2023-05-15 08:00:40 ET
Summary
- Lowe's Companies, Inc. reports earnings on the 23rd.
- Lowe's stock is in a very bullish long-term formation, and sentiment is negative.
- Seasonality is very favorable for the next few months, and Lowe's Companies, Inc. stock is cheap.
Hardware and home improvement legend Lowe's Companies, Inc. ( LOW ) reports earnings in just over a week’s time ( expected May 23 pre-market), and heading into the report, the stock is showing some technical strength. The last time I covered Lowe’s, I noted the stock looked a bit “meh” and therefore just recommended looking elsewhere. The stock is essentially flat since then, so I’ll call that one a win. But what do we do now?
Before we get into the analysis, I’ll say again that trading anything – and I mean anything – into an earnings report is risky. Earnings reports are binary events that can go either way, and we have no way of knowing what any company will say, or how the market will react. If that sort of thing isn’t for you, probably better to wait and see what happens and trade accordingly; absolutely nothing wrong with that.
With the disclaimer out of the way, I do think the technical setup, along with very favorable seasonality, and really awful sentiment may combine to produce a reasonably good buy setup here.
Long-term uptrend intact
Let’s start with the chart, and the first thing I want to point out is the wedge that has been forming for the past year. The blue uptrend line is the bottom of the wedge, with price resistance at the top with the two red lines. Wedges are one of my favorite patterns to trade because they tend to be pretty reliable, and right now, Lowe’s is probably within a few weeks of breaking out of this wedge. The odds are it will be higher, given that’s how wedges work, but Lowe’s is far from a perfect stock right now.
The group has been weak (bottom panel), and momentum is waning a bit for Lowe’s itself. However, the PPO is resetting to the centerline after a bullish move, and the accumulation/distribution line is making new highs. That’s key as it means Wall Street is buying dips rather than selling rips, and that bodes well for the eventual break of this pattern being higher rather than lower.
The bottom line on the price chart is that I think you can own Lowe’s so long as it’s inside this wedge. In other words, if the blue trendline fails, it’s probably time to sell and just take the loss.
I mentioned seasonality, and it really couldn’t be much better for Lowe’s heading into June. Below is a chart that shows the percentage of months that closed higher than they started for the past five years.
May is weak at just 2 out of 5, but June through August offer much better prospects. The end of the year has been reasonably kind to Lowe’s as well. This argues that after May, you’re quite likely to see a higher share price for Lowe’s, particularly as the summer months come to a close.
This is the same chart, but relative to the S&P 500 (SPX).
We see a similar story, with June kicking off a strong period of outperformance. Does any of this guarantee a move higher? No, of course not. However, the confluence of a bullish wedge formation and what is a very clearly bullish period for the stock heading into the summer months makes me think the odds of a breakout are pretty strong.
Is sentiment finally bottoming?
That’s the key question from a fundamental perspective for me. Lowe’s has seen some pretty steady and sizable downward revisions in the past year or so. It’s been ugly out there, but the one silver lining is that sentiment, therefore, is pretty awful.
Revenue revisions have been basically nothing but negative for the past year, but the past month or two have seen slight bumps. Does that mean the worst is over? Maybe, but for now, we’re looking at a weak revenue environment to be sure.
When looking at the earnings report, it will be critical to see what comparable sales are doing, but also if management guides for anything in particular for comparable sales. Given that Lowe’s doesn’t really change its store count, the only real way to move revenue is to see higher comparable sales. Thus, the headline revenue number is less important for Lowe’s than the comparable sales number, so watch for whether that beats consensus or not. Coming off of an extremely hot period for comparable sales during and after COVID, estimates for this year are slightly negative, and again for next year. That means that Lowe’s has a very low bar to step over to outperform; let’s see what we get next Tuesday.
In addition to weak revenue revisions, we have a similar story on EPS.
Lowe’s has a couple of levers to grow EPS, so the outlook here is better than revenue. The first lever is comparable sales gains, as that affords Lowe’s additional gross profit without much in the way of incremental costs. That means that even though gross margins basically never move for Lowe’s, it can see higher operating income over time through rising comparable sales.
When it comes to the earnings report, we want to make sure there’s no deterioration in gross margins, but also that if comparable sales are weak, that the damage to operating earnings isn’t overly severe. Operating leverage works in both directions, so if comparable sales are negative, we don’t want to see an outsized impact on operating margins. Lowe’s has control over SG&A costs, and if the environment is weak, we want to see management of those costs to preserve margins. If margins disappoint next Tuesday, it will be tougher for Lowe’s to breakout of the wedge formation sooner than later.
The second lever Lowe’s can (and does) pull to boost EPS is share repurchases.
This is one of the best repurchase programs around and it’s because the company buys back stock consistently, and in big quantities. That boosts EPS irrespective of whatever else happens, and it’s why I love buyback programs for companies that are consistently profitable. Lowe’s generates a huge amount of cash it cannot profitably invest in the business, and you can see where it’s going above. Something to keep in mind as Lowe’s can grow EPS without the benefit of creating growth in dollar earnings.
Cheap, but cheap enough?
Let’s finally take a look at the valuation, because this is, in a way, another form of a sentiment gauge. Lowe’s has traded in a range of 10X to 22X forward earnings in the past five years, with the average at 17X.
Today the valuation is 15X times forward earnings, up from its recent lows near 13X. This would argue the stock looks pretty cheap, but with the constant whispers of a recession incoming, that probably makes sense for a home improvement chain. However, what it also does is reduce the risk that you’re overpaying for the stock. In addition, what if things go right? What if we get a strong report and the recession either doesn’t come, or is shallow? The upside here is pretty sizable.
If we put all of this together, Lowe’s is certainly not a perfect stock. However, it has a reasonable valuation, a very bullish long-term chart pattern, and a history of going higher during the summer months. If I put those things together, I have a hard time not recommending Lowe’s, so I am doing just that. If you want to own Lowe’s, I believe your chance is now.
As I mentioned, the earnings report could show any number of things, and the reaction could be either muted, or gigantic in either direction. Earnings reports are binary events and if that’s not for you, just wait until after the report comes out. The long-term trend and the seasonality I mentioned will still be relevant next week and the week after, so no need to rush. But for now, I’m putting a buy rating on Lowe’s as this confluence of factors makes me lean bullish.
For further details see:
Bullish On Lowe's Stock Ahead Of Q1 Earnings