2023-12-28 12:03:36 ET
Summary
- Lowe's Companies is a dividend growth stock with a strong growth profile and a track record of 60 consecutive years of dividend hikes.
- The company has faced challenges in the DIY customer segment due to the COVID-19 pandemic, but is implementing initiatives to stimulate spending.
- Despite concerns about EPS expectations, Lowe's is currently undervalued and has the potential for future growth, making it a potential buying opportunity during market downturns.
Introduction
It's time to talk about one of the most fascinating dividend growth stocks on the market. Founded in 1946, Lowe's Companies ( LOW ) is one of the few dividend growth stocks that has dividend king status (more than 50 consecutive annual hikes) and a strong growth profile.
Over the past ten years, LOW shares have returned more than 440%, beating the S&P 500 by more than 200 points!
Nonetheless, the stock has gone sideways since 2022, when economic tailwinds turned into headwinds, including the impact of elevated rates on the housing market and fading COVID-19 benefits.
My most recent article on the company was written on September 24.
Lowe's is a compelling choice for investors seeking consistent dividend growth and potentially market-beating returns.
With a remarkable track record of hiking dividends for 59 consecutive years and an impressive annual total return compounding rate of 17.7%, LOW has shown resilience and strategic foresight.
Despite recent stock price fluctuations and potential economic challenges, the company remains well-positioned for growth.
My mistake in September was giving the stock a Neutral/Hold rating. Usually, when dealing with such strong stocks that I consider good long-term investments despite tough economic environments, I give Buy ratings with the additional hint for investors to buy the stock during corrections.
With that said, now, it's time for an update, as we have to discuss new market and economic developments, including the company's attractive risk/reward, in light of ongoing challenges.
So, let's get to it!
Resilience Amidst Headwinds
Earlier this month, Lowe's presented at the Morgan Stanley Global Consumer & Retail Conference.
During this conference, the company acknowledged the challenges posed by a discretionary pullback in the do-it-yourself ("DIY") customer segment, which constitutes approximately 75% of Lowe's revenue.
The COVID-19 pandemic has led to a more pronounced pullback in DIY discretionary spending than anticipated.
This is what the comparison between the LOW stock price (the black line) and the annualized number of building permits in the U.S. looks like:
TradingView (LOW, Building Permits)
During its 3Q24 (2024 fiscal year) earnings call, the company shed light on challenges faced in crucial categories such as appliances, decor, flooring, and kitchen/bath.
These are areas where the company has a robust DIY presence.
In response to consumers delaying purchases of bigger-ticket items like appliances, Lowe's acknowledges the need for strategic interventions.
Hence, the company is gearing up to implement initiatives in Q4 and beyond to stimulate DIY spending, focusing on value-conscious customers.
This includes competitive offers on single-unit appliance purchases and the launch of Lowe's lowest price guarantee, aimed at instilling confidence in customers seeking the best deals.
During the quarter, comparable store sales were down 7.4%.
Lowe's Companies
Furthermore, due to the pullback in DIY spending and uncertainty in macro factors, the 2023 outlook was updated.
Fourth-quarter comp sales are expected to be consistent with third-quarter results.
Full-year 2023 sales are forecasted at roughly $86 billion, with a comparable sales decline of approximately 5%.
Adjusted operating margin is expected to be approximately 13.3%, and adjusted diluted earnings per share are projected to be approximately $13.
Lowe's Companies
The good news is that despite the downturn in the DIY sector, the company is seeing resilience in Pro sales.
Professionals who are dealing with unavoidable repairs due to wear and tear in aging homes contribute significantly to project backlogs.
The company's ability to deliver positive Pro sales comp in the third quarter reflects the success of past investments made to enhance service offerings.
Lowe's Companies
Furthermore, in the pursuit of opportunities, Lowe's introduced innovative initiatives, notably the Lowe's Outlet stores and the Rural Strategy, which I also discussed in my prior article.
The Outlet stores, smaller in format, leverage lower-cost real estate to offer savings on big and bulky items.
