Lowe’s Companies, Inc. (NYSE:LOW) Q4 2023 Earnings Call Transcript
Lowe's Companies, Inc. (NYSE:LOW) Q4 2023 Earnings Call Transcript February 27, 2024
Lowe's Companies, Inc. beats earnings expectations. Reported EPS is $1.77, expectations were $1.68. Lowe's Companies, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning, everyone. Welcome to Lowe's Companies Fourth Quarter 2023 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, Vice President of Investor Relations and Treasurer.
Kate Pearlman: Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2024. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the Risk Factors MD&A and other sections of our Annual Report on Form 10-K and our other SEC filings.
Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found on the Quarterly Earnings section of our Investor Relations website. Now, I'll turn the call over to Marvin.
Marvin Ellison: Thank you, Kate, and good morning, everyone. In the fourth quarter, comparable sales declined 6.2% as DIY customers continue to remain cautious with their home improvement spend and harsh weather impacted large parts of the U.S. in January. In spite of these challenges, I'm very pleased with the excellent customer service in our stores and strong operating profit performance for the quarter, driven by disciplined focus on our perpetual productivity improvement initiatives or PPI. Looking at the full fiscal year 2023, we delivered sales of $86.4 billion, adjusted operating margin of 13.3%, and adjusted earnings per share of $13.09. Beginning with our DIY sales results, November and December trends improved from the third quarter, followed by a sharp drop in traffic during periods of extreme weather in January.
Macroeconomic factors like persistent inflation and a stagnant housing market continue to make DIY customers and consumers hesitant to spend on big ticket purchases for their homes, and those who did engage in home improvement activities took on smaller non-discretionary projects with a heightened focus on value. This impacted demand for bigger ticket interior categories like kitchen and bath, flooring and appliances. In the last quarter, we shifted our strategy to adapt to these changing consumer behaviors, resulting in record Black Friday and Cyber Monday online sales and improved holiday sell-through and margins. While we're pleased to see these results, we're now focused on winning spring, and we're excited to see how the customer responds to our more targeted traffic driving marketing strategy and our lineup of great spring products at an outstanding value.
Bill will provide more detail on our compelling product assortment for spring later in the call. Amongst the most exciting changes for this spring is our new DIY loyalty program that we announced in January. This first of its kind rewards program designed for DIY customers gives these value-focused homeowners more reasons to choose Lowe's. In a marketplace renewing all DIY home improvement customers shop multiple retailers, MyLowe's Rewards loyalty program is designed to get these DIY customers to choose Lowe's over other retail competitors for the home improvement needs. We expect this to drive traffic and return visits while also enabling us to personalize offers and experiences for our loyalty members, creating a flywheel effect that increases DIY loyalty and demand over time, both in-store and online.
MyLowe's Rewards will be available nationwide in March, just in time for spring, making Lowe's the only national home improvement retailer with a distinct loyalty offering to both Pro and DIY customers. Now, moving to Pro, despite a challenging macro environment and difficult weather in January, our comparable Pro sales were flat quarter-to-quarter. As a reminder, our core Pro customer is a small to medium-sized business owner. And in our recent Pro survey, these customers told us their backlogs are in line with last year and they are cautiously optimistic about their ability to generate and close leads in 2024. We remain focused on executing our holistic Pro strategy with more convenient fulfillment options, an enhanced product assortment, creating a best-in-class digital experience, and a rewards program that incentivizes long-term loyalty.
As these investments scale and mature, they will increasingly save Pros time and money, enabling us to earn more of their business as we aim to grow Pro at 2x the market rate. Now turning to online, comparable sales were flat for the quarter and we were pleased to see higher conversion rates and lower returns, a positive indicator that customers are responding to our faster fulfillment and improved digital experience. Our talented technology team remains focused on developing a best-in-class omni-channel experience to seamlessly serve our multi-generational customer base, including co-creating innovative customer solutions with world class technology companies like our immersive kitchen design app for Apple's new Vision Pro headset and using generative AI to improve how we sell, shop and work like our home improvement ChatGPT plug-in.
