Investors who are familiar with Mr. Ellison’s playbook at Home Depot will not be surprised that Lowe’s has reallocated store payroll to emphasize customer service rather than administrative tasks.
As he did at CVS, he now begins his conference call presentation with capital allocation.
Home Depot recently mentioned that it is seeing an increase in household formation and rising home prices. This should give consumers confidence that home-improvement remains a good investment.
On December 9, Lowe’s hosted its much anticipated virtual Investor Update. The company reiterated the 4Q21 (current year ending January 29, 2021) guidance it provided in its earnings call a few weeks ago, announced a $15 billion addition to the $4.7 billion remaining on its share repurchase plan, provided some planning assumptions for next year (FY22) and provided an update on its long-term operating targets (for sales to reach $460 per square foot and the operating margin to reach 12% in 12-24 months and then climb to 13%). The company also sees the return on invested capital rising by more than 700 basis points to 27% in FY21 and then to 32%.
The main questions CFO Denton aimed to answer, affirmatively, were how Lowe’s could continue to grow sales on top of the extraordinary results that have come as millions of Americans have sheltered at home, and how the company could grow market share while improving profitability.
During the meeting, CEO Ellison said that recent initiatives to improve the business had been successful and that management was shifting its focus from improving retail fundamentals to taking market share. This comes about 18 months ahead of the timeline that management set at the 2018 investor meeting. The new initiative is called ‘Total Home.’ Major projects will be directed at serving professional customers, expanding the online business, improving installation services, better serving local markets, and improving and expanding the product assortment.
Mr. Denton affirmed the FY21 outlook for comp sales growth of 23%, an operating margin of approximately 10.8% (up 170 basis points), and adjusted EPS of $8.62-$8.72.
He expects sales in the home improvement sector to decline by 5%-7% in FY22 from the extraordinary growth in FY21, but still sees two-year stacked growth of 18%. There will be headwinds as new vaccines allow people to spend more time away from home, as well as from reduced sales of cleaning supplies and the absence of a government stimulus package. The sector should benefit from residential investment in aging homes, low mortgage rates, home price appreciation, increased household formation, and strong consumer balance sheets. He also sees an ongoing benefit as people continue to work at home. The company expects sales to hit $423 per square foot in FY21 and rise to $460 per square foot in subsequent years.
In a robust market share scenario in which industry sales fall 5%-7% and Lowe’s outperforms the industry by 300-400 basis points, Mr. Denton estimates that Lowe’s sales would fall approximately 2% to $86 billion. In this scenario, he projects a 12% operating margin and EPS of $9.90.
In a moderate scenario, Lowe’s assumes that industry sales decline 7%-9% and that its own FY22 sales decline 5% to $84 billion, with an operating margin of 11.5%. Finally, if industry sales decline 10%, Lowe’s sees its sales dropping 7% to $82 billion, with an operating margin of 11.2%, up 40 basis points. The company plans to modify its expenses and capital spending as market conditions evolve in order to deliver a higher operating margin.
EARNINGS & GROWTH ANALYSIS
This is on an adjusted, or non-GAAP basis. The company’s guidance is $8.62-$8.72. We are raising our 4Q estimate to $1.12 from $1.11. The increase in our 4Q estimate is based on an increase in our sales growth forecast to 17% from 6%.
We continue to expect a shift to home-and-yard spending from travel spending, and may continue to see a greater focus on grilling at home than on eating out. The change in our estimate is mainly due to a reduction in our SG&A forecast. The company seems very intent on managing expenses in order to increase operating margins. Our estimate is pretty close to the company’s moderate scenario. We are modeling sales of a little more than $84 billion and an operating margin of about 11.3%, compared to 11.5% in the moderate scenario. There could be upside to this estimate depending on how much market share Lowe’s can gain and how well it can manage expenses.
The company wants to deliver an EBIT margin of 12% by the end of FY22 or FY23 on the way to even higher profitability.
The new target includes operating leases and is equivalent to the previous target of 35%. Lowe’s has a solid balance sheet and strong potential. It must deliver on these goals as rival Home Depot has done so consistently.
FINANCIAL STRENGTH & DIVIDEND
Total debt, including leases, was $26.2 billion.
Management once-again raised the target ratio to about 2.75-times in the calendar 2018 investor meeting. The company is committed to maintaining its investment-grade credit ratings. The ratio was 2.26-times at the end of 3Q21, down from 2.64-times a year earlier. If the ratio keeps improving we would consider raising our financial strength assessment to Medium High. Another scenario is that the company will maintain its target ratio, adding debt and returning cash to shareholders as EBITDA rises.
In 1Q21, Lowe’s added $770 million of borrowing capacity to its revolving credit facilities. LOW had $3 billion of undrawn capacity on its revolving credit facilities, giving it $11.2 billion of liquidity excluding the short-term investments.
The company’s long-term debt rating is Baa1 from Moody’s. The outlook from Moody’s is stable. The S&P rating is BBB+.
Lowe’s paid an FY20 dividend of $2.06 per share. The company raised the dividend by 9% to $0.60 a couple days after the 2Q earnings release. This increase was anticipated in our FY21 estimate.
The company reactivated the program, repurchasing $621 million of shares in 3Q. Lowe’s plans to repurchase $3 billion of shares in 4Q. At the December 9, 2020 analyst meeting, Lowe’s announced a $15 billion addition to the $4.7 billion remaining on its share repurchase plan.
MANAGEMENT & RISKS
The company has dramatically increased spending to protect and reward employees who are working in stores and warehouses. A concern is that repair and remodeling sales have historically been correlated with GDP. Without any way to know how long the pandemic and the associated economic downturn will last, the company has suspended its financial guidance.
We expect CEO Marvin Ellison to be successful with his turnaround initiatives. The strong performance in 1H21 was potentially a turning point, but he still has a lot of work to do.
We believe that he has made the right decision in exiting noncore businesses such as Orchard Supply, the retail operations in Mexico, Renovation Services, and Smart Home, and making efforts to simplify the Canadian business. The 1Q20 weakness last year was an unfortunate validation of Mr. Ellison’s early complex, that the labor management system is antiquated, that associates are distracted by too many tasks, and that special or installed sales are too complicated.
CFO Dave Denton has an excellent track record of transparency and shareholder friendliness from his days at CVS. We were disappointed that he was displaced by CVS’s takeover of Aetna, but we think he was an excellent addition for Lowe’s. The early part of the COVID crisis was unusual in that consumers rushed to make home improvements. That may not be the case if the current economic decline drags on.
Retail selling space was 208 million square feet. Home Dâ€ šcor, which includes appliances and paint, was the biggest merchandise division at 36% of FY20 sales. Building Products, including lumber, was 32%; Hardlines, including tools, seasonal, and lawn & garden, was 29%; Other categories represented 3% of sales. About 75% of sales are to individuals and 25% are to maintenance, repair, operations and construction professionals.
They are up about 34% this year. We are using our five-year growth rate of 14%, declining to 3% as the business matures.
On December 11 at midday, BUY-rated LOW traded at $158.02, down $2.20.}