2023-06-27 15:55:55 ET
Summary
- Lowe's shares have increased by over 440% in the past decade, significantly outperforming the S&P 500.
- The latest earnings were pretty underwhelming but growth should rebound throughout the year as the backdrop starts to improve.
- Residential construction spending finally rebounded in April, and housing starts in May came in substantially above expectations.
- Falling lumber prices impacted Pro sales in Q1, but prices have been rebounding amid a stabilizing housing market.
Investment Thesis
Lowe's ( LOW ) has been an excellent compounder in the past decade with shares up over 440%, significantly outperforming the S&P 500 ( SPY ) by a wide margin. Despite having grown a lot in size, the company still has ample growth opportunities in the massive and fragmented home improvement market. While the latest earnings were underwhelming, growth should rebound throughout the year as the backdrop continues to show signs of improvement.
Why Lowe's?
Lowe's is a leading home improvement retailer in the US with over 1,700 stores across the country. In the past few decades, it has grown to become one of the largest companies in the world. Despite the increase in size, there should still be significant expansion opportunities moving forward.
Home improvement is a massive and ever-expanding market. According to Statista , the US market size of home improvement is forecasted to grow from $558.3 billion in 2022 to $621.3 billion in 2025, representing a CAGR (compounded annual growth rate) of 3.6%. Lowe's themselves are even more optimistic and expect its addressable market to be $1 trillion .
The market expansion is mainly driven by the DIY (do-it-yourself) segment, which continues to gain popularity amid the work-from-home trend, rising living standards, and increasing disposable income. This should favor Lowe's as the DIY segment accounts for 75% of its sales. As of FY22, Lowe's has a market share of 15.6%, while Home Depot ( HD ) has a market share of 25.3%. Outside of the two leaders, no companies have a market share of over 5%, which provides ample white space for Lowe's to pursue in the future.
Underwhelming Earnings
Lowe's announced its first-quarter earnings last month and the results are underwhelming, especially the top line which continues to face pressure from lumber deflation and economic headwinds. The company reported revenue of $22.3 billion, down 5.9% YoY (year over year) compared to $23.7 billion. Comparable transactions declined by 4.3% while the average ticket size slipped by 0.3%. Online sales were particularly strong, which grew 6% YoY.
The bottom line came in slightly better due to moderated spending and improved productivity. For instance, SG&A (selling, general, and administrative) expenses as a percentage of sales declined 110 basis points from 18.2% to 17.1%. This resulted in the net income down 3% YoY from $2.33 billion to $2.26 billion. The net income margin expanded 20 basis points from 9.9% to 10.1%, partially due to lower tax provisions. The adjusted diluted EPS was $3.67 compared to $3.51, up 5% as the company repurchased roughly 10.6 million shares for $2.1 billion.
The company also lowered its guidance for FY23. Total revenue is now expected to be $87 to $89 billion, down from $88 to $90 billion. Comparable sales are expected to be down by 3% at the midpoint, compared to the prior decline of 1%. The adjusted diluted EPS is now expected to be between $13.20 and $13.60, down from the prior range of $13.60 to $14.
Improving Backdrop
Although Lowe's Q1 earnings were soft, I remain pretty optimistic about the company's outlook. I believe its financials will rebound throughout the year as the backdrop is finally improving, as highlighted in the recent economic data. For instance, housing starts in May jumped 21.7% MoM (month over month)from 1.4 million to 1.63 million , well above the consensus of 1.4 million. This is the highest level recorded since April last year, as shown in the chart below. The significant increase should drive residential construction spending, which subsequently benefits Lowe's as well.
Residential construction spending has been sliding in for the past year but finally rebounded in April. According to the FRED (Federal Reserve Economic Data), the seasonally adjusted annual residential construction spending increased 0.4% from $851.5 billion in March to $855.2 billion in April. While one month does not make a trend, I believe the increase can continue as housing starts came in substantially strong than expectations.
Falling lumber prices have been a major headwind in the first quarter. According to the company, lower lumber prices impacted Pro sales by approximately 800 basis points. However, the headwind should ease moving forward as lumber prices have been rebounding in the past few weeks amid the stabilizing housing market. It is currently trading at $560 per thousand feet, up 40% from the January low of $400 per thousand feet.
Attractive Valuation
Lowe's is still attractively-priced in my opinion. The company is currently trading at a fwd PE ratio of 16.1x, which remains meaningfully discounted compared to Home Depot, as shown in the chart below. The 20% discount seems unjustified, considering how similar their business and financials are. The company's current multiple also represents a discount of 10% compared to its 5-year average fwd PE ratio of 17.8x. As growth rebounds, I believe the multiples should revert back to levels near the historical average, or even catch up to Home Depot.
Risk
The major risk regarding Lowe’s is still a recession. While the latest economic data such as housing starts have been encouraging, the inverted yield curve seems to indicate a high possibility of a recession happening soon. If it were to happen, most economic data will likely reverse its course and head downwards. This will impact Lowe’s meaningfully as demand shrinks. This is not my base case but it is something to be aware of moving forward.
Investors Takeaway
Lowe's is a reliable compounder that should deliver solid returns in the long run. The company is pursuing a massive and fragmented market that should continue to expand, led by the DIY segment. Higher interest rates and tighter credit conditions have been weighing on the housing market in the past year, but the backdrop seems to be rebounding finally, as recent housing-related data all came in well above expectations. The easing headwind should help drive growth in the remainder of the year. If the company can reaccelerate growth, multiples could easily revert back to levels near the historical average, which should translate to decent upside potential.
For further details see:
Lowe's: Improving Backdrop Should Drive Growth