What Is Lowe’s Fair Value?

by Trefis Team
+12.64%
Upside
114
Market
128
Trefis
LOW
Lowe's
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Lowe’s (NYSE: LOW) has reported decent top-line and bottom-line growth through the first nine months of the year, driven by increased comp sales – as a result of higher average ticket and new store additions, partially offset by reduced customer transaction and adoption of the new revenue recognition standard. However, the company still lags behind its closest competitor, Home Depot (NYSE:HD). Lowe’s is faced with significant organizational changes, including a new CEO and CFO, along with certain disruptions and inventory issues which have pressured sales, despite favorable macroeconomic conditions. Although the industry outlook remains bright, the company has reduced its guidance for the year given the number of strategic initiatives being undertaken. Sales and comps growth is now expected to be 4% and 2.5% (versus 4.5% and 3% earlier), the operating margin is anticipated to decline by 240 to 255 basis points (versus a fall of 180 basis points earlier), including 135 to 150 basis points from charges associated with its strategic reassessment, and diluted EPS is projected to be in the $4.08 to $4.24 range (versus $4.50 to $4.60 earlier). Meanwhile, the company’s adjusted diluted EPS is expected to be in the range of $5.08 to $5.13.

We have a $114 price estimate for Lowe’s, which is over 15% higher than the current market price. Our interactive dashboard on Our Outlook For Lowe’s In 2019 details our key forecasts and drivers for the company. You can modify the driver assumptions to gauge their impact on the company’s revenue, earnings, and valuation.

We have arrived at our $114 price estimate for Lowe based on revenue projections of $6.2 billion for 2019, net income of $544 million, a P/E multiple of 21, and a share count of 80.1 million.

Factors That Should Impact Performance

1. Focus On Pro-Customers: Professional customers generally place larger orders compared to the do-it-yourself (DIY) segment, and better serving these customers should boost revenues for Lowe’s in the long term. Despite the recovery in the housing segment, Lowe’s growth has not been on par with Home Depot’s, largely due to its focus on DIY consumers. While the DIY segment is lucrative and accounts for most of Lowe’s revenues, these customers are comparatively smaller-ticket buyers and often just one-time buyers. On the other hand, pro customers account for only 30% of Lowe’s revenues, but they often 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.

2. Housing Market: Lowe’s has continued to benefit despite news regarding a soft housing market, reflected in the declining home sales figures. The company saw its revenues grow by just under 5% in the first nine months of 2018, as more homeowners preferred to remodel their homes rather than selling. Further, the company remains positive about the home improvement sector as much of the housing stock in the country is in need of renovation. Additionally, home price appreciation continues to encourage homeowners to engage in discretionary projects, which in turn should benefit the likes of Lowe’s and Home Depot. Moreover, consumer confidence is high, 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.

3. Digital Growth: Comps grew 12% on the company’s website in Q3, which accounts for nearly 5% of the overall company sales. Lowe’s intends to continue enhancing the shopping experience, with features such as optimized search capability, expanded assortment, faster site speed, improved checkout, and next day delivery. In addition, the company also provides flexible fulfillment options – buy online, pick up in store, and buy online, deliver from store – in addition to making it easier for customers to engage with its in-home project specialists to request services. We expect solid growth from this segment, once the company sorts out its inventory issues.

4. Exiting Orchard Supply Hardware Operations: The main reason for exiting these operations is to concentrate on the core home improvement business. The company’s 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 EBIT, so our expectation is that the closure should positively impact margins from the next financial year.

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