Lowe's continued adding new stores despite weakening demand. In addition, there was pricing pressure as Lowe's was trying to increase its market share amid the weakened demand scenario, thereby taking a hit on profit margins.
In 2010, margins slightly improved to 12.5% as the company began implementing cost-cutting, supply chain optimization, and other efficiency initiatives. In 2011, margins declined to 11.4%, due to the "5% off every day" promotions by Lowe's for its credit card holders, other promotional activities, higher fuel expenses, as well as inventory costs and SG&A de-leveraging related to the closing of 27 stores and discontinued projects. In 2012, margins rose to 12% and further grew to 12.4% in 2013, boosted by benefits from the Value Improvement initiatives. Margins remained flat in 2014. Going forward, we expect the margins to improve over the Trefis forecast period, as Lowe's comps improve. There could be a 7% downside to our price estimate if long-term margins fall to 12%, if Lowe's offers more discounts and other incentives on products to compete on a pricing front. On the other hand, there may be a 7% upside to our price estimate if margins grow to 13.5% in the long run.
Lowe's is the world’s second largest retailer of home improvement products, after Home Depot. Through its more than 1,850 stores spread across the U.S., Canada, and Mexico, Lowe's offers a wide range of home improvement products and installation services to individual home owners as well as professional builders. In addition to the physical stores, consumers can buy these products through the company’s dedicated website.
Lowe's has deep penetration levels in the U.S. with a total of 1,857 stores at the end of 2015. It is also trying to increase its presence in Canada. Lowe's is keen to venture aggressively into Mexico's home improvement industry where it recently opened two stores. Lowe's main selling point is that it outshines its main competitor Home Depot in terms of in-store shopping experience for the consumers. This has forced Home Depot to upgrade its store environment and provide better customer service.
Lowe's business is vulnerable to the housing market and the recent slowdown has affected its sales to a great extent in the past three years. In the current slow economy, attaining historical high revenue growth rates seems very difficult to replicate in the near future.
The Plumbing, Electrical & Kitchen and Hardware and Seasonal products divisions are more valuable than Lowe's other divisions for the following reasons:
Plumbing, Electrical & Kitchen have a larger total market than the Hardware & Seasonal, Paint & Flooring markets
The Plumbing, Electrical, Kitchen and Appliances market size is more than twice the Hardware & Seasonal market and Paint & Flooring market combined. Consumers are more likely to buy home plumbing, electrical and kitchen products owing to their importance in their daily lives. For example, products like electrical lights, kitchen appliances, water pipes, wash basins, toilets, and showers are basic requirements for every household. These products become necessary for consumers to carry out repair projects. Lowe's occupies a much higher market share in the Seasonal & Hardware Tools category, compared to the Plumbing, Electrical and Kitchen division.
Smaller market size but greater market share than the Building Materials, Lumber & Millwork segment
Though the Building Materials, Lumber & Millwork market is twice the size of the Plumbing, Electrical & Kitchen market, it is a very fragmented market and Lowe's currently captures only around 3.5% of it. In comparison, Lowe's share in Plumbing, Electrical & Kitchen goods is about 14% and in Seasonal & Hardware Tools is close to 40%.
Consistently trailing Home Depot in terms of comps
As Lowe's looks to add stores and improve its reach and availability, focus has somewhat shifted away from comparable sales growth. In 2013, while comparable sales for Lowe's rose by 4.8%, the figure for Home Depot stood at 6.8%. Although the figure narrowed in 2014 with 5.3% for Home Depot against 4.3% for Lowe's, and further in 2015 with Lowe's scoring 4.8% comp growth compared to Home Depot's 5.6% growth, larger comp growth for Home Depot could further decrease Lowe's market share in the coming years.
Home Depot has been stealing valuable market share from arch-rival Lowe's due to better pricing models. In late 2011, Lowe's had decided to move away from promotions to everyday low prices to establish itself as the retailer offering the most competitive prices. However, Lowe's sales continue to struggle more than they already would have in a depressed housing market, as customers continued to seek discounts, particularly for discretionary and big-ticket purchases.
Following the recession, Home Depot focused on cost-cutting and improving customer service, whereas Lowe's opted for promotional sales and kept opening new stores, which produced diminishing returns. Since mid-2010, Home Depot's quarterly comparable-sales-growth rates have consistently outpaced Lowe's.
Do it Yourself (DIY) activity will drive the home improvement industry growth in the near future
As the housing market situation in the U.S. improves, more buying action is anticipated from DIY customers. Repair & maintenance of small house projects will dominate DIY activity. The North American Retail Hardware Association (NRHA) forecasts that plumbing & electrical products will be a major part of consumer spending in the near future. The spending will come mainly from DIY consumers who will demand more selection and information & service from the retailers.
Shift in consumer preferences will impact traditional range of home improvement products
A survey from NRHA suggests a change in the buying patterns among U.S. home improvement consumers. People are no longer loyal to only products made in the U.S. Consumer demand is driven more by price and quality. Consumers may find foreign products which are better suited to their needs more appealing than products made in the domestic market. Another observable trend is the shift in consumers toward buying green or eco-friendly products such as water saving flushes and electricity saving appliances.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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