2023-09-27 14:00:00 ET
Summary
- LOW remains a great Buy at these levels, thanks to the excellent 5Y dividend growth at a CAGR of +19.97% and potential upside potential to our long-term PT of $252.91.
- However, since the DIY and DIFM customers comprise 75% of its sales in 2022, it is unsurprising that the tighter housing market has triggered its lowered FY2023 guidance.
- Based on the Fed's commentary, the higher interest rate environment may continue for a little longer, with the 2% inflation rate target likely only achieved by 2026.
- Combined with the LOW stock's sideways movement since 2021, investors may want to observe the situation for a little longer and add according to their risk tolerance and dollar cost averages.
We previously covered Lowe's Companies, Inc . ( LOW ) in April 2022, discussing its status as a staple stock during the worst of the pandemic and the housing boom afterwards, triggering the dramatic expansion in its top and bottom line growth then.
These had also led to the stock's embedded premium and highly optimistic rally, easily outperforming the wider market over the past three years.
In this article, we will be covering LOW's FQ2'23 bottom line beat and lowered FY2023 guidance, thanks to the deflated DIY demand as the US housing market remains tight.
While we continue to rate the stock as a Buy, investors may also want to temper their intermediate term expectations as the stock is likely to continue trading sideways for so long as the elevated interest rate environment persists.
The LOW Investment Thesis Appears To Be Fairly Valued At The Moment
For now, LOW records a more than decent performance in the latest quarter, with revenues of $24.96B (+11.6% QoQ/ -9.2% YoY) and gross margins of 33.7% (inline QoQ/ +0.5 YoY).
The management has also made great efforts to optimize costs with $4.51B in operating expenses (+6.6% QoQ/ -7.9% YoY), naturally leading to the improvement in its operating margins to 15.6% (+0.9 points QoQ/ +0.2 YoY).
While LOW's EPS profitability of $4.56 (+20.9% QoQ/ -2.3% YoY) has been temporarily hit by the increased annualized interest expense of $1.5B (+3% QoQ/ +39.7% YoY) in FQ2'23, we are not overly concerned yet.
This is because the retailer's annualized EBITDA of $17.44B (+16.2% QoQ/ -7.8% YoY) remains more than enough to cover its interest obligations and annualized dividend cash flow of $2.49B (-1.4% QoQ/ +19% YoY).
LOW Valuations
As a result, it is unsurprising that LOW continues to trade at stable valuations with FWD EV/ Sales of 1.80x, FWD EV/ EBITDA of 11.54x, and FWD P/E of 15.67x, somewhat inline to its 1Y means and to its 3Y pre-pandemic means.
While the stock may trade at a premium compared to the sector median of 1.12x/ 9.26x/ 14.25x, we are not overly concerned, since the same premium has been observed in its peer, The Home Depot ( HD ), at 2.30x/ 14.13x/ 20.06x, respectively.
Then again, investors must also note that the LOW management has recently lowered its FY2023 guidance, with revenues of $88B (-9.3% YoY), adj operating margin of 13.5% (+0.5 points YoY), and adj EPS of $13.40 (-2.9% YoY), and Free Cash Flow generation at approximately $8.5B (+25% YoY) at the midpoint.
This is compared to the previous guidance of $89B (-8.2% YoY), 13.7% (+0.7 points YoY), $13.80 (inline YoY), and $9B (+32.3% YoY) offered in the FQ4'22 earnings call , respectively.
Nonetheless, it appears that the LOW stock is still trading near its fair value of $209.97, based on its FWD P/E of 15.67x and the FY2023 adj EPS guidance of $13.40.
Based on the consensus FY2025 adj EPS estimates of $16.14, we are looking at a long-term price target of $252.91 as well, implying a more than decent upside potential of +20.1% from current levels.
However, The Ongoing Housing Crisis Is Not Going Anytime Soon
On the one hand, LOW has been a beneficiary over the past three years of pandemic, enjoying expanded top and bottom lines at $93.22B and $10.02 over the last twelve months, compared to FY2019 levels of $72.14B and $5.49, respectively.
On the other hand, we believe the stock may continue trading sideways as it has over the past two years, attributed to uncertain US housing market with borrowing costs remaining elevated.
The US 30Y National Fixed Rate Mortgage Average
For example, the 30Y National Fixed Rate Mortgage Average is still highly inflated at 7.19% (+0.41 points MoM/ +0.9 YoY) by September 21, 2023, compared to the 2019 average of 3.8%.
Based on the Fed's commentary in the recent FOMC meeting, it appears that the higher interest rate environment may also continue for a little longer, with the target inflation rate of 2% likely to be achieved only by 2026.
With the US housing market supply remaining tight, we may see home prices remain elevated for the foreseeable future, worsened by the tightened discretionary spending as the federal student loan repayment restarts from October 2023 onwards.
These issues matter indeed, since the do-it-yourself (DIY) and do-it-for-me (DIFM) customers comprise 50% of LOW's customer base and 75% of its sales in 2022, with the lowered FY2023 guidance partly attributed to the lower DIY discretionary demand .
The same has been observed with Stanley Black & Decker ( SWK ), whose products are often featured in home improvement retail stores such as LOW and HD, continues to report impacted demand with bloated inventories in the latest quarter.
While LOW has been making great efforts to " drive Pro penetration and expand installation services" over the past few quarters, it is unsurprising that the weak housing market has contributed to the retailer's impacted FQ2'23 comparable sales at -1.6% YoY, worsened by the tougher YoY comparison.
As a result, with the DIY segment expected to underperform for a few more quarters, it is likely that LOW may experience minimal top and bottom line growth until the macroeconomic outlook normalizes.
So, Is LOW Stock A Buy , Sell, or Hold?
LOW 3Y Stock Price
LOW has also retreated drastically over the past week to retest its support levels of $210 at the time of writing, implying further volatility in the near term
Therefore, investors may want to observe the situation for a little longer and add according to their risk tolerance and dollar cost averages.
However, we are not so bearish as to project another retest at the LOW stock's next support levels of between $190 and $180, due to the immense improvements in its operating margins to 12.7% and FCF margins to 7.1%, compared to the FY2019 levels of 8.9% and 3.9%, respectively.
The robust profitability has also allowed the management to pay out $4.40 in annualized dividends by FQ2'23, growing at an impressive CAGR of +19.97% over the past five years compared to the sector median of 7.39%.
This cements the stock's position as a dividend aristocrat with 59 years in consecutive dividend growth indeed. As a result of the great combination of income payouts and (potential) capital appreciation, we maintain our buy rating for LOW.
However, this is with a caveat that investors must remain patient, since its stock reversal may take longer than expected.
For further details see:
Lowe's: Still A Dividend Aristocrat - Reversal May Be Delayed