Lowe’s Companies Inc. (NYSE: LOW) and maintaining our target price of $200.
In the near term the company is resetting its stores and upgrading its supply chain. The next catalyst is an investor update on December 9.
We think some investors were concerned about expenses. The 3Q SG&A rate was above consensus. One factor was that the company invested $100 million on a merchandising reset of U.S. stores and it will spend another $150 million in the fourth quarter. To be sure, the company did say in its 2Q call that it would be reinvesting in the business in 2H21. As a reminder, management said that while investments to improve the store environment and reposition complimentary products may crimp 2H results, we believe they are necessary if the company is going to permanently raise margins.
During the 3Q call, both Mr. Ellison and Mr. Denton reiterated their confidence in reaching and potentially surpassing a 12% operating margin, but some investors may have become concerned about the near term when Mr. Denton said, during the question and answer session, ‘let’s not get hung up on where we end 2020 (fiscal 2021) and where we end 2021 (fiscal 2022).’ He did add that the company has a good ‘line of sight’ on reaching 12% and surpassing it over time. We will know more when the company hosts an investor update on December 9.
The company had a GAAP profit of $0.91 per share, which included $0.02 per share of restructuring related to the Canadian.
Sales were up 28% to $22.3 billion.
Comparable sales rose 30.1%, which was above the consensus of 22.8%, according to StreetAccount. U.S. comp sales rose 30.4%. Sales to individuals were stronger than sales to pro customers. Still, LOW saw growth above 20% from professional contractors.
Lowe’s provided financial guidance for 4Q. The company expects both total and comparable sales to grow by 15%-20%. The pre-release consensus, according to StreetAccount, was for comps to rise 12.3%. LOW expects the 4Q operating margin to be flat including COVID-related expenses, $150 million of costs to reset the layout of U.S. stores, and costs to expand the supply chain network. The guidance for adjusted earnings is $1.10-$1.20. Our pre-release estimate was $1.07, but on substantially lower sales. Our estimate did not include the benefit of a buyback.
The company generated comparable sales growth exceeding 15% in all 15 product categories. All 15 of the company’s regions had positive comps of at least 20%, and all stores hit their profit-sharing targets.
Online sales surged 106%. The company substantially improved and modernized the web infrastructure to handle volumes that were higher than the traffic that crashed the old system on Black Friday.
By month, U.S. comps at Lowe’s were up 28.9% in August, 31.8% in September and 30% in October.
Contrary to some press reports, we do not believe that gross margin was hurt by discounting. The company reduced promotional activity in 3Q and expects to do the same in 4Q. Product margins increased by 65 basis points in the quarter. Supply chain costs were a drag relative to our expectations, and while product margins increased, we believe that we underestimated the pressure from high lumber prices. Customers are showing an aversion to debt and using their debit cards more often.
Interest expense of $219 million was near our estimate of $225 million as the company borrowed to boost liquidity.
Lowe’s also spent $245 million in 3Q to support associates. On a year-to-date basis, the company has spent $1.1 billion to provide COVID-related support for associates, communities, and store safety.
EARNINGS & GROWTH ANALYSIS
There is a partial offset from a higher tax rate, based on the company’s guidance, and from higher spending to reset the stores for a focus on projects rather than products. This is actually something that HD has done pretty well. A years-old example is that Home Depot had success by putting screwdrivers near the blinds so that someone would be reminded that they might need a cordless screwdriver to do the project, and someone who did remember might be presented with a high-margin model or at least be saved from walking across the store to the tool department where there is an overwhelming number of specialized screwdrivers.
Management has not provided a specific time table. There are likely to be some investments along the way because the company wants to make sure it has the infrastructure to deliver consistently higher margins rather than hoping for a good macro environment.
The new worry is actually a familiar one for investors. Will Lowe’s be able to contain expenses so that strong sales flow to the bottom line. We remain confident in the turnaround plan.
On November 19 at midday, BUY-rated LOW traded at $149.17, up $2.43.