This strategy aligns with the aforementioned current consumer trend of seeking value.
The Rural Strategy, launched in over 300 stores, addresses the unique needs of customers in rural areas.
So far, the company noted that initial success is observed in categories like pet, apparel, and automotive, prompting consideration for expansion.
Lowe's is exploring the potential growth opportunities presented by these strategies, which provide tailored solutions to specific consumer segments.
So, what does this mean for shareholders?
Shareholder Value And Total Return Potential
In light of macroeconomic challenges, the company made clear that it maintains a strong commitment to its dividend strategy.
The company has a target dividend payout ratio of 35%, which means that long-term dividend growth is expected to be close to long-term earnings per share growth.
Currently, the stock has a low 30% payout ratio, which supports its 2.0% yield.
As we can see below, the company has exponential dividend growth with a track record of 60 consecutive annual dividend hikes.
Even better than that is its dividend growth rate. While a 2.0% yield may not be a lot, especially for income-focused investors, the dividend has been hiked by 19.3% per year over the past five years (on average).
The company also bought back 44% of its shares since the end of 2013, making it one of the most aggressive repurchasers on the planet, which has helped the company to beat the S&P 500.
However, accelerated buybacks and dividends were mainly a result of the pandemic, which caused DIY demand to fly.
The most recent dividend hike was on May 26, when the company hiked by 4.8%.
I expect dividend growth to remain subdued.
While the company is not in a spot where it will be forced to cut its dividend, as it has a low 30% payout ratio and a balance sheet with a 2.5x net leverage rating and a BBB+ credit rating, it does not help that EPS expectations are poor.
Using the data in the chart below:
- In the 2024 fiscal year, EPS is expected to decline by 5%, followed by a potential decline of 1% in the 2025 fiscal year. 2026 is expected to see a rebound of 11%.
FAST Graphs
However, despite these numbers, the stock is far from overvalued.
LOW is currently trading at a blended P/E ratio of 17.1x. Over the past two decades, the normalized valuation was 19.1x.
A return to this valuation would pave the road for 12.1% annual returns through FY2026 . Since 2003, LOW shares have returned 13.4% per year.
Additionally, the company's expectations are low.
Over the past six months, EPS expectations have come down significantly, reflecting ongoing economic challenges.
Current EPS Estimate | EPS Estimate 6 Months Ago | |
FY2024 | $13.00 | $13.35 |
FY2025 | $12.83 | $14.63 |
FY2026 | $14.31 | $16.56 |
Once economic expectations bottom, I expect the company to benefit from its current undervaluation on top of EPS outlook hikes from analysts.
For the time being, I expect the company's growth rates to remain subdued, which means I'm hunting for buying opportunities on weakness.
As I own Home Depot ( HD ), I am looking to buy LOW shares for family accounts. I bought HD in 2020, and I am not yet sure if I will gain significant risk/reward benefits by adding two stocks that are very similar.
Nonetheless, I have highlighted the LOW ticker on my watchlist. If the market presents a 10% to 15% drawdown opportunity in 2024, I will be a buyer of the stock.
Given my view on the economy, which includes expectations that rates may remain higher than the market currently expects, I am fairly sure I will get a buying opportunity in 2024.
On a long-term basis, I expect LOW shares to maintain high-single-digit to low-double-digit annual dividend growth and stock price outperformance.
Takeaway
While economic headwinds have impacted the stock, particularly in the DIY customer segment, Lowe's resilience and strategic initiatives are noteworthy.
The company's commitment to maintaining a strong dividend strategy, with a target payout ratio of 35%, underscores its long-term stability.
Despite near-term concerns about EPS expectations, LOW's current undervaluation and historical performance suggest potential for future growth.
As an investor, keeping an eye on LOW for a buying opportunity during market downturns could be a prudent move.
In the long term, Lowe's appears poised for high-single-digit to low-double-digit annual dividend growth and stock price outperformance.
For further details see:
Lowe's: Over 12% Annual Total Return Potential Despite Headwinds