Lowe’s (“LOW”) (LOW, Financial)
Lowe’s is a high-quality business with significant long-term earnings growth potential underpinned by a superb management team that has been successfully executing a multi-faceted business transformation.
2022 presented a challenging macroeconomic backdrop which required Lowe’s to navigate commodity and retail price inflation along with the post-COVID-19 normalization of consumer purchase patterns. These challenges were further complicated by a shift in Lowe’s selling channels, with Do-It-Yourself (“DIY”) categories generating relatively weak results, offset by continued strength for projects requiring professional installation (the “Pro” business), a critical focus area for the company. Despite these headwinds, Lowe’s delivered strong financial results including nearly flat same-store-sales growth, revenue growth of 1%, operating profit growth of 5% (and an improved now 13.0% operating margin), and 15% growth in earnings-per-share, aided by a large share buyback program.
At present, the macroeconomic picture continues to create uncertainty about the short-term prospects of the home improvement business. The rapid rise of mortgage rates in 2022 combined with elevated home prices has meaningfully pressured homebuyer affordability. As a result, existing home sales have declined sharply in recent months. These factors have caused many market participants to become concerned that the home improvement sector is at risk of revenue and profit deterioration.
We are more constructive on the sector as its demand drivers tend to more closely correlate with home price appreciation, the age of the country’s housing stock, and consumers’ disposable income, all of which are predictive of future growth in demand. In addition, the national housing shortage, a lack of new builder inventory, continued post-COVID-19 hybrid work, high levels of home equity (vs. pre-COVID-19 levels), and continued strong Pro project backlogs should also continue to underpin home improvement market growth over the medium term. Furthermore, nearly two-thirds of Lowe’s revenue comes from non-deferrable repair and maintenance activity, which should be relatively unaffected by the macroeconomic environment.
In December, Lowe’s held its semiannual Analyst Day at which the company updated its medium-term targets to $520 sales per square foot (a low-teens percentage uplift from current levels), an operating margin target of 14.5%, with “line of sight” to 15% thereafter, and a targeted return on invested capital of 45%. If Lowe’s were to achieve these targets over the next several years, the company’s earnings would increase to more than $20 of earnings-per-share, or approximately 50% above current levels. In other words, the continued successful execution of Lowe’s business transformation should allow the company to generate accelerated earnings growth for the foreseeable future.
Notwithstanding our views on Lowe’s attractive long-term earnings outlook, Lowe’s currently trades at only 13.5 times forward earnings, a low valuation for a business of this quality, and a substantial discount to its direct competitor, Home Depot which trades at a price-earnings multiple of 18 times. We believe that Lowe’s current valuation reflects investors negative sentiment regarding the US housing market and incorporates the possibility of a greater than expected revenue decline. We are confident in management’s ability to execute and expect that Lowe’s will continue to generate high rates of return for shareholders as it continues its successful transformation.
From Bill Ackman (Trades, Portfolio)'s Pershing Square 2022 annual letter.
