Streetwise for Sunday, October 28, 2018
Last week’s column took the position that a major player in rebuilding the devastation resulting from the 2018 hurricane season would likely be Home Depot (HD) and delved into an analysis of why this might be a good time to look at that company as a potential research opportunity.
However, anytime you are investigating an investment candidate, you must also examine its major competitors to see if one or more is an equal or superior opportunity. Since Home Depot only has one major competitor, next up is Lowe’s, a company that again I have never written about.
Founded in 1946 and based in Mooresville, North Carolina, Lowe’s is a FORTUNE® 50 home improvement company serving more than 18 million customers a week in the United States, Canada and Mexico.
With fiscal year 2017 sales of $68.6 billion, the retail giant operates or services more than 2,390 home improvement and hardware stores employing more than 310,000 people.
Not only has Lowe’s increased its dividend for 56 consecutive years, the 10-year dividend growth rate is 19.31 percent. The majority of the chain’s clients stems from Do-It-Yourself customers, with only about 30 percent being “pro” customers, who are essentially contractors.
Lowe’s has seen strong growth over the past five years. Revenue has seen a compounded annual growth rate (CAGR) of 6.32 percent. Add in an aggressive stock buyback program and earnings-per-share has a CAGR of 19.33 percent for the same period.
The Street’s consensus is for Lowe’s to earn $5.20 per share for the full 2018 fiscal year. Based on this, the stock is currently trading at a multiple or price/earnings ratio of about 21. In other words, the shares are trading at about 21 times earnings. This is in line with the company’s 10-year median multiple over the past decade.
The earnings multiple is reasonable in this case because Lowe’s was able to grow earnings by 6.8 percent annually, while its net profit margin improved from 4.6 percent up to 5.9 percent. The side benefit was both an improvement in sales and in the quality of those sales.
Keep in mind that if shares outstanding remained constant, earnings growth would equate to earnings-per-share growth. With Lowe’s, that wasn’t even close to actuality.
Lowe’s substantially reduced its share count, from 1.47 billion shares in 2008 to 800 million shares this year. This resulted in earnings-per-share growing by over 13 percent on an annual basis.
Shares began trading 5-years ago at around 16 times earnings. Today, the P/E about 22, or about a 13 percent annual growth in earnings per share that morphed into share price appreciation of about 16 percent per year.
Now before your eyes glass over thinking about how Lowe’s will really enhance your portfolio, you need to consider that while Lowe’s has been a bountiful investment in the past because of rising sales and a share repurchase program that resulted in a higher valuation, the future may not be as prolific.
For Lowe’s future to continue as it has in the past, the company will need to continue substantial share buy-back programs and/or entice Wall Street to increase the multiple awarded Lowe’s outstanding shares. Both are unlikely to continue at the same pace as in past years.
In addition, Lowe’s must improve its gross and operating margins. This means focusing on improving its inventory management. The company has a
higher days-in-inventory than Home Depot. Lowe’s inventory days number is 83.62 as compared to Home Depot’s 64.64, meaning Lowe’s inventory requires 23 percent more time to move.
Lowe’s management believes it can close this gap and lower its days-in-inventory, resulting in a more efficient use of working capital.
The intrinsic value of the shares, using the conservative free cash flow to the firm model, yields an intrinsic value of $112 per share. My earnings estimate for fiscal 2019 is $5.20 per share.
The shares recently closed at $98.12. My 12-month projected share price is $120 for a 22.4 percent capital gain. There is also an indicated dividend of $1.92 or 1.93 percent.
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddInternational.com.