Lowe (LOW, Financial)’s shares appreciated 21% during the third quarter as investors responded enthusiastically to new CEO Marvin Ellison’s initial commentary regarding Lowe’s significant long-term potential. On his first earnings call, Mr. Ellison provided detailed examples that highlighted the opportunities for improvement and outlined a list of short and long-term initiatives to enhance the company’s operational performance. Since then, Mr. Ellison has completed the hiring of his executive team and announced the closure of 50 underperforming stores (~2% of total stores). We expect the company to provide additional detail on its long-term strategic plans and financial targets at the upcoming analyst day in December. Based on Mr. Ellison’s public commentary and initial actions, we have increased confidence that Lowe’s can meaningfully narrow the performance gap with Home Depot over time.
Since the end of the quarter, Lowe’s share price has declined 16% as investors have become concerned about the housing cycle based upon weaker trends in recent housing statistics and broader worries about a potential economic slowdown and rising interest rates. We believe the market’s response is an overreaction as there is likely further upside to the housing cycle as many of the fundamental drivers of the housing market remain well below their long-term average levels. In addition, Lowe’s derives a meaningful portion of its revenue from less-cyclical repair and maintenance spend which should moderate the impact of fluctuations in the housing cycle. Most importantly, we believe that successful execution of the significant opportunity for operational improvement at the company will allow Lowe’s to generate strong earnings growth over the next several years, even if the housing market and economy soften.
Lowe’s currently trades at 17 times analyst estimates of next year’s earnings, which do not yet reflect the operational improvements that we expect Mr. Ellison to achieve over the next several years. We believe there is substantial upside potential if the company can narrow the performance gap with Home Depot, which will significantly increase earnings and likely result in a valuation that better reflects the company’s underlying business quality and growth prospects.
From Bill Ackman (Trades, Portfolio)'s third-quarter 2018 Pershing Square shareholder letter.
