Lowe’s (LOW, Financial) is the second largest publicly traded home improvement store with a market cap of $58 billion. The company’s larger competitor Home Depot (HD, Financial) has a market cap of $133 billion. Lowe’s has managed to grow its revenue per share at 8% over the last decade, and has increased its dividend payments for over 50 years. Part 40 of the Dividend Aristocrats In Focus series will examine Lowe’s growth prospects and competitive advantages. Lowe’s business operations are analyzed below.
Business overview
Lowe’s owns and operates over 1,700 Lowe’s stores in the U.S., plus an additional 70+ Orchard Supply hardware stores in California and Oregon which Lowe’s acquired in 2013 for $205 million. In addition, the company operates 35 stores in Canada and 8 stores in Mexico. In 2009, Lowe’s acquired a 33% stake in Australian home improvement retailer Woolworth’s. Lowe’s owns 33% of Woolworth’s 38 home improvement stores in Australia.
Lowe’s is the second-largest home improvement retailer in the U.S. The company employs about 260,000 people in North America. The company sells its products to both retail customers (~70% of sales) and construction and housing professional customers (~30% of sales).
Competitive advantage
Lowe’s 50-year streak of consecutive dividend increases is evidence of a competitive advantage. The company’s competitive advantage comes from its recognizable brand, economies of scale, convenient locations and distribution network. New entrants to the home improvement retail market would be hard-pressed to compete with Lowe’s (and Home Depot for that matter). Lowe’s established brand lets consumers know they can expect quality products at low prices when shopping at Lowe’s.
Lowe’s has generated about $54 billion in revenue over the last 12 months. The company’s large scale allows it to put pressure on suppliers to reduce costs and drive more customers to its stores. This creates a virtuous improvement cycle that smaller competitors cannot match. Lowe’s size also makes it more recognizable and convenient due to its 1,700+ locations in the U.S.
Growth prospects
Lowe’s has managed to grow revenue at 8% a year over the last decade. While the company is growing revenue, EPS have not matched revenue growth. EPS have grown at just 4.6% per year over the last decade. The North American home improvement industry has had a tough decade due to the collapse of the housing bubble from 2007 to 2009. Lowe’s rival Home Depot has managed EPS growth per year of 5.75% over the last decade, over a full percentage point higher than Lowe’s. Both businesses have seen weakness due to a tough housing market, but Home Depot’s management navigated the difficult time better than Lowe’s management.
Lowe’s has attempted to fuel growth through the Orchard Hardware acquisition and the partial acquisition of Woolworth’s in Australia. In addition, the company is expanding into Canada and Mexico. North American expansion makes sense as Lowe’s can leverage its US distribution network and brand recognition in both Canada and Mexico. The Woolworth’s acquisition and expansion into Australia makes less sense strategically as Lowe’s is not leveraging its brand or its supply chain in Australia. The company
One bright spot for Lowe’s is its obsession with share repurchases. The company has reduced its share count at over 5% per year over the last decade. Management may not have made wise acquisitions in Australia, but it has put much of its cash flows to work in share repurchases which have driven EPS and revenue per share growth over the last decade.
Going forward, I expect Lowe’s to deliver a strong CAGR of close to 10% from share repurchases (5%), dividends (1.6%) and organic growth (2% to 4%). The company is very shareholder friendly thanks to its long history of dividends increases and share repurchases. Otherwise, the company has lackluster growth potential and management has not proven it can produce strong growth through difficult housing markets.
Recession Performance
I have referenced the weak housing market brought about by the Great Recession of 2007 to 2009 several times in this article. The Great Recession significantly affected Lowe’s business operations. Lowe’s had EPS of $1.99 in 2006. It did not hit new EPS highs until 2013, 7 years later. Holding on to a stock for 7 years is a long time to wait for recovery. The company did remain profitable through the Great Recession, but EPS fell sharply. The company’s EPS from 2006 through 2013 are shown below to give an idea of how recessions impact Lowe’s:
- 2006 EPS of $1.99 (high EPS mark at the time)
- 2007 EPS of $1.86 (start of recession)
- 2008 EPS of $1.49
- 2009 EPS of $1.21 (recession low)
- 2010 EPS of $1.44 (start of recovery)
- 2011 EPS of $1.69
- 2012 EPS of $1.76
- 2013 EPS of $2.16 (new EPS high)
Dividend analysis
Lowe’s has a current dividend yield of 1.6%. The company has a payout ratio of 35% of expected 2014 EPS. Lowe’s has grown its dividend payments by 25% per year over the last decade. The company is slowly increasing its payout ratio and increasing dividends significantly faster than overall company growth. I expect Lowe’s to continue increasing its dividend payments faster than overall company growth for the next several years, giving it strong dividend per share growth.
Valuation
Lowe’s is currently trading at a P/E ratio of about 23 times expected 2014 EPS. The company has historically traded at a premium to the S&P500’s P/E ratio of about 1.1x when the U.S. housing market is strong. When the U.S. housing market is weak, Lowe’s trades at a discount of about 0.8x to the S&P500’s P/E ratio. It is best to purchase shares of Lowe’s during weak housing markets, and sell the stock when its P/E multiple expands and housing markets are strong. Now is not the time to start a position in Lowe’s.
Final thoughts
Lowe’s is ranked in the middle of the pack based on The 8 Rules of Dividend Investing. The company has a strong historical revenue per share growth rate thanks to its 5% per year share count reduction. Lowe’s has a fairly low payout ratio and a mediocre dividend yield. Now is not the time to start a position in Lowe’s. The company’s EPS and valuation multiple will likely contract next time the US enters a weak housing market. At that time, Lowe’s will likely make an attractive purchase for investors seeking both income growth and capital appreciation.
