Shares of Lowe's (LOW) are under pressure after the U.S. second largest home improvement retailer announced a solid set of third quarter results. While competitor Home Depot (HD) managed to beat consensus estimates by a comfortable margin yesterday, Lowe's results were a bit soft, as the company continues to lag its main rival in the domestic market.
Whit shares trading at elevated valuation levels amidst favorable operating conditions and strong shareholder payouts, I would be very cautious to jump on the bandwagon at these historically expensive levels.
Third Quarter Results
Lowe's generated third quarter revenues of $12.96 billion, up 7.3% on the year before. Revenues comfortably beat on consensus estimates of $12.72 billion.
Net earnings rose by 26.0% to $499 million. On the back of share repurchases earnings per share advanced by 34.3% to $0.47 per share. Earnings missed consensus estimates by a penny.
CEO and Chairman Robert Niblock commented on the third quarter performance, "I am pleased we delivered another solid quarter driven by balanced performance. This balanced performance resulted from our improved collaboration and execution within a strengthening home improvement market, combined with our employees' hard work and continued dedication to serving customers."
Looking Into The Results ...
Revenue growth was driven by comparable sales growth which was up by 6.2%. The company ended the quarter with 1,831 home improvement and hardware stores, each generating quarterly revenues of an average $7.1 million.
Gross margins rose by 26 basis points to 34.6% of total revenues. Lowe's furthermore benefited from operating leverage through lower selling, general and administrative expenses which fell by 47 basis points to 24.6% of total revenues.
This operating leverage and fewer shares outstanding after large share repurchased fueled earnings per share growth.
... And Looking Ahead
Full year sales for 2013 are seen up by some 6%, driven by a 5% increase in comparable store sales and 9 store openings.
Operating margins are seen up by 75 basis points, resulting in diluted earnings per share of $2.15. Analysts were looking for an ever higher guidance at $2.19 per share.
Lowe's ended its third quarter with $1.21 billion in cash, equivalents and short term investments. Total debt stands at $10.14 billion, resulting in a nearly $9 billion net debt position.
Revenues for the first nine months of the year came in at $41.76 billion, up by 5.8% on the year before. Net earnings rose by 18.6% to $1.98 billion, with diluted earnings per share coming in at $1.84 per share.
At this pace annual revenues are seen around $53.5 billion. Full year earnings are seen around $2.3 billion.
Factoring in losses of around 4%, with shares trading at $48.50 per share, the market values Lowe's at $51 billion. This values operations of the firm at 1.0 times annual revenues and 22 times annual earnings.
The quarterly dividend of $0.18 per share provides investors with a dividend yield of 1.4% per annum.
Some Historical Perspective
Just like competitor Home Depot, Lowe's has been benefiting from the recovery of the US housing market. Shares have steadily risen from their low teens in 2009 to highs of $52 in recent weeks.
Even when factoring in the losses on Wednesday, shares are still up some 37% for the year.
Between the fiscal year of 2009 and 2013, Lowe's is set to increase its annual revenues by a cumulative 13% to $53.5 billion. Earnings are seen up by some 28% to $2.3 billion Yet the real growth came from massive share repurchases as Lowe's retired nearly 30% of its shares outstanding over this time period.
Investors are not pleased with Lowe's performance, given the fact that the second largest home improvement chain did not raise the outlook for the remainder of the year as much as analysts were expecting. The full year guidance implies fourth quarter earnings of $0.31 per share, compared to $0.26 per share in the comparable period last year.
This relative soft performance could partially be explained by the fact that roughly 25% of sales are derived from professional contractors, which results in additional demand given the housing market recovery. Home Depot generates roughly 10 percent point more of its revenues from professional contractors.
Despite the somewhat disappointing performance and outlook, CEO Niblock expects that the home improvement industry is positioned for persisting growth with a further acceleration into 2014. Note that Lowe's has adjusted pricing to everyday low pricing instead of relying on high discounts to drive sales.
Besides showing topline growth, accompanied by earnings growth, Lowe's is focusing on pleasing its shareholders. The company pays a 1.4% dividend yield, while it already repurchased $2.8 billion of its own shares so far this year, at a rate of little over 7% per annum.
Back in May, when Lowe's reported its first quarter results, I last took a look at the company's prospects. At the time the company was still reporting flat comparable sales growth, while operations have seen a big acceleration throughout the year.
The problem is that Lowe's remains structurally less profitable compared to Home Depot, despite similar gross margins, although the company has seen some improvements lately. Similar to Home Depot, Lowe's has been operating in an increasingly more favorable environment, which has driven operational growth. Yet management decided to please investors even more, largely through large buyback programs, resulting in increasing debt levels.
These actions have worked and resulted in a share price rise from levels around $42 in May to current levels around $49 per share. Of course, this action has been amidst a very strong general market sentiment. It is obvious that Lowe's is still the laggard in the home improvement area.
As such I remain extremely cautious as strong market circumstances and a shareholder-friendly strategy are already supporting shares at this point in time. At these elevated valuation levels I would not consider taking a long position in the company.