Lowe’s Tops Expectations In The Second Quarter But Disappoints With Its Full Year Guidance
Lowe’s (NYSE:LOW) reported its second quarter results on August 22, wherein a substantial rise in both revenues and earnings was noted, with both metrics exceeding analysts’ expectations. After an astounding performance by Home Depot (NYSE:HD) in the second quarter, much was expected from Lowe’s as well. The latter has been playing catch up to the former in recent quarters, and the same trend continued this time around as well, with LOW posting a comps growth of 5.2%, falling short of the 5.4% anticipated, and well behind HD’s 8.1% improvement. The company is faced with significant organizational changes, including a new CEO and CFO, along with certain disruptions and inventory issues which have pressured the sales. Consequently, the company downgraded its sales growth and comps growth outlook to 4.5% and 3%, from 5% and 3.5% earlier, and has guided for a 180 basis point decline in operating margins versus -40 bps.
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. Exiting Orchard Supply Hardware Operations: The main reason for exiting these operations is to concentrate on the core home improvement business. The management expects to close all 99 stores which are located in California, Oregon, and Florida, as well as one distribution facility by the end of FY 2018, which is one of the factors driving a larger than intended decline in operating margins. In FY 2017, Orchard generated $600 million in sales, but was a $65 million drag on the EBIT, and hence, our expectation is that the closure should positively impact the margins from the next financial year.
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 by introducing pro-focused brands such as Mapei and Zoeller.
3. Soft Housing Market: Despite news regarding a weak housing market, reflected in the declining home sales figures, the company feels positive about the strength in the home improvement sector. Given the fact that the housing stock in the country is old and in need of repair and renovation, prospects for Lowe’s look strong. Moreover, 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. Strong macroeconomic conditions bode well for a company like Lowe’s that is heavily reliant on the improvement of the economy.
4. Digital Growth: Comps improved 18% on the company’s website, 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.
5. 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 slight improvement in gross margins witnessed in the 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 180 basis points of decline in the operating margin, as mentioned earlier.
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