Now, let's transition to our view of the macro. As we look forward, many of you are asking, when do we expect home improvement demand to inflect, although it's a very fair question, unfortunately still very difficult to predict. And while there's increased confidence of a soft landing, there's still a lot of speculation on the timing of anticipated interest rate cuts and the pace of slowing inflation. It's also unclear how quickly the consumer will react to these changes and how quickly their spending habits will change. Overall, the consumer is financially healthy, but in this post-pandemic timeframe, customers are still showing a preference for spending on services with elevated demand for travel, restaurants and other experiences. And while we anticipate these trends will normalize, the timing is uncertain.
Also, existing home sales are at levels we've not seen in almost 30 years, and even as mortgage rates decline, two-thirds of homeowners remain locked in at rates below 4%, which may keep many on the sidelines. Due to these factors, we expect DIY demand to remain under pressure. And Brandon will provide more detail on our 2024 expectations later in the call. However, we're very confident in our strategic plan and in our ability to execute at a high level in a multitude of economic environments. Despite near-term uncertainty, let me remind you why we remain bullish on the medium to long-term outlook for home improvement. The three core demand drivers of our business: disposable personal income, home price appreciation and the age of housing stock, remain supportive.
When you pair these factors with trends like chronic undersupply of homes, millennial household formation, baby boomers aging in place, and a sustained number of people working from home, you can see why we are confident that home improvement demand will trend upwards over time across both homeowners and Pros. In the meantime, we're focused on controlling what we control and making the right investments in our Total Home strategy to modernize our supply chain and IT infrastructure, localize and improve our merchandising assortments, rolling out a Pro and DIY loyalty program, continuing to elevate our store environment, and developing a best-in-class digital and omni-channel experience. All of these investments in our Total Home strategy will position Lowe's to win in the short run and set us up for strong sales and profit growth when the home improvement market recovers.
Before I close, I'd like to extend my appreciation to our hardworking associates for their commitment to serving customers. In recognition of their dedication, we awarded our frontline associates with an end of year discretionary bonus of $140 million. This is our way of saying thank you to hourly associates and assistant managers who serve our customers and make our communities better. As I travel across the country visiting stores and conducting town halls to hear directly from our frontline associates, I'm consistently humbled by their passion, commitment and their expertise. Now, I turn the call over to Bill.
Bill Boltz: Thanks, Marvin, and good morning, everyone. While softer DIY demand trends continued this quarter, we remain focused on highlighting value and convenience both in our stores and online to a price conscious consumer, all while maintaining a balanced focus on profitability. We are also staying committed to serving a resilient Pro, which resulted in flat Pro comps as we continue to enhance our Pro product and service offering. Beginning with building products, this was our best performing area with positive comps in building materials. This strength was fueled by an increased demand for roofing and drywall combined with improved fulfillment capabilities and in-stock positions to better serve our Pro customers. Throughout the quarter, we continued to launch additional Klein products across our stores, bringing the number one tool brand for electrical and HVAC professionals back to Lowe's.
We now have the largest assortment of Klein Tools in the home improvement retail channel, with initial sales exceeding our expectations across electrical, hand tools, and stackable tool storage. Throughout the store, we continue to introduce new and innovative products to Lowe's like Pella's Hidden Screen windows. This new window includes a built-in screen that appears when the window is open but hides away when it's closed. Turning to home decor, this division was significantly impacted by softer DIY demand in bigger ticket interior categories like kitchens and bath, flooring and appliances. This past quarter, we pivoted our go-to-market strategy to be more responsive to a shift in shopping trends like the appliance consumer's increasing preference for a single unit purchase and their search for the best deal.
