2023-12-29 16:00:00 ET
Summary
- Mr. Market tested bullish LOW investors immensely at the $180s level in October 2023, before the upward surge after Powell's dovish commentary surrounding a potential Fed pivot by Q1'24.
- Despite the lowered FY2023 guidance, the stock has kept much of its recent gains, partly attributed to the declining 30Y mortgage rates.
- Therefore, while LOW's FQ4'23 earnings call may end up being underwhelming, we believe that there are great tailwinds in 2024 once borrowing costs fall below 5%.
- Combined with the increased new home listings and LOW's stable profit margins, we may see an upward rerating in its top/ bottom line estimates over the next few quarters.
- We maintain our Buy rating, since the stock continues to offer (prospective) dual pronged returns through capital appreciation and dividend income, with it currently being fairly valued.
We previously covered Lowe's Companies, Inc. ( LOW ) in September 2023. On the one hand, the impacted housing market had triggered its consistently lowered forward guidance, with it remaining to be seen when the macroeconomic outlook would normalize.
On the other hand, we had continued rating the stock as a Buy for value oriented investors then, attributed to its stable profit margins and its robust dividend investment thesis, with the inflation likely to peak soon.
Since then, Mr. Market has tested the bulls immensely in October 2023, with the stock plunging beyond its previous support levels of $200s to retest the $180s, before surging up after Powell's dovish commentary surrounding a potential Fed pivot by Q1'24.
Despite the immense recovery, we maintain our Buy rating in this article since the stock continues to offer potential dual pronged returns through capital appreciation and dividend income, with it currently being fairly valued.
We shall further discuss.
The LOW Investment Thesis Has Great Tailwinds In 2024
For now, LOW has reported a top-line miss in its FQ3'23 earnings call, with revenues of $20.47B ( -17.9% QoQ / -12.8% YoY), EPS of $3.06 (-32.8% QoQ/ -6.4% YoY), and comparable sales of -7.4% YoY. Most of the top-line headwind is attributed to the sustained decline in the DIY discretionary spending, which is not surprising given the state of the housing market in the US.
For now, while the 30Y National Fixed Rate Mortgage Average has already peaked at 7.79% by October 26, 2023 (+1.21 points YoY) while moderating to 6.67% at the time of writing (+0.4 points YoY), borrowing costs remain elevated compared to the 2019 averages of 3.8%.
Opendoor ( OPEN ), an iBuying company has also reported low housing supply despite the resilient buyer demand in the recent FQ3'23 earnings call, with most homeowners reluctant to list their homes, since 82.4% report an average fixed-rate mortgage rate of well below 5%.
The same has been reported by Redfin, with pending home sales still comparatively lower by -7% YoY for the four weeks ending December 17, 2023 and home sales only likely to improve when borrowing rates further decline below 5%.
Since the DIY segment historically comprises 75% of LOW's revenues, we are not surprised that its FQ3'23 results have been underwhelming, with FQ4'23 likely to be similar given the typically slower holiday season.
Perhaps this is also why the management has further lowered their FY2023 guidance, with revenues of $86B ( -11.3% YoY ), EPS of $13 (-5.3% YoY), and comparable sales of -5% YoY. This is compared to the original midpoint guidance of $89B (-8.2% YoY), $13.80 (inline YoY), and -1% YoY offered in the FQ4'22 earnings call, respectively.
This is also why LOW continues to report elevated inventory levels of $17.53B (inline QoQ/ -11% YoY), compared to FY2019 levels of $13.17B (+4.8% YoY).
The burden on its balance sheet is notable indeed, with growing long-term debts of $34.93B (-1.2% QoQ/ +7.9% YoY) and deteriorating liquidity of $1.53B (-60.3% QoQ/ -61.2% YoY), compared to the FY2019 debt levels of $16.15B (+18% YoY).
The silver lining to LOW's execution thus far, is its stable gross margins of 33.7% (inline QoQ/ +0.4 points YoY) by the latest quarter, compared to FY2019 levels of 31.8% (-0.3 points YoY), implying that the management has refrained from aggressive pricing strategies to boost sales.
This is on top of the more than decent FCF generation of $5.4B (-26% sequentially) and margin of 6% over the LTM (-1.7 points sequentially), compared to pre-pandemic averages of $3.9B and 5.5%, respectively.
As a result, we believe that LOW remains sufficiently profitable and liquid to survive the uncertain macroeconomic outlook over the next two quarters, until the US property market starts its recovery and DIY demand returns.
Redfin already expects significant improvements in 2024, with listing consults increasing on a MoM basis and new listings up by +9% YoY for the four weeks ending December 17, 2023, as the "biggest annual increase since July 2021."
LOW Valuations
As a result, it is unsurprising that LOW's FWD EV EBITDA valuations of 12.91x and FWD Market Cap/ Free Cash Flow valuations of 16.14x have finally normalized nearer to its 3Y pre-pandemic means of 11.04x/ 15.62x.
This is despite the stock appearing to be expensive compared to the sector median of 12.76/ 15.21x, respectively.
The Consensus Forward Estimates
These valuations are not overly optimistic either, since LOW is expected to maintain their expanded EBITDA margins of over 15% and FCF margins of over 9% through FY2025, compared to its pre-pandemic average of 11.1% and 5.5%, respectively.
Therefore, while the consensus has consecutively lowered their top and bottom line estimates over the past few months, attributed to the tight housing market supply from the elevated interest rate environment, we are not overly concerned, since its reversal seems imminent.
Most importantly, LOW's dividend investment thesis remains robust, based on Seeking Alpha Quant's TTM Dividend Coverage Ratio of 3.01% and TTM Interest Coverage Ratio of 7.97x, compared to the sector median of 2.76% and 7.81x, respectively.
This is also why we believe that the projected dividend per share growth at CAGR of +7.6% through FY2025 is not overly ambitious in our view, building upon its historical growth at a CAGR of +22.39% over the past three years.
So, Is LOW Stock A Buy , Sell, or Hold?
LOW 3Y Stock Price
Based on the LOW management's FY2023 adj EPS guidance of $13 and its FWD/ normalized P/E of 17x, the stock appears to be trading near its fair value of $221.
Based on the consensus FY2025 adj EPS estimates of $14.73, there seems to be a decent upside potential of +12.3% to our long-term price target of $250.40 as well. This is on top of the expanded forward dividend yield of 1.97%, higher than its 4Y average of 1.64% and nearing sector median of 2.12%.
Therefore, we continue rating the LOW stock as a Buy attributed to its decent dual pronged returns through capital appreciation and dividend income, though without a specific entry point since it depends on individual investors' dollar cost averages and risk appetite.
With the stock already breaking out of its 50/ 100/ 200 day moving averages in one fell swoop, it appears that its upward momentum is already stalling at its previous resistance level of $220s.
Assuming so, we may see LOW moderately retrace to its new support level of $210s in the near-term, implying a -5.7% downside from current levels. Bottom fishing investors may consider those levels for an improved margin of safety.
For further details see:
Lowe's: DIY Demand Destruction Is Ending Soon - Bright Prospects Through 2024