Lowe's Needs To Improve Operationally Before It Can Be Considered Attractive

| About: Lowe's Companies, (LOW)

Shares of Lowe's Companies (LOW), the home improvement retailer, fell 5.8% in Monday's trading session. The company reported a weak second quarter earnings report, accompanied by a weak full year outlook.

Second Quarter Results

Lowe's reported second quarter revenues of $14.2 billion, down 2.0% on the year. The shift in a comparable week impacted results by 1.8%. On average, analysts expected the company to report revenues of $14.4 billion. Comparable sales fell by 0.4% on the year, while comparable sales for the US business fell 0.2%.

Net earnings fell 10.0% to $747 million, resulting in diluted earnings per share of $0.64. The results include a $0.01 charge related to headcount reductions, and a $0.03 charge related to a shift in comparable weeks. On average, analysts expected earnings in the low seventy cents per share.

During the quarter, the company repurchased 36.8 million shares for a total value of $1 billion. During the first six months of 2012, the company repurchased $2.75 billion in its own stock.

The company expects to open 10 new stores for the full year, bringing the total store count to 1,748 at the end of the quarter. Chairman and CEO Robert Niblock commented on the results:

Our results fell short of our overall expectations. However, I have confidence in our strategy and in our employees. While we recognize the significant magnitude of change that we've asked the organization to absorb as we transform our business, we fully understand that we must improve our level of execution.

Outlook

For the full year of 2012, Lowe's expects total sales to be flat. Adjusting for the fact that 2011 had 53 weeks, sales are expected to grow by 1%. Comparable sales are expected to grow 0.5% on an adjusted basis.

Diluted earnings per share are expected to come in around $1.64 per share. This compares to a previously guided earnings range of $1.73-$1.83 per share. On average, analysts expected the company to earn $1.79 per share.

Valuation

Lowe's ended its second quarter with $2.3 billion in cash, equivalents and short term investments. The company operates with $9.6 billion in short and long term debt, for a net debt position of $7.3 billion.

For the first six months of 2012, Lowe's reported revenues of $27.4 billion. It net earned $1.28 billion, or $1.07 per share. At this rate, the company is on track to report annual revenues of $50 billion, on which it is expected to earn $1.64 per share.

This values the firm at $31 billion, or 0.6 times annual revenues. Lowe's is valued at 16 times earnings. The valuation compares to a revenue multiple of 1.2 times for Home Depot (HD) and 21 times annual earnings. Home Depot recently announced the acquisition of U.S. Home Systems (USHS).

Currently, Lowe's pays a quarterly dividend of $0.16, for an annual dividend yield of 2.4%.

Investment Thesis

Year to date, shares of Lowe's have returned a mere 3%, after Monday's correction. Shares rose to $32 in April, as an early spring boosted first quarter sales. Shares fell to $25 in May after the company lowered its full year outlook.

Over the past years, annual sales remained stable around the $50 billion mark. Net earnings hovered between $1.8-$2.2 billion during that time period. Between 2008 and 2011, the company repurchased 15% of its shares outstanding. The company boosted its annual dividend from $0.34 in 2008, to an annual rate of $0.64 in 2012.

Lowe's is demonstrating little improvement in revenues and earnings in recent years. Despite a modest rebound in the housing market, revenues are expected to come in flat for the full year of 2012. Shareholders only see modest improvement in earnings per share and dividends, as a result of the sizable repurchase programs.

I remain on the sidelines, I would like to see improvements in operational performance, before initiating a long position in Lowe's. As the new company mission states, "never stop improving".

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.