2023-11-21 16:08:21 ET
Summary
- Lowe's Companies reported weak sales data for Q3, with revenue declining by 12.8% compared to the previous year.
- Earnings per share increased year over year, but adjusted earnings still fell. Cash flows and EBITDA also declined.
- Management reduced revenue and profit guidance for the year, but the stock is cheap compared to rival The Home Depot.
- Add on top of this leading indicators that suggest better times ahead, and the firm should make for a decent long-term play.
In the construction and DIY (Do-It-Yourself) retail space, there are really only two large players these days. One of these, the smaller of the two, is Lowe's Companies ( LOW ). The fact that there are so few players in this market means that the performance of either firm can serve as a barometer of the markets that they service. Well, on November 21, the management team at Lowe's Companies reported financial results covering the third quarter of the company's 2023 fiscal year. The data presented showed a surprising amount of weakness occurring on the top line. In addition to this, while bottom line performance exceeded analysts’ expectations, cash flows seem to be weakening on a year over year basis. In the near term, this is bound to be a drag on the company. But when you focus on changing industry conditions and when you consider how cheap the stock is compared to rival The Home Depot ( HD ), I do think the enterprise makes for a soft ‘buy’ right now.
A mixed quarter
After announcing financial results for the third quarter of the 2023 fiscal year, shares of Lowe's Companies declined by nearly 3% in early afternoon trading on November 21. The sales data was particularly negative, with revenue coming in at $20.47 billion. In addition to representing a decline of 12.8% compared to the $23.48 billion reported one year earlier, sales actually came in $390 million lower than what analysts anticipated . Management attributed this decline to a couple of things. For starters, comparable sales dropped by 7.4% because of a decline in DIY discretionary spending. The picture would have been worse had it not been for growth on the Pro customer comparable sales side of the equation. It is worth mentioning that the company benefited from the opening of one new store and three Lowe’s Outlet stores during the quarter, bringing the total store count in operation to 1,746.
Author - SEC EDGAR Data
The bottom line was a bit more complicated. Earnings per share actually skyrocketed year over year, climbing from only $0.25 to $3.06. That resulted in an increase for earnings from $154 million last year to $1.77 billion this year. It also meant that the company exceeded analysts’ forecasts by $0.06 per share. It's imperative to note that, in the third quarter of last year, the company took a $2.1 billion impairment charge associated with its Canadian retail business. If we remove that from the equation, earnings per share last year would have been $3.27. So even though official earnings were much higher this year than last, adjusted earnings still managed to fall.
Author - SEC EDGAR Data
We should also pay attention to other profitability metrics. Operating cash flow, for instance, fell from $2.13 billion in the third quarter of 2022 to $1.06 billion the same time this year. If we adjust for changes in working capital, it dropped from $2.67 billion to $2.40 billion. And finally, EBITDA declined from $3.54 billion to $3.21 billion. In the chart above, I also showed financial performance for the first nine months of 2023 relative to the same time last year. This shows that revenue and all of the cash flow data reported by the company worsened year over year. The only uptick came from net profits. But once again, that is only because of the aforementioned impairment charge.
The weakness experienced during the quarter has caused management to reevaluate what this year might look like as a whole. Previously, the company was forecasting revenue of between $87 billion and $89 billion. That has now been reduced to roughly $86 billion. Part of this change can be attributed to the expectation that comparable sales will be down by around 5% that compares to the 2% to 4% decline previously anticipated. Guidance on the bottom line has also been reduced to $13 per share in profits. That compares to the $13.20 to $13.60 management forecasted in the past. At the midpoint, that should translate to net profits of $7.5 billion. Based on my own estimates, adjusted operating cash flow should be around $10.48 billion, while EBITDA should be roughly $13.34 billion.
Author - SEC EDGAR Data
Using these figures, we can easily value the company. As you can see in the chart above, I priced the company using estimates from 2023 and actual data from 2022. Two out of the three metrics show that the stock is cheaper on a forward basis. But in the grand scheme of things, the pricing for the enterprise looks reasonable for such a high-quality player that is one of the largest in its space. I also, in the table below, compared pricing for it to pricing for rival The Home Depot. Comparatively speaking, Lowe's Companies is cheaper across the board.
