Lowe's: The Retailer With Insulation From Amazon

| About: Lowe's Companies, (LOW)

Lowe's (NYSE:LOW) is one of the retailers (Home Depot (NYSE:HD) included) that is insulated from the migration to online shopping sites such as Amazon (NASDAQ:AMZN). Most of the goods that Lowe's offers in its store cannot be easily shopped for, purchased or cheaply shipped. Given the Company's high moat, reasonable valuation and favorable outlook it is a solid investment opportunity today.

I. COMPANY OVERVIEW

Lowe's Companies, Inc. is a home improvement retailer. The Company operates 1,745 stores, consisting of 1,712 stores across 50 United States, 31 stores in Canada and two stores in Mexico. The Company serves homeowners, renters and commercial business customers. Individual homeowners and renters complete an array of projects and vary along the spectrum of do-it-yourself (DIY) and do-it-for-me (DIFM). Commercial business customers include those who work in construction, repair/remodel, commercial and residential property management, or business maintenance professions.

II. HISTORICAL PERFORMANCE

2009 2010 2011 2012 2013
Revenue $48,230 $47,220 $48,815 $50,208 $50,521
% Growth n/a -2.1% 3.4% 2.9% 0.6%
Gross Profit 16,501 16,463 17,152 17,350 17,327
% Margin 34.2% 34.9% 35.1% 34.6% 34.3%
EBITDA 5,474 4,959 5,325 5,342 5,271
% Margin 11.3% 10.5% 10.9% 10.6% 10.4%
Net Income 2,195 1,783 2,010 1,839 1,959
Avg Diluted Shares 1,468 1,464 1,403 1,273 1,152
% Growth n/a -0.3% -4.2% -9.3% -9.5%
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Note: All figures are MM's (except per share data) unless noted otherwise.

Lowe's performance has been relatively flat over the past five years. The Company's revenue contracted only once at a rate of 2.1% in 2010. In spite of the one-year contraction, the Company managed a positive compounded annual growth rate of 1.2% over the past four years. The gross margin has trended positively while also staying within a tight 0.9% range over the past five years (bottoming at 34.2% and peaking at 35.1%). On the other hand, EBITDA Margins have contracted from 11.3% in 2009 to 10.4% in 2013 resulting in EBITDA compression from $5,474MM in 2009 to $5,271MM in 2013 (4% contraction) over the five-year period.

Per Share Data

2009 2010 2011 2012 2013
Revenue $32.85 $32.25 $34.79 $39.44 $43.86
% Growth n/a -1.8% 7.9% 13.4% 11.2%
Gross Profit 11.24 11.25 12.23 13.63 15.04
EBITDA 3.73 3.39 3.80 4.20 4.58
Net Income 1.50 1.22 1.43 1.44 1.70
Dividends 0.34 0.36 0.42 0.53 0.62
Payout Ratio 22.4% 29.1% 29.3% 36.7% 36.5%
Dividend Growth n/a 6.0% 18.3% 26.2% 17.0%
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Note: Per share data based on weighted average diluted shares outstanding.

On a per share basis, we need to view the Company wide historical performance in a different light. The Company has changed their weighted average shares outstanding through share redemption from 1,468MM to 1,152MM over the period (a 21.5% decrease), resulting in a more favorable performance on a per share basis. EBITDA per share has expanded from $3.73 to $4.58 (a 23% increase as compared to a 4% decrease at the Company level). The Company's dividends per share have been growing, increasing from $0.34 per share in 2009 to $0.62 per share in 2013 (an 85% increase or a 16.6% compounded annual growth rate), while the payout ratio has increased from 22% to 36%.

III. CAPITALIZATION

Market / Par Value EBITDA Multiple
- Cash and Equivalents $1,216 0.2x
+ Total Debt $10,141 1.8x
+ Market Capitalization $49,970 8.7x
Total Enterprise Value $58,895 10.3x
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Note 1: Based on TTM EBITDA of $5,722MM as of 11/1/13.

Note 2: Market Cap based on 1,045.8MM shares outstanding and a $47.78 market price as of 1/17/14.

Lowe's has a low leveraged capital structure. The Company is levered at 1.8x TTM EBITDA (1.6x net of cash) with a total enterprise value of 10.3x TTM EBITDA. Ideally, the Company would incur a little bit of low cost debt to leverage their equity returns. Even with moderate leverage, the Company would have a low cost of debt and maintain significant financial flexibility, while enhancing returns to the equity holders.

IV. PROJECTIONS

2014 2015 2016 2017 2018
EBITDA $5,726.2 $6,340.9 $6,920.0 $7,465.7 $7,705.3
% Growth 8.6% 10.7% 9.1% 7.9% 3.2%
Interest Expense 434.0 434.0 434.0 434.0 434.0
Taxes 1,381.4 1,547.1 1,703.3 1,850.4 1,915.0
Capital Expenditures 874.6 968.5 1,057.0 1,140.3 1,176.9
Dividends 753.0 753.0 753.0 753.0 753.0
Addl' FCF $2,283.2 $2,638.2 $2,972.7 $3,288.0 $3,426.4
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Note: All figures are MMs (except per share data) unless noted otherwise. Consensus Estimates only relate to EBITDA projections. All other assumptions are based on unadjusted LTM actuals.

The consensus estimates for Lowe's are aggressive projecting a growth rate between 10.7% and 3.2% annually through 2018 at the EBITDA line. Under the consensus case the Company is projected to have significant additional free cash flow available to reinvest in the business, repurchase shares (always assumed for modeling purposes), or increase the dividend.

2014 2015 2016 2017 2018
Addl' FCF $2,283.2 $2,638.2 $2,972.7 $3,288.0 $3,426.4
Share Redemption Price $54.95 $63.19 $72.67 $83.57 $96.10
Shares Redeemed 41.6 41.8 40.9 39.3 35.7
Wtd Avg Diluted Shares 1,045.8 1,004.1 963.2 923.8 888.2
Dividends Per Share $0.72 $0.75 $0.78 $0.82 $0.85
Dividend Growth 16.1% 4.2% 4.2% 4.3% 4.0%
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The share redemptions are assumed to be at a 15% annually compounded price. I believe that this is structured very conservatively. If the weighted average redemption price exceeded this threshold, the investor would have ample opportunity and time to re-evaluate their position and consider selling their position for a gain from today's price. The Company's share redemption would allow for a 4% increase in the dividend annually from the share redemptions alone. Additionally, the Company's payout ratio would decline as the dollar amount of dividends paid would not be increasing while the Company's earnings (using EBITDA as a proxy) would be increasing.

If the Company performs in line with the consensus estimates and pay dividends / redeems shares as outlined above, the Company would achieve the IRR / Cash on Cash returns illustrated below based on the outlined terminal EBITDA multiples.

Returns Based on Terminal EBITDA Multiple

7.8x 8.3x 8.8x 9.3x 9.8x 10.3x
IRR 5.9% 7.8% 9.5% 11.2% 12.9% 14.7%
Cash on Cash 1.25x 1.34x 1.44x 1.53x 1.62x 1.73x
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V. RECOMMENDATION

A lot has been going on at Lowe's over the past five years. The Company has come out of the great recession, but EBITDA has been down even from 2009 levels. That said, the Company has combated the trends of the base business through share reduction that has actually resulted in a fairly significant increase in EBITDA per share. Going forward the Company is poised to do well on a company wide level, which will be magnified if the Company continues to retire shares.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LOW, over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.