Why Lowe's Looks Like A Good Pick Even At 52-Week Highs

Sep. 4.14 | About: Lowe's Companies, (LOW)

Summary

Lowe's valuation is cheaper than the industry, its cash flow is strong, and its earnings are expected to grow at a good pace in the next five years.

The housing market is still improving, and Lowe's is improving its pros platform to make the most of it.

Lowe's results are getting better as it recovers from extreme winter conditions witnessed earlier this year.

Lowe's dividend yield is healthy, and it won't be surprising if it raises the dividend going forward due to its strong fundamentals and strong end-market prospects.

The improving housing market in the U.S. has been a boon for home improvement retailers. As such, it is not surprising that Lowe's (NYSE:LOW) has gained some good momentum in the past three months, appreciating around 12%. Its results have been strong as well, as Lowe's reported good numbers for the second quarter that topped analysts' expectations.

However, Wall Street was disappointed on account of a lowered sales forecast. The reduction was mainly because Lowe's could not make up for the sales missed during the extreme winter in North America. But, management anticipates better results for the third quarter as the U.S. housing market is still recovering. Moreover, Lowe's strong fundamentals, a decent dividend, and improving results make it look like a smart investment.

Strong fundamentals

Lowe's has a trailing P/E of 23.28, which is better than the industry average P/E of 24.91. Moreover, it has a forward P/E of 16.7, which is highly impressive as it signifies bottom line growth. Also, the expected improvement in the housing market reflects in Lowe's earnings growth projections. Over the next five years, its earnings are estimated to grow at a CAGR of 16.7%, which is greater than the growth rate seen in the last five years. Moreover, the forecast is better than the industry average of 14.39%.

In addition, Lowe's has a healthy dividend yield of 1.90%, and its payout ratio is low at 32%. Since the company has strong cash flow and its earnings are expected to grow at an impressive rate going forward, it should continue paying a strong dividend. In the past one year, Lowe's has generated operating cash flow of $4.68 billion, while its levered free cash flow is $3.60 billion. So, investors would do well to remain invested in this stock as it looks like a consistent dividend payer.

Housing improvement to drive growth

According to Robert Niblock, CEO of Lowe's, "Consumers are indicating stronger intentions to complete a home-improvement project, with most of them planning a specific project in the next three months." The data from the commerce department shows that the U.S. housing market rebounded strongly in July, indicating a recovery in the housing space after being hit by high interest rates last year. In addition, the economic forecast also suggests that employment, income, and consumer spending will continue to improve, which will strengthen Lowe's business going forward.

Moreover, according to Reuters:

"Commerce Department said new home sales vaulted 18.6 percent to a seasonally adjusted annual rate of 504,000 units, the highest level since May 2008. The increase in sales was the biggest since January 1992. New home sales increased in all four regions. They hit a six-year high in the Midwest and were the highest since June 2008 in the South. Economists had forecast new home sales rising to a pace of only 440,000 units last month. Compared to May of last year, sales were up 16.9 percent, indicating some momentum in the new homes market."

Strengthening the platform

Hence, the housing market is gaining momentum, and as a result, better times lie ahead for Lowe's. The company is getting back on its feet after a prolonged winter weather in the first quarter. Lowe's operates in around 14 regions, and all of them reported positive comps during the second quarter, with strength in all product categories. Especially, its pro service business outperformed the company average. This segment has a strong growth rate compared to the rest of the home improvement market. Consequently, Lowe's will continue to invest in its core product and service offering for pros.

As a result, Lowe's has re-launched the website, www.lowesforpros.com, which is a dedicated platform for pros to purchase online from Lowe's. This initiative will improve its functionality as it has various useful tools to develop requisition lists and views of the purchase history. In addition, the platform will streamline day-to-day operations by integrating the site with pros purchase systems used to manage the business.

Also as weather conditions have improved, the company sees a rise in demand in many of its categories. For instance, its lawn and garden category should improve as consumers take advantage of the improved weather to spruce up their yards. Similarly, other outdoor power equipments of national brands such as Husqvarna, John Deere, and Troy-Bilt are also gaining traction.

Lowe's is also making progress in its productivity and operating profitability. Going forward, management will look for new ways to make further progress in this direction. As the company moves into the second half of the year, it plans to use the same processes to address a new set of customer needs.

Although the company lowered its sales forecast for the year, yet it is positive about its performance going forward. Niblock said "We are still bullish on the outlook for the industry, which gives us confidence in our guidance for the back half of the year." As such, investors should not go into panic mode after Lowe's slashed its forecast slightly. Moreover, the company's enticing valuation is another reason why it could be a good long-term pick.

Decent results indicate positive momentum

All in all, investors should be focusing on Lowe's impressive performance during the quarter and the prospects that lie ahead. Its revenue for the quarter rose 5.7% to $16.6 billion as compared to last year, and was marginally better than the consensus estimate of $16.5 billion. In addition, its comparable store sales also increased 4.4% year-over-year.

Lowe's reported a strong rise of 18% in its EPS to $1.04, and topped expectations by 2 cents. In fact, this was the first time in the past four quarters that its EPS was above estimates, which is a good sign for the future. Yet, management is cautiously optimistic, and cut its sales forecast for the year to around 4.5% from the earlier estimate of 5%.

Hence, Lowe's treaded the cautious path as far as the outlook is concerned, but its performance can improve in the long run on the back of housing market and consumer confidence improvements. As such, the stock looks like a decent investment even though it trades close to its 52-week high.

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.