Lowe's (NYSE:LOW) first quarter earnings in May demonstrated that the company continues to make meaningful progress on its business transformation. Lowe's reported U.S. same-store sales growth of 4.2% despite the negative impact from adverse weather. Lowe's results exceeded those of Home Depot for only the third time in nine years. We attribute Lowe's strong same-store sales results to a handful of recent initiatives that have improved product selection, customer service and convenience, particularly for the Pro customer, the professional tradesmen that perform repair and maintenance, remodeling and construction services for others, and are Lowe's most frequent and highest value customers.
While Lowe's reported same-store sales growth, this progress was offset by a 165 basis point decline in gross margins, the majority of which was due to the complexity of the company's legacy pricing systems coupled with employee turnover in the merchandising organization, which resulted in a failure to sufficiently raise retail prices to offset the impact of product cost inflation. Since the end of the quarter, the company has begun to remediate the pricing issues, and expects to launch a new price management system later this year. Lowe's anticipates gross margin pressure to abate over the course of the year, ultimately being restored to prior levels.
Lowe's stock has increased 6% year-to-date and currently trades at 17 times analyst estimates of Lowe's next-twelve-month earnings, which do not incorporate the potential for significant future profit improvement. Lowe's EBIT margin guidance for 2019 is for an approximate 9% operating profit margin (inclusive of the recent pricing issues), compared to its medium-term margin target of 12% and Home Depot's current margin of 14.5%. If Lowe's achieves its medium-term margin target, it will generate significant increases in profit, which, when coupled with the company's large share repurchase program, should lead to accelerated future earnings-per-share growth. We believe that Lowe's stock has the potential to appreciate substantially as the company continues to make progress on its business transformation.
From Bill Ackman (Trades, Portfolio)'s second-quarter 2019 Pershing Square shareholder letter.
This article first appeared on GuruFocus.
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