While these actions pressured our average selling price, as expected, this approach was a major contributor to our successful Black Friday and Cyber Monday events. And while some consumers remain budget conscious, we are seeing others trade up for innovation, which we continue to offer across all major appliance categories. A great example is our exclusive LG smart refrigerator, which has a double freezer and also makes the popular slow melting craft ice. This product is consistently a top seller despite retailing for over $2,500. This type of innovation adds to our already industry-leading assortment in appliances, including high quality brands like Bosch, Miele, LG, Samsung and KitchenAid, and we are continuing to help our customers see the value and attainability of trading up for affordable premium features.
Paint is another category where we've seen product innovation resonate like our exclusive line of spec right paint designed for Pros who paint. Beyond gaining traction with Pros, we saw strong exterior paint demand before the weather turned colder in January. This gives us confidence we have the right offering in place as spring arrives. We also recently completed the rollout of our upgraded paint department, which converted our color wall to trusted Sherwin-William colors and improved the shopping experience to make it easier for our customers to grab the higher margin attachment items they need to complete their paint projects. Turning to our results in hardlines, this is another area where we quickly adjusted to the changing consumer buying patterns, which was reflected in our improved holiday sell-through and profitability.
We are also encouraged that our new rural assortments continue to resonate across the country with strength in apparel, pet and automotive as consumers respond to the products and brands. We also recently launched a new partnership with Sunrun, the market leader in home, solar, and battery installation. This partnership now enhances our services offering for consumers looking to power their homes with renewable energy. Lowe's is the go-to destination for homeowners in spring. And as we enter our biggest season of the year, we are positioning ourselves to capitalize on this demand. As Marvin mentioned, we are excited about our product lineup. The launch of Toro builds on our industry-leading outdoor power equipment lineup alongside John Deere, Ariens, EGO, Craftsman, Husqvarna, Kobalt and Skil.
Our outdoor power equipment assortment is unmatched in home improvement, which is reflected in our continued market leadership in this space. I'm also excited about our new patio sets from our private brands Allen and Roth and Origin 21, which enables homeowners to update their outdoor spaces for spring with trending styles across multiple price points. And if consumers don't see the color they're looking for on our sales pour, they can easily shop the extended aisle, with associates now able to tender the purchase directly on their mobile smart devices. The merchants in our seasonal businesses are also bringing customers' innovation and functionality at more competitive prices, like our new exclusive Char-Broil grill lineup, which lets grillers switch from a traditional grill to a griddle in seconds, or the fast growing Blackstone brand of grills that continues to bring new features and value to the market.
Beyond our compelling seasonal assortment and strong in stock position, I'm also looking forward to launching our enhanced marketing strategy for spring. This season, we are taking a more sophisticated, tech-enabled advertising approach and we will be featuring traffic driving events that will motivate homeowners to get started on their spring projects at Lowe's. We are also leaning into live sports with an expanded NFL relationship and leveraging our popular commercials featuring Lowe's home team players trying their hands at DIY projects. We are extremely pleased with the success of this season's home team players with two members of the Lowe's team, Travis Kelce and Christian McCaffrey both participating in Super Bowl 58 while being featured in our commercials.
Shifting gears to merchandising productivity, our team is making tremendous progress on our perpetual productivity improvement or PPI initiatives, which as we planned are offsetting the costs of our supply chain and Pro investments. As a reminder, the PPI initiatives that I outlined at our analyst and investor conference include expanding our private brand penetration, improving inventory productivity, maintaining a disciplined approach to pricing and promotions, scaling our retail media network, and closely managing product costs. Over the past year, we have been working closely with our vendor partners to claw back some of the cost increases we absorbed during periods of exceptionally high inflation. And now that raw material and transportation costs are normalizing, our best-in-class cost optimization tool gives us robust data down to the item level that allows us to take a calculated surgical approach, helping guide us to reducing costs across our portfolio.
