Lowe’s Companies (LOW, Financial) was founded in 1946. In the 70 years since, the company has grown into the number two home improvement retailer in the U.S., behind only The Home Depot (HD, Financial).
Lowe’s has attained a high and consistent level of profitability by building a positive brand image with consumers and aggressively opening stores across the country.
This has translated into market-beating returns for shareholders over the last decade:
Lowe’s has done more than grow its stock price, Â it has a long track record of paying rising dividends. Lowe’s has increased its dividend payments for 54 consecutive years.
This is more than double the requirement to be a Dividend Aristocrat (at least 25 consecutive years of rising dividends). You can see all 50 Dividend Aristocrats here.
Lowe’s dividend history qualifies it for the most exclusive dividend increase list, the Dividend Kings list. To be a Dividend King, a stock must have at least 50 consecutive years of dividend increases.
Keep reading this article to learn more about the investment prospects of Lowe’s.
Business overview
Lowe’s is a home improvement retailer. It serves more than 17 million customers each week in the U.S., Canada and Mexico.
The company offers a wide range of products for maintenance, repair, remodeling and decorating. Its product lineup is broken down into several categories:
- Lumber & Building Materials
- Tools & Hardware
- Appliances
- Fashion Fixtures
- Rough Plumbing & Electrical
- Lawn & Garden
- Seasonal Living
- Paint
- Flooring
- Kitchens
- Outdoor Power Equipment
- Home Fashions
A typical Lowe’s store stocks approximately 36,000 items, with hundreds of thousands of additional items available through its special order sales system, as well as through its digital channels and website.
Growth prospects
Lowe’s has done an excellent job of producing growth across a number of key metrics, including sales per square foot, earnings per share and profit margins.
Source: 2015 Annual Report, page 4
A major reason why Lowe’s has consistently expanded its margins and returns on invested capital is its effective capital allocation procedures.
The company keeps a laser-like focus over allocating capital in only the highest-value opportunities. Today, that means strategically investing in omni-channel development, particularly digital. Lowe’s other strategic priorities include opening new stores, particularly in new markets, and refurbishing existing stores.
Lowe’s capital expenditure breakdown is as follows:
Source: Strategy Overview Presentation, page 5
The company has continued this practice in 2016, which has fueled its impressive results. Over the first half of 2016, Lowe’s earnings per share increased 21% from the same period last year. Comparable sales, a very important metric for retailers that shows growth at stores open at least one year, rose 4.4% in the first six months. This is a very strong comparable sales growth rate in a difficult environment for retail more broadly.
This allowed the company to raise its dividend by 25% earlier this year.
Going forward, Lowe’s growth prospects are promising. In the U.S., consumers are benefiting from the steady economic recovery and low gas prices. This has put more disposable income in their pockets. And, rising home values have compelled many home owners to spend more of that disposable income on home renovations. This all provides Lowe’s with a strong tailwind going forward.
In addition, another growth catalyst is international expansion. Earlier this year, Lowe’s acquired Canadian home improvement retailer Rona for $2.3 billion. The acquisition has a compelling strategic rationale.
There are many growth opportunities from the deal. First, it gives Lowe’s access to the Canadian home improvement market, which is large and growing.
Source: Canada Acquisition Presentation, page 4
Furthermore, Rona’s footprint is concentrated in Quebec, which is home to 25% of the country’s home improvement market.
Lowe’s believes there is room to double its operating profits in Canada over the next five years, once it is able to bring its scale and financial resources to Rona.
Competitive advantages & recession performance
No company can raise its dividend for more than 50 consecutive years without a clear and durable competitive advantage. In Lowe’s case, its competitive advantage is its valuable brand, as well as its size and scale.
Lowe’s has developed a high reputation among its customers because it has clean stores, a wide range of products and helpful store staff. The home improvement industry is one in which customers may have a lot of questions about their renovation projects. Being able to ask questions to qualified staff members helps build customer loyalty and a sustainable competitive advantage over competitors.
The biggest reason why major home improvement retailers have squeezed out the ‘mom-and-pop’ hardware stores is scale. Lowe’s has more than 2,300 home improvement and hardware stores. It generates more than $59 billion in annual sales.
With such a massive footprint, Lowe’s can reap efficiencies in distribution and supplier relationships. It then funnels the savings to customers through low prices that smaller outlets cannot match. As a result, the barriers to entry are fairly stiff in an industry dominated by two huge companies.
Over the past decade, Lowe’s increased its earnings per share by 5% per year. As should be expected, Lowe’s suffered during the Great Recession. As a retailer, Lowe’s is reliant on a financially healthy consumer for growth. The 2008-2009 recession had a significant impact on its business. It had a pronounced effect on Lowe’s because the housing market was hit particularly hard during the recession.
- 2006 earnings per share of $1.99 (high at the time)
- 2007 earnings per share of $1.86 (start of recession)
- 2008 earnings per share of $1.49
- 2009 earnings per share of $1.21 (recession low)
- 2010 earnings per share of $1.44 (start of recovery)
- 2011 earnings per share of $1.69
- 2012 earnings per share of $1.76
- 2013 earnings per share of $2.16 (new high at the time)
The good news is that Lowe’s business bounced back. Earnings per share rebounded to a new high by 2013 and have continued to increase since then.
The company maintains a low payout ratio (currently at around 38%). Lowe’s also remains profitable during recessions. This means the company’s dividend is unlikely to be cut, even during recessions.
Valuation & expected total returns
Lowe’s stock trades for a price-earnings (P/E) ratio of 21.6. This is a bit lower than the average P/E ratio in the S&P 500 of 24.5. But it is significantly above Lowe’s average P/E ratio since 2000 of about 16.
The company is likely trading around fair value at current market prices, but is above its historical average ‘fair value’.
Going forward, Lowe’s stock will deliver total returns comprised of earnings growth and dividends, plus or minus any expansion or contraction of the valuation multiple. Its earnings and dividends may look as follows:
- Earnings per share growth of 7%-9%
- Dividend yield of 2%
Earnings per share growth will be through a combination of 6% to 8% sales growth, and an additional 1% to 2% in annual repurchases.
As a result, investors can reasonably expect 9% to 11% total returns moving forward.
Final thoughts
Lowe’s has a strong brand, a highly profitable business and a clear path for growth up ahead. It is a shareholder-friendly company that has raised its dividend consecutively for the past half-century.
While its current dividend yield of 2% only matches the average dividend yield of the S&P 500, Lowe’s makes up for this with high dividend growth rates. Consequently, Lowe’s is a long-term hold for dividend growth investors. The company currently ranks in the top 33% of stocks with 25-plus years of steady or rising dividends using The 8 Rules of Dividend Investing.
Disclosure: I am not long any of the stocks mentioned in this article.
Published October 28th, 2016 by Bob Ciura
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