Lowe’s (NYSE:LOW) has been one of our favourite stock picks in the recent years. Lowe’s not only grew its revenue and net income, but also managed to improve its margins, buy back shares, and return value to its shareholders in the form of dividend payments.
Although in Lowe’s most recent quarterly report some of the financial figures looked promising, we believe there might be some potential headwinds in the near-term.
Let us first take a look LOW’s Q1 figures.
First quarter financials and operational outlook
Lowe’s has reported total sales of $23.7 billion in Q1 2022, compared to the $24.4 billion in the year ago quarter. Comparable sales have decreased by 4%, primarily due to the decrease in sales of the U.S. home improvement business segment. The firm has explained the decline in sales by the unusually cold temperatures experienced in March and April this year, impacting the mainly the DIY customer base.
The drop in revenue was offset by the improving operating margin, enabled by the firm’s “Total Home” strategy and their “Perpetual Productivity Improvement” initiatives. The firm reported EPS $3.51, up by more than 9% compared to the year ago quarter.
Also a proof of LOW’s well-functioning business model is that the firm has managed to consistently increase its return on assets (ROA) over the last decade.
In our opinion, LOW’s financial results and unmodified outlook for 2022 seems encouraging; however, we believe there might be macroeconomic headwinds in the near term, mainly due to increased input costs and labor shortages. So far, Lowe’s has proven that even in this inflationary environment, they can successfully expand their margins. Looking forward, the home improvement market is expected to remain strong and the operating margin is also forecasted to expand even further in 2022.
Lowe’s stock, just like many others, has been hit quite hard in 2022, resulting in a more than 26% decline year to date.
Lowe’s definitely looks more attractive now than 6 months ago.
But to decide whether this could be a good entry point, we have to take a closer look at some of the traditional price multiples comparing them with the sector medians and also with Lowe’s 5-year averages.
The TTM price to earnings ratio of Lowe’s is approximately 15, about halfway between the sector median of 11 and its 5-year historical average of 20. In terms of EV/EBITDA and P/CF the firm is also trading at a premium compared to the sector median, but at a discount compared to its own 5-year historical average.
In our opinion, the current price multiples are justified for four reasons:
Lowe’s has been paying and growing its dividend in the last 58 years. The current dividend yield is approximately 1.7% or quarterly $0.8 per share. We believe this dividend is sustainable, as the payout ratio currently is about 24%, below both the sector median and its own 5-year historic average.
2.) Share buybacks
The firm has been committed to buying back shares continuously in the last one decade. They have reduced their number of shares outstanding by as much as 40%. In the first quarter of 2022, the firm has repurchased 19 million shares for a total of $4.1 billion.
3.) Expanding margins
In the last years, Lowe’s has not only increased its revenue, but also managed to expand its margins. In our view, improving operating and net margins signal a positive development of the firm’s efficiency and profitability.
4.) Forecasted growth
According to analysts’ estimates, earnings per share average in the next four quarters is expected to be $13.52, representing a more than 12% increase compared to the EPS of $12.04 in the last four quarters.
We believe these forecasts are encouraging in light of the potential macro headwinds, including tight labour market and increasing labour costs, in the near term.
All in all, we believe that the valuation of Lowe’s at these price levels is reasonable. Although further volatility may be ahead, this could be an attractive entry point for investors looking for moderate growth, sustainable dividends, and value through share buybacks.
Before concluding our overview, we need to highlight some of the key risks mentioned in Lowe’s annual report.
1.) Rapidly evolving retail environment
In our opinion, many of the retailers in the first quarter, including Walmart (WMT) and Target (TGT), failed to address the changing demand and shopping habits of their customers. Although Lowe’s is not directly comparable to WMT or TGT, in turbulent times, with rising inflation all retailers have to pay close attention to the behavioural changes of their customers. Failing to address change could potentially hurt not only earnings but could also lead to declining inventory turnover or even to obsolete inventory.
2.) Tight labour market
The current labour market in the United States is very competitive. Many businesses have been struggling in the first quarter of 2022 to recruit, train and retain workers. If Lowe’s fails to hire and retain the right number of workers, they may have difficulties with providing the customers a unique and more personalised experience. Also, the increasing labour cost may have negative impact on the firm’s earnings.
3.) Cooling housing market in the United States
Although the housing starts in the U.S. still appears to be relatively strong, there has been a slight decline both in March and April in the new housing starts.
The three main headwinds for the housing industry are: high mortgage rates, increasing material prices and supply chain constraints. This general economic uncertainty may negatively impact Lowe’s financial performance in the near term.
Further, both the new homes sales and the existing home sales have declined sharply in the last few months.
In our opinion, this trend is not likely to reverse in the near term, while high material prices, supply chain constraints and high mortgage rates persist.
Solid financial performance in the first quarter, with increasing EPS and operating margins.
Attractive valuation after a significant drop in the share price year to date.
Cooling housing market can create temporary headwinds for Lowe’s.