Lowe's 2nd Quarter Earnings Report
Lowe's (NYSE:LOW) is the second largest home improvement retail store in the US with a market cap of over $50 billion. The company operates over 1,750 stores under its flagship Lowe's name primarily in the US, with some stores in Canada and Mexico. Lowe's also operates over 70 Orchard Supply Hardware stores in the Pacific Northwest. The company was founded in 1946, publicly listed in 1961, and has increased its dividend for 52 consecutive years.
Source: Lowe's Investor Relations
Strong Second Quarter Results
Lowe's released its second quarter results this morning. The company saw diluted earnings per share rise 18.2% versus the 2nd quarter of 2013. Total sales for the quarter increased 5.7%, and comparable store sales for the quarter were up 4.4%. Despite strong comparable store sales, Lowe's underperformed industry rival Home Depot (NYSE:HD). Home Depot's comparable sales for its US stores were up 6.4% over the same time period, outpacing Lowe's by a full 2 percentage points.
Lowe's strong comparable store sales growth is being driven by an improving US economy. As the US economy improves, more consumers own homes and have disposable income to spend on home upgrades. Low interest rates have also made it more economical for consumers to purchase a home rather than renting an apartment due to the low cost of borrowing.
Not only did Lowe's grow earnings per share, revenue, and comparable store sales, the company also returned $1.1 billion to shareholders in the form of share repurchases in the second quarter alone. This comes out to about 2% of shares outstanding repurchased in only one quarter. The company has repurchased about $2 billion worth of shares through the first half of 2014, giving current shareholders a 4% boost of ownership in the business.
Lowe's expects to repurchase $3.4 billion in stock this year, which is about 6.8% of shares outstanding. The company also has a dividend yield of 1.8%, and expects revenue growth of about 5%. All together, Lowe's shareholders can expect a CAGR of over 13% over the next several years as the company continues to reduce its share count and invest in future growth.
Lowe's growth potential comes from greater expansion and market penetration in the US, Canada, and Mexico. For comparison, the US has a $640 billion home improvement market, Canada has a $40 billion home improvement market, and Mexico has a $25 billion home improvement market. The company currently has about 35 stores in Canada and 8 stores in Mexico. For Lowe's to reach the same level of market saturation it has in the US in Canada and Mexico, the company would need to build an additional 77 stores in Canada, and 62 in Mexico.
Additionally, Lowe's owns about one third of Australian home improvement retailer Woolworths. Woolworths operates 38 stores in the $40 billion Australian home improvement industry. For Woolworths to achieve the same market share as Lowe's, the company will need to add an additional 74 stores to its operations.
Lowe's management has repeatedly expressed they want to expand internationally. They have footholds in Canada, Mexico, and Australia with plenty of room for growth in those three countries. Lowe's management is likely looking for additional bolt on home improvement acquisitions in international markets to continue expanding outside the US. One publicly traded business that would make an interesting acquisition target for Lowe's is Kingfisher PLC.
Kingfisher PLC is Europe's largest home improvement retailer with 1,130 stores in 9 countries. The company's stores are significantly smaller than Lowe's. Kingfisher PLC has a market cap of under $13 billion, with total earnings of around $1.2 billion. Shares of Kingfisher PLC trade at a P/E multiple of just above 10, versus Lowe's P/E ratio of nearly 23. The company would likely be better off purchasing a stake in Kingfisher PLC or acquiring the company outright rather than repurchasing its own shares.
Comparison To Other Dividend Growth Businesses
Lowe's will be compared to other businesses with a long history of dividend increases using the 5 Buy Rules from the 8 Rules of Dividend Investing. These rules compare dividend growth stocks over several metrics that have historically been shown to improve returns.
Consecutive Years of Dividend Increases
Lowe's has increased its dividend payments for 52 consecutive years. It has one of the longest active streaks of dividend increases of any businesses. The company's long history of dividend increases speaks to its ability to consistently grow despite setbacks during times of economic uncertainty.
Why it matters: The Dividend Aristocrats (stocks with 25-plus years of rising dividends) have outperformed the S&P 500 over the last 10 years by 2.88 percentage points per year.
Source: S&P 500 Dividend Aristocrats Factsheet
Lowe's has a dividend yield of about 1.8%. The company's dividend yield is the 95th highest out of 132 businesses with 25+ years of dividend payments without a reduction. Lowe's dividend yield is not especially attractive compared to other dividend growth stocks.
Why it Matters: Stocks with higher dividend yields have historically outperformed stocks with lower dividend yields. The highest-yielding quintile of stocks outperformed the lowest-yielding quintile by 1.76 percentage points per year from 1928 to 2013.
Source: Dividends: A Review of Historical Returns
Lowe's has a payout ratio of about 32%. The company's management has stated they want to keep the payout ratio around 35%. Lowe's has the 39th lowest payout ratio out of 132 businesses with 25+ years of dividend payments without a reduction.
Why it Matters: High-yield, low-payout ratio stocks outperformed high-yield, high-payout ratio stocks by 8.2 percentage points per year from 1990 to 2006.
Source: High Yield, Low Payout by Barefoot, Patel, & Yao, page 3
Long-Term Growth Rate
Lowe's has grown its revenue per share by about 8% a year over the last decade. The company's strong revenue growth is due to both store count growth and strong share repurchases. Lowe's has the 22nd highest growth rate out of 132 businesses with 25+ years of dividend payments without a reduction.
Why it Matters: Growing dividend stocks have outperformed stocks with unchanging dividends by 2.4 percentage points per year from 1972 to 2013.
Source: Rising Dividends Fund, Oppenheimer, page 4
The company has a long-term standard deviation of about 31.5%, which is the 83rd lowest out of 132 businesses with 25+ years of dividend payments without a reduction. Lowe's fairly high volatility is due to its susceptibility to recessions. When the housing market plummets, Lowe's typically sees declining earnings which results in increased price volatility.
Why it Matters: The S&P Low Volatility index outperformed the S&P 500 by 2 percentage points per year for the 20-year period ending September 30th, 2011.
Source: Low & Slow Could Win the Race
Lowe's has a strong competitive advantage in the largely duopolistic US home improvement market. The company is attempting to expand internationally, and may be able to accomplish this through an acquisition. Overall, Lowe's ranks only slightly above average using The 8 Rules of Dividend Investing due to its fairly low payout ratio and high volatility. The company trades at a P/E ratio over 22, yet continues to spend the bulk of its free cash flow on share repurchases. Lowe's management would likely be able to find better uses for this money (or simply hoard it for later opportunities) rather than buying shares when the company is likely trading at a premium to fair value.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.