Company | Price / Earnings | Price / Operating Cash Flow | EV / EBITDA |
Lowe's Companies | 15.3 | 10.9 | 11.2 |
The Home Depot | 19.6 | 14.6 | 13.6 |
Clearly, management is not terribly enthusiastic about the near-term outlook. The fact of the matter is that the housing market plays a major role in the health of a company like Lowe's. And while home prices have been moving up for the past four months now, home sales continue to drop. New data covering the month of October showed that sales of previously owned homes were 4.1% lower than they were in September. In fact, that represented the slowest sales pace since August of 2010. Year over year, the number of sales are down 14.6%.
It might seem peculiar to claim that home sales would have a major role to play for a company like Lowe's, but the fact of the matter is that when home sales are robust, you have more people wanting to fix up their properties for the purpose of elevating prices and increasing the likelihood of a buyer at an attractive price. In addition to that, when people move into a home, they are much more likely to want to make additional investments into it than a home they have been living in for years. Add on top of this the fact that if home sales are weak, home construction is weak. And weak home construction also should translate to a reduction in demand for the types of goods and services that Lowe's Companies provides.
Company | Backlog (Units) Latest Quarter | Backlog (Units) - Same Quarter Last Year |
KB Home | 7,008 | 10,756 |
Taylor Morrison Home Corporation | 6,118 | 7,941 |
Meritage Homes | 3,608 | 6,064 |
Century Communities | 1,887 | 3,455 |
Beazer Homes USA | 1,711 | 2,091 |
PulteGroup | 13,547 | 17,053 |
Toll Brothers | 7,295 | 10,725 |
NVR Inc. | 10,371 | 10,758 |
D.R. Horton | 15,197 | 19,614 |
*Data from Quarterly and Annual Reports on SEC EDGAR Database
The good news is that we are starting to see a turnaround in this space. But the turnaround is in its early phases. Those looking at the backlog of homes amongst home construction companies might feel at odds with this statement. In the table above, I looked at nine different home construction firms and showed the backlog as of the end of the most recent quarter for each one and compared that to the backlog that they reported the same time last year. Without exception, they are down materially year over year.
Company | Net New Orders (Units) - Latest Quarter | Net New Orders (Units) - Same Quarter Last Year |
KB Home | 3,097 | 2,040 |
Taylor Morrison Home Corporation | 2,592 | 2,069 |
Meritage Homes | 3,474 | 2,310 |
Century Communities | 2,149 | 1,318 |
Beazer Homes USA | 1,003 | 704 |
PulteGroup | 7,065 | 4,924 |
Toll Brothers | 2,425 | 1,266 |
NVR Inc. | 4,746 | 4,421 |
D.R. Horton | 18,939 | 13,582 |
*Data from Quarterly and Annual Reports on SEC EDGAR Database
If we look at the next table above, however, we can see that net new orders at all of these companies are, without exception, up nicely compared to the same time last year. So although the plunge in demand for housing has resulted in a drop in backlog that continues to the present day, orders are now coming in strong and that should bode well for a company like Lowe's. Meanwhile, in the chart below, I also looked at the cancellation rate of orders. Once again, we get a favorable picture, with every one of the entities reporting a decline in the most recent quarter compared to the same time last year. Cancellation rates are still well in excess of what they were prior to the start of the decline in backlog. But to see such a nice improvement across the industry is encouraging. Investors should view both the cancellation rate and the net new orders as leading indicators for a company such as Lowe's.
Company | Cancellation Rate - Latest Quarter | Cancellation Rate - Same Quarter Last Year |
KB Home | 21% | 35% |
Taylor Morrison Home Corporation | 11% | 16% |
Meritage Homes | 11% | 30% |
Century Communities | 16% | 35% |
Beazer Homes USA | 17% | 33% |
PulteGroup | 15% | 24% |
Toll Brothers | 10% | 13% |
NVR Inc. | 14% | 15% |
D.R. Horton | 21% | 32% |
*Data from Quarterly and Annual Reports on SEC EDGAR Database
Takeaway
At the end of the day, I understand why investors are unhappy with the performance achieved by Lowe's Companies. High interest rates and inflationary pressures are leading to industry conditions that are unpleasant for the company. The fact that management has had to reduce guidance is certainly telling. Having said that, the company is trading cheaper than its main competitor and leading indicators in the home construction market imply quite heavily that the worst is behind the business and that the future should see a nice rebound. Given all of these factors, I have decided to keep the company rated a ‘buy’.
For further details see:
Lowe's Companies: Move Lower Represents A Buying Opportunity