As we work to recoup these costs with our suppliers, we are reinvesting those savings into our marketing and merchandising strategies to drive traffic and sales. As I close, I'd like to thank our vendors and merchants for their unwavering focus on delivering value to our shared customers and for putting us in a strong position to win spring. I'll now turn the call over to Joe.
Joe McFarland: Thank you, Bill, and good morning, everyone. I would like to start by thanking our frontline team for their relentless focus on execution this quarter. Their efforts to serve our customers while tightly managing controllable expenses once again resulted in improved customer service scores and strong operating profit performance despite slower sales. Customer satisfaction scores were up 200 basis points this quarter versus last year with improvements in both Pro and DIY reflecting the hard work of our frontline associates combined with improved omni-channel fulfillment capabilities. In fact, this year omni-score has improved almost 25% since 2020. Customers have new functionality like two-way texting where they can be notified in advance to confirm their delivery date, as well as same day delivery options through our gig network.
They can also use our new self-service functionality to track their order status and resolve issues directly, all without needing to call a store. In addition to expanding our fulfillment options and improving how we communicate with our customers, we're also enhancing the BOPIS or Buy online, pickup in-store experience through our new front end configuration. We completed over 450 front end rollouts this year, with over 500 planned for 2024. Customers are embracing the new front end experience, telling us they appreciate the faster and easier checkout process. This new front end configuration also keeps sales associates in the aisles, helping customers instead of needing to assist with checkout process when lines get long. While we are improving the front end of our stores, we are also making strides on the back end with our ongoing freight flow transformation.
We are further improving our freight flow process with distribution centers now adding new labels that are linked to each store's layout. These labels provide our store teams with direction of exactly where to place the product on the sales floor once the freight is removed from receiving. These enhancements will make it quicker and easier for associates to get products onto the floor and cross merchandise attachments, and will drive better in stocks for our customers and improve payroll productivity for our stores. These new capabilities and improved processes are all part of our ongoing perpetual productivity improvement or PPI initiatives, which both improve the customer experience and drive profitability. Turning to our efforts to become the employer of choice in retail.
I am really pleased with the progress we've made. Last quarter, we saw a record response rate to our annual associate engagement survey with 90% plus participation. And even more importantly, scores improved significantly across three areas that we measure: engagement, leadership effectiveness, and inclusion. It's clear that better associate engagement leads to lower turnover and directly translates into better business results with a workforce more focused on serving our customers and driving productivity in our operations. As Marvin mentioned, we announced $140 million in discretionary bonuses this quarter. This includes an incremental $5,000 for our assistant store managers and other frontline supervisors, as well as our special discretionary bonus of $400 for full time hourly associates and $200 for part time hourly associates.
Additionally, since 2018, we have invested over $3.5 billion in incremental wage and share-based compensation for our frontline associates. In fact, we are one of the few retailers to award stock grants to our store managers and assistant store managers, so they share in our long-term success. These programs for our store leaders are not new. In fact, store managers have been receiving share-based compensation for decades and assistant store managers since 2019. We are also creating opportunities for advancement for our associates to encourage them to build their careers with Lowe's. Since 2018, we have added over 10,000 new department supervisors and over 2,500 new assistant store managers. And through Lowe's University, we are training and developing our associates for their next role.
This year, we're extending our advanced leadership training to our assistant store managers to equip them with the tools they need to succeed as they move up in their career. With these enhancements, we've worked to increase the number of store managers promoted from ASM to over 80% over the past three years. In fact, more than 80% of our leadership roles are now filled from within. All of these investments have led to one of the best spring staffing levels in many years and the stores are ready to serve our customers this spring. We are very excited about the new MyLowe's Rewards, DIY loyalty program and the great spring merchandise lineup Bill outlined. As I close, I would like to once again thank all of our store associates for their hard work and dedication.
Now, I'll turn it over to Brandon.
