2023-11-27 04:54:30 ET
Summary
- Lowe's had a disappointing Q3, with weakness in the DIY segment impacting its performance.
- The company adjusted its guidance downwards due to macro headwinds and expects lower revenues and EPS for FY23.
- Expense management was a bright spot, with Lowe's improving margins and aligning inventory with sales. However, the company's strategy and clarity on sustaining these initiatives remain unclear.
Investment Thesis
Lowe’s ( LOW ) had a disappointing third quarter, mainly due to major weakness seen in the DIY segment. In this article, I outline the major takeaways of the third quarter and analyse what the future could look like for the retail giant.
A Snapshot of Q3 Performance
Lowe’s had a disappointing third quarter, in my opinion. Revenues came in at $20.47 billion , down 13% Y/Y and missing analyst estimates by $385 million. Diluted EPS came in at $3.06, beating analyst estimates by $0.03, but down from the adjusted figure of $3.27 achieved during the third quarter of FY22.
Management re-adjusted their guidance to the downside, citing macro headwinds, with FY23 revenues now expected to come in at approximately $86 billion (previous guidance was a range between $87 billion and $89 billion), and adjusted diluted EPS expected to come in at about $13.00 vs the previous guidance of between $13.20 and $13.60.
DIY Weakness Kills the Quarter Albeit Unsurprisingly
One of the major takeaways from the third quarter earnings was how the company’s DIY segment was the biggest drag on the company’s Q3 numbers. This shouldn’t be surprising at all given that the segment accounts for nearly 75% of the company’s revenue, making it a prime target of the weakness seen in discretionary spending, compared to its peer Home Depot .
The company found that consumers were prioritising spending on travel and entertainment , as opposed to big ticket discretionary items. Although this trend was expected, what was worrying was that the management did not offer any concrete mechanism through which, the company plans to offset this decline.
While the management, during the earnings call, did suggest that they have made “ foundational improvements to effectively align labor to demand ,” these improvements are still in the early stages. For instance, the company opened more Outlet stores closer to where the company’s core customers were functioning. Furthermore, the company revamped its rural strategy by introducing the concept of one-stop-shopping and also introduced weekly deals on items such as power tool.
While the management exuded confidence that these moves will allow it to be more efficient in this challenging macro environment, the talk was centered more around potential growth opportunities for the future rather than anything tangible. Unlike Home Depot, which clearly mentioned that they were going to shift their focus towards Pro, there was no such concrete strategy laid out by Lowe’s management during the earnings call. This lack of clarity is a cause of concern, in my opinion.
Expense Management A Bright Spot From Q3
While there was a lack of clarity in how Lowe’s strategy would pay off, one certain takeaway from the company’s Q3 earnings was that the company is doing a great job in managing its expenses. Despite a challenging macro-environment and despite the DIY segment getting crushed, the company still managed to improve its margins. Gross margins came in at 33.7% of sales in Q3, which represents a growth of 36 bps Y/Y. Operating margins came in at 13.2%, which represents a growth of 46 bps Y/Y. The company also managed to bring down its inventory and aligned it with sales, which is also a promising pattern.
The company attributed the improvements in margins to the ongoing perpetual productivity improvement initiatives ((PPI)). These initiatives include replacing old check-out systems with proprietary self-checkout systems, which are more user friendly, as well as improving the overall product cost management, inventory productivity, and pricing and promotional strategies.
The increased discipline as well as continuous improvements made to the business are indeed positive, and the fact that the company was able to boost margins even during a period of decline in sales, was indeed a bright spot of the quarter. However, once again, the degree of clarity on how the company plans to sustain these initiatives was less clear. During the earnings call, several questions were raised by analysts on the PPI initiatives, but the management’s response was not entirely convincing, in my opinion.
Overall though, it does appear that the company’s moves to control expenses and boost margins are so far paying off. Whether it can sustain this in the coming quarters will be integral to the company’s growth prospects, especially since the macro-environment is unlikely to change anytime soon.
No Changes to Dividend Policy but Don’t Expect Bumper Repurchases
Like Home Depot, Lowe’s management reiterated that they had no plans of altering their dividend policy despite the challenging macroenvironment. The company is targeting a 35% dividend payout ratio and there are no plans to cut dividends at all.
However, management also cited that share repurchases are likely to remain modest, which should not be surprising, given the challenges, which lie ahead for the company, for the foreseeable future.
Valuation
Forward P/E Multiple Approach | |
Price Target | $221.00 |
Projected Forward P/E multiple | 16x |
Projected Forward PEG Ratio | 2.55 |
Projected Earnings Growth Rate | 6..3% |
Projected FY24 EPS | $13.82 |
Sources: Refinitiv, LOW’s Q3 Earnings Report , and Author’s Calculations
The company currently trades at a forward P/E of 15x, according to Refinitiv. Historically, the company has been trading at a forward P/E of 17x. The company, despite operating in a challenging macroenvironment, the company has been cutting expenses in a disciplined manner. Taken things together, I have assumed a forward P/E of 16x. The company expects FY23 EPS to come in at approximately $13.
Lowe’s trades at a forward PEG ratio of 2.55, which results in a projected earnings growth rate of 6.3%. At this growth rate, the projected FY24 EPS amounts to $13.82.
At a forward P/E of 16x and a projected EPS of $13.82, we would get a price target of $221, which represents an upside of about 11% from Friday’s closing price.
Risk Factors
The main risk factor surrounding the stock is the lack of clarity around its strategies. Given that the DIY segment accounts for almost 75% of the company’s revenues, it is strange that the management has not clarified its overall business strategy for the challenging macro-environment.
Furthermore, the fact that the Pro segment is also showing signs of weakness could mean that the expense management strategy of the company may not be sustainable.
Concluding Thoughts
Bottomline, Lowe’s had a disappointing Q3, which is unsurprising given that the company relies on the DIY segment, an area that is clearly showing signs of weakness, for majority of its revenues. And based on the earnings call, there was no clear strategy outlined by the management about how to counter the headwinds.
Having said that, the company still managed to boost margins through disciplined expense management. And from a valuation perspective, the stock does appear to be attractive at current levels.
There are challenging times ahead for LOW, which means that offering some clarity on its strategy would provide some relief for its investors.
For further details see:
Lowe's: A Lack Of Clarity From Q3 Report Overshadows Attractive Valuation