What’s The Downside To Lowe’s Valuation If Its EBITDA Margin Continues To Fall?
Lowe’s (NYSE:LOW) seems to be perpetually lagging behind Home Depot, and sometimes even an earnings and revenue beat isn’t enough, as the latter company would have inevitably done a better job. This was the case when Lowe’s released its fourth quarter and FY 2017 earnings just a few days after Home Depot. Although Home Depot had set a pretty high standard, Lowe’s performance was nowhere close to matching that of its biggest competitor, and did nothing to close the gap between the two giants in the home improvement industry. Even for FY 2018, LOW has guided for a 4% growth in sales, and a 3.5% improvement in comps (deceleration compared to FY 2017), with a flat gross margin and continued decline in the operating margin. This reflects another point of difference between the two companies — Home Depot expects an improvement in the margins for FY 2018.
There have been a number of factors that have pressured the margins for Lowe’s. These include:
1. An outperformance of the company’s expectation in the appliance category, which resulted in market share gain, had a negative impact on both the mix and rate from a margin perspective.
2. The company focused on getting more competitive, and increasing its value perception among consumers, in order to gain market share. These actions were started in the second quarter and continued until the fourth quarter, which put an increased pressure on the margins.
3. Lowe’s integration with RONA, a company it acquired in 2016, resulted in some “accounting harmonization” which had a further impact on the margins.
Lowe’s intends to stabilize the gross margins by focusing on price increases for highly elastic traffic-driving products, improving promotional effectiveness, and working closely with vendors to reduce cost. Inventory investments are also being undertaken for key categories such as appliances, flooring, and tools. These steps should help to deliver a flat gross margin in FY 2018. However, incremental expenses associated with its strategic investments will pressure SG&A, causing the operating margin to decline by roughly 30 basis points. Looking ahead, as the strategic investments begin to dwindle, we expect the operating margin to stabilize.
However, if Lowe’s continues to remain promotional, or isn’t able to reign in its inventory problems, its operating margin could continue to decline. In such a scenario, where instead of flat margins in 2019 and 2020, the EBITDA margin declines by 30 basis points annually, there is an over 5% downside to our price estimate for Lowe’s. We have created an interactive dashboard showing this scenario. You can click here to modify the different assumptions and come up with your own price estimate for the company.
See our complete analysis for Lowe’s.
Have more questions about Lowe’s? See the links below.
- Lowe’s Bets On The Smart Home Market
- Improving Housing Trends Bode Well For Home Improvement Companies
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