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Lowe's Companies (NYSE:LOW) is the second largest home improvement retailer that deals in home maintenance, repair, remodeling, and decorating. In this article, we are going to look into the future return prospects of the company in the wake of the improving US economy, declining unemployment rates, and expectation regarding the improvement (or the lack thereof )in the US housing sector.

Industry Analysis

While studying the home building and construction industry of the United States it becomes apparent that the future outlook of the housing industry is positive. The National Association of Home Builders' (NAHB) Market Index underscores this fact.

Source: Bloomberg

The trend above shows that the NAHB Market Index currently stands at 58 thus it is expected that the number of people buying homes in the U.S will improve in the upcoming future. This projection is based on the fact that the country's unemployment rate has declined to approximately 7% compared to 8.6% in 2012. The National Association of Home Builders (NAHB) further believes that the new home sales will surge to 607,000 in 2014 compared to 430,000 in 2013. This translates into a 40% year-on-year growth in sales. Moody's has an even higher growth projection of 680,000 new home sales. Such growth in sales will have a trickle-down effect on the profit margins of the companies doing business in the housing sector.

Further evidence of these growth projections is evident from the consumer confidence index that has risen to 82.5. Consumers are expecting a hike in employment rates that leads them to hope for a better year ahead and thus spend more.

Source: Trading Economics

Despite the positive movement in the indices growth in the housing sector in the current year is going to slow down due to an increase in the supply of houses in the market and rising ownership costs. Mortgage rates were lower towards the end of 2013 but they are expected to rise by approximately 5.5% by the end of 2014. This spike is expected to repel a number of home buyers thereby lowering the profits of the companies dealing in this market.

Company Performance compared to the Industry

As of November, the company is operating 1,831 stores with more than 90% of its stores spread across the United States and the remaining stores distributed between Canada and Mexico. New store openings up until now indicate a YoY growth in stores of about 4.63% mainly accounted for by the acquisition of Orchard. Comparable store sales have grown by 6.2% compared to the same quarter last year.

Over the most recently-ended quarter, profit margins have shown fluctuating results with second quarter margins shooting up only to come down to 4% at the end of the third quarter. The fluctuation is attributed to the changes in the quarterly revenues of the company that trickled down to the net profit margin. With regards to changes in sales revenue, Lowe's revenue base showed a 7.3% YoY growth in sales even when the QoQ rate plunged by approximately 18%.

Comparing Lowe's performance with the industry indicates that Lowe's sales growth (7.3%), net profit margin (4.3%), and asset turnover (1.55) underperformed the industry average. The financial condition of the company is the only factor that is in favor of Lowe's with a lower debt to equity ratio and a lower financial leverage compared to its peers. Furthermore, the subordinate net profit margin and asset turnover ratio led to a below-average return on equity. Comparing the company's ROE (16.89) with Home Depot's (NYSE:HD), a leading home improvement retailer and Lowe's major competitor, we see that Home Depot's higher than industry average ROE (33.76) is mainly the result of its net profit margin (6.8%)(also higher than its peers). These results are shown in the graph below.

Source: MSN

Future Outlook

Lowe's lags behind Home Depot mainly because of its wide-reaching network and because Lowe's network of stores is smaller. A smaller network leads to fewer customer purchases from Lowe's compared to the number of customers purchasing products from Home Depot. However, increasing same store sales just by growing the number of stores is a costly and time-consuming process. Therefore, to cater to this problem Lowe's plans to reach a higher number of customers through the internet.

Lowe's recently partnered with Porch.com, an online startup website that brings together homeowners with home improvement professionals. The website is meant to highlight the home improvement professionals in the neighborhood of the customer by clearly indicating the number of houses that the specific professional has worked on around the neighborhood. The website also groups each professional's licenses, past projects, and endorsements to allow the homeowner to choose their own professional worker. The partnership will allow Lowe's to reach every neighborhood without immediately building a brick and mortar store to reach them. This will tremendously cut down Lowe's costs and enhance its reach to the consumer group.

Concluding Remarks

Although Lowe's profit margins and overall performance have improved over the past few quarters the company's performance was still not as fruitful as the industry. Moreover, Porch is expected to enhance accessibility to Lowe's services but the company will eventually have to increase its number of stores if it wants to fully benefit from the enhanced customer reach. Whether the company succeeds in doing so or not is uncertain as of now.

Therefore, given a slowing improvement in the housing sector and uncertainty regarding the improvement in the future profit margins of the company I would not recommend investing in this company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

Source: Lowe's Prospects Are Dimming