Can Lowe’s Match Home Depot’s Performance In The Second Quarter?

by Trefis Team
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Lowe’s (NYSE:LOW) is scheduled to report its second quarter results on August 22, wherein a substantial rise in both revenues and earnings is expected. Unseasonably cold weather played a dampener in Lowe’s first quarter results, when the company missed consensus expectations on both revenue and earnings. The poor performance in the quarter, nevertheless, will not have an impact on the full year results. The company, in fact, revised its revenue and gross margin guidance slightly upward, though that was solely a result of the adoption of the new revenue recognition standard. For FY 2018, Lowe’s has now guided for a 5% growth in sales, 3.5% improvement in comps (deceleration compared to FY 2017), with a 60 basis points improvement in gross margin and continued decline in the operating margin. After an astounding performance by Home Depot (NYSE:HD) in the second quarter, much is expected from Lowe’s, as well. The latter has been playing catch up to the former in recent quarters, and the same trend is expected this time around as well, with analysts expecting a 7% increase in sales and a 29% growth in the EPS for Lowe’s, compared to 8% and 36%, respectively, posted by Home Depot.

We have a $108 price estimate for Lowe’s, which is higher than the current market price. The charts have been made using our new, interactive platform. You can click here for the interactive dashboard on Our Outlook for Lowe’s In FY 2018, to modify our driver assumptions to see what impact it will have on the company’s revenues, earnings, and price estimate.

Factors That May Impact Future Performance

1. Rebound In Traffic: Poor weather conditions during the month of April in some parts of the country had a considerable impact on the traffic, as well as on the sales of outdoor items, particularly in the gardening category in Q1. Lowe’s has a highly seasonal business, with 35% of Q1 and 40% of Q2 sales historically driven by outdoor categories. Consequently, the weather had a significant impact on the comps. On a more positive note, the company had stated that the comps in May were in the double-digits and we anticipate the fall in traffic in Q1 to be counterbalanced by strength in Q2.

2. Focus On Pro-Customers: Professional customers place larger orders compared to the do-it-yourself segment, and better serving these customers can boost revenues for Lowe’s in the long term. While the recovery in the housing segment has benefited players such as Home Depot and Lowe’s, the latter’s growth has not been as stellar, primarily due to its focus on the do-it-yourself consumer segment. While the do-it-yourself segment is lucrative and accounts for the bulk of Lowe’s revenues, these customers are small ticket buyers and many are just one-time customers. On the other hand, pro-customers account for only 30% of Lowe’s revenues, but they enter into big-ticket transactions and are usually repeat customers. Keeping this in mind, the company has been focused on these customers, and was rewarded in the first quarter with accounts above the company average.

3. Soft Housing Market: The strength of the housing market can be gauged by looking at the residential construction spending and existing home sales, both of which were down in June (latest available data). The permits authorized for privately-owned housing units were down 2.2% sequentially, and 3% below the June 2017 level. Meanwhile, privately-owned housing starts in June were lower by a massive 12.3% versus May, and 4.2% below the corresponding figure for last year. The rising cost of construction materials is probably one of the main factors which has resulted in reduced confidence among builders. Moreover, according to the National Association of Realtors, existing-home sales decreased for the third straight month in June, at a rate of 0.6% sequentially, and 2.2% versus June 2017. On the other hand, given the low housing turnover rate (about 5%), it implies that roughly 95% are staying at home and investing in the repair and renovation of their homes, which augurs well for Lowe’s.

4. Strong Macroeconomic Conditions: Unemployment is at its lowest level since 2000, and wages are improving. Although interest rate hikes make mortgages more expensive, on the whole, it is indicative of a strong economy. These factors signal a solid U.S. economy, and have given rise to supportive housing fundamentals. This bodes well for a company like Lowe’s that is heavily reliant on the improvement of the housing industry.

5. Digital Growth: Comps improved by 20% on the company’s website in Q1, which now accounts for 5% of the total sales. Lowe’s intends to continue upgrading the shopping experience, with features such as optimized search capability, expanded assortment, faster site speed, improved checkout, and next day delivery. Lowe’s also provides flexible fulfillment options of buy online, pick up in store, and buy online, deliver from store, besides making it easier for customers to engage with its in-home project specialists to request services. We expect strong growth from this segment to continue.

6. Stabilizing Gross Margins: Lowe’s has implemented new pricing and promotion analytics tools to ensure that the company is “competitive on highly elastic traffic driving products while increasing profitability across less elastic items.” This factor played a role in the stable gross margins witnessed in the first quarter. The metric also benefited from the adoption of the new revenue recognition standard. On the other hand, increased transportation costs had a negative impact on the gross margin. The company has guided for a gross margin expansion of 60 basis points for this year, along with 40 basis points of decline in the operating margin, as mentioned earlier.

See our complete analysis for Lowe’s.

 

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