Lowe's Makes Transition To Value / Differentiation

| About: Lowe's Companies, (LOW)
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Home improvement retailer Lowe's (NYSE:LOW) is focused on value improvement and product differentiation, as noted by Robert A. Niblock, Chairman, CEO, President and Chairman of Executive Committee, in the company's 2012 Analyst and Investor Conference held on December 5, 2012. Mr. Niblock indicated that almost 2/3 of its home improvement consumers cross-shop, i.e. shop at competitors like The Home Depot (NYSE:HD), and in an effort to counter customer cross-shopping, the company is moving forward with improvement in the value for its product offerings and product differentiation. Mr. Niblock sees the company's focus on value improvement and product differentiation as a component for transforming the business in order to drive long-term sales growth, increased profitability and enhanced shareholder returns.

Gregory M. Bridgeford, Chief Customer Officer, further noted Lowe's is working closely with its vendors in order to provide compelling products with improved value. Additionally, Mr. Bridgeford indicated Lowe's had realized it had been underutilizing its most valuable real estate located within a store - its end caps. In response, the company has been revising its end cap locations, now providing 60 end caps per store which highlight innovative new products with significant value or present private or national brands.

Mr. Niblick noted another focus of the company is the "creators" customer segment which drive 70% of home improvement sales. Creators are seeking new ideas for home improvement and Lowe's plans on providing Creators with new ideas and products to go with the new ideas.

Lowe's can now sell its wares to customers via its stores, online or at a customer's home or business location. In order to increase consumer-facing sales, Rick D. Damron, Chief Operating Officer, noted the company has been using Apple's (NASDAQ:AAPL) iPhones in order to perform task and sales activities. Lowe's has deployed 42,000 iPhones in its stores which represents about 25 iPhones per location. Additionally, the company is piloting using iPhones for point-of-sale with e-receipts. Mr. Damron indicated consumer-facing mobile sales have grown to represent 20% of the company's overall online sales traffic. Mr. Damron noted that in addition to the creator market segment, the company is also cognizant of customers with a pre-determined shopping list and customers working on multistage projects. In order to cater to all three market segments, the company has developed role-playing exercises in order to build sales skills and build confidence in the company's sales associates. Mr. Damron also indicated Lowe's is focused on its Pro Services market segment which now represents 25% of sales.

Mr. Niblock indicated the company is encouraged by recent trends for new and existing home sales and appreciation in home prices. However, the company's outlook for 2013 is modest growth due to stagnant employment, low income growth and issues related to the U.S. Federal Government such as the Fiscal Cliff.

Lowe's is evaluating opportunities in new and existing international markets. The company previously evaluated business opportunities in India and China, but did not envision profitable business models in those regions. However, the company sees opportunities in Canada which is currently a competitive 3-way market. To increase its Canadian presence, Lowe's proposed an acquisition of RONA, a Canadian distributor and retailer of hardware, home renovation and gardening products. However, the proposal was withdrawn. Lowe's expects to have 34 stores in Canada by the end of fiscal year 2012 and believes there is opportunity for 100 stores in Canada. Lowe's recently launched a Canadian website as another indication of the company's interest having a large presence in the Canadian region.

The company sees opportunities in Mexico and has five new stores opening in the region. On a negative note, Robert F. Hull, CFO and Executive Vice President, noted real estate in Mexico is very expensive and there isn't a lot of opportunity for lawn and garden products.

Lowe's also has a 1/3 interest in a joint venture with Woolworths in Australia, with the joint venture being branded as Masters. Since the first Masters store opened 14 months ago, the chain has grown to 23 stores in 5 states. Additionally, 12 new Masters stores are under construction and 100 approved sites are in the pipeline. The company believes there is opportunity for 150 Masters stores in Australia.

In all, the company expects to have revenue of $50.3 billion in fiscal 2012 which is flat as compared to 2011. Additionally, the company expects to have 1,754 stores in the U.S., Canada and Mexico at the end of fiscal year 2012.

Lowe's Price-to-Earnings ratio of 22 is reasonable and its Price-to-Sales ratio of 1 is very attractive and puts Lowe's in the value category. Lowe's stock price has gone ballistic over the last six months as shown below:

The stock price has pulled back over the last couple of days which could be a good opportunity to enter a position for the company. Lowe's should have experienced robust sales on the East Coast due to its customers rebuilding and repairing after being pummeled by hurricane Sandy. With Lowe's set to report its fourth quarter 2012 earnings on Monday, February 25, this could be a good opportunity for riskier investors to enter a long straddle for the company, as the long straddle position provides an opportunity to pay off handsomely if the stock price makes a large upward or downward movement. However, a stagnant stock price presents a problem for a long straddle position and can result in a loss or even a significant loss, so the long straddle position is for Vegas capital only. The long straddle position can be entered by purchasing a put option and a call option with the same strike price and month of expiration.

A couple of long straddle positions were found for Lowe's for March 2013 expiration as shown below:

Since we're expecting a pop in Lowe's stock price, the long straddle using the 37 strike price is selected, as it has the more attractive upper break even price of $40.34. The details for entering the long straddle are shown below:

Lowe's Long Straddle Position:

  • Buy LOW 2013 Mar 37 Put at $1.22
  • Buy LOW 2013 Mar 37 Call at $2.12

A profit/loss graph for one contract of the Lowe's long straddle position is shown below:

As can be seen above, if the stock price increase or decreases significantly, the position is profitable. However, if the stock price doesn't move very much the position results in a loss.

For more conservative investors, a married put position may be considered, as it provides for unlimited upside with limited downside. The married put position can be entered by purchasing a put option against a long position in a stock. The put option's expiration month is typically selected several months out in the future in order to reduce the per-day cost of the put option "insurance."

Using PowerOptions, several married put positions were found for Lowe's for July 2013 expiration as shown below:

The married put using the 2013 Jul 38 put option looks attractive as it has a maximum potential loss of 6.9%. However, the 6.9% maximum potential loss is prior to taking into consideration the expected dividend payments during the holding time. After taking expected dividend payments into consideration, the maximum potential loss is reduced to 6.5%. So, even if the price of Lowe's stock drops to zero, the maximum loss which can be sustained is 6.5%. Yet, as the price of the stock increases, the profitability of the married put position also increases. The details for entering the Lowe's married put position are shown below:

Lowe's Married Put Position:

  • Buy LOW stock (existing or purchased)
  • Buy LOW 2013 Jul 38 Put at $2.88

A profit/loss graph for one contract of the Lowe's married put position is shown below:

For an increasing stock price, the value of the married put also increases. For a stock price below the $38 strike price of the put option, the value of the married put position remains unchanged. And, if the price of the stock increases to above the $38 strike price of the put option, then income methods can be applied to generate income and reduce risk as taught by RadioActiveTrading.com.

Look forward to your comments below!

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.