Brandon Sink: Thank you, Joe. Let me begin with our Q4 results. We generated diluted earnings per share of $1.77. As a reminder, in the prior year, we recognized $441 million of pre-tax transaction costs associated with the sale of the Canadian retail business. My comments from this point forward will include comparisons to certain non-GAAP measures from last year where applicable. Q4 sales were $18.6 billion. Of note, prior year sales included $958 million generated in our Canadian retail business and approximately $1.4 billion related to the additional 53rd week. Also Q4 results reflect approximately $200 million in sales headwind due to the related shift in our fiscal calendar. Comp sales were down 6.2% driven by continued pressure in DIY bigger ticket spending and unfavorable January winter weather.
Lumber deflation did not have a material impact on comp sales. Although, the calendar shift pressured total sales growth in Q4, it had no impact on comparable sales as comps are calculated based on weeks 41 to 53 in fiscal 2022. Comparable average ticket was down 0.1% to prior year. Continued ticket growth in many Pro heavy categories offset appliance pricing pressure and lower DIY bigger ticket sales. Comp transactions declined 6.1% driven by the DIY slowdown and unfavorable January winter weather impacting traffic. Our monthly comps were down 4.8% in November and 6.6% in December. January comps declined 7.4% as we experienced significant pressure during weeks of unfavorable winter weather. Gross margin was 32.4% of sales in the fourth quarter, up 7 basis points from last year.
Gross margin benefited from multiple PPI initiatives as well as favorable product mix and lower transportation costs. These benefits were somewhat offset by supply chain expansion cost. SG&A of 20.9% of sales delevered 5 basis points versus prior year adjusted SG&A as the momentum we continue to build with our PPI initiatives across all functional areas of the company largely offset sales volume deleverage. Operating margin rate of 9.1% declined 48 basis points versus prior year adjusted operating margin. The effective tax rate was 23.8% in line with prior year adjusted effective tax rate. Inventory ended the quarter at $16.9 billion, $1.6 billion lower than the prior year quarter as we invest in high velocity Pro SKUs while managing replenishment in line with sales trends and improving the flow of spring product builds through our supply chain.
As a reminder, prior year inventory excluded Canadian operations as the sale was complete before year-end. Now turning to capital allocation, in 2023, we generated $6.2 billion in free cash flow and returned $8.9 billion to our shareholders through a combination of share repurchases and dividends. During the fourth quarter, we paid $632 million in dividends at $1.10 per share and repurchased 1.9 million shares for $404 million, returning over $1 billion to our shareholders. Capital expenditures totaled $620 million in Q4 as we continue to invest in strategic initiatives to drive growth and profitability. Adjusted debt-to-EBITDA finished the year at 2.81x. And lastly, we delivered a return on invested capital above 36% for the year. Now, I would like to discuss our 2024 outlook.
As Marvin mentioned, we are bullish on the medium to long-term outlook for the home improvement industry, with the near-term macro backdrop remains uncertain. There is optimism around potential interest rate cuts and improved consumer sentiment, however, the timing of Fed actions remains unclear and there can be a lag before monetary policy impacts the consumer. Also, housing turnover remains depressed and the consumer is still showing a greater preference for spending on services rather than goods. We are expecting these factors to continue to pressure home improvement spending in 2024, especially for the DIY. And with that in mind, we are expecting sales ranging from $84 billion to $85 billion and comparable sales declines in a range of 2% to 3%.
Pro sales should continue to outpace DIY as we leverage our multi-year strategy to improve product offerings, fulfillment options, and the in-store and digital shopping experience to drive Pro growth at 2x the market rate. We expect operating margin in the range of 12.6% to 12.7%. When we bridge our 2023 operating margin to our 2024 expectations, there are a couple of points to keep in mind. First, the impact of sales volume deleverage, and second, the cycling of a favorable legal settlement in each of the first two quarters. These pressures are partly offset by the expected positive impact of our ongoing enterprise-wide PPI initiatives. We have made significant progress in realizing our productivity goals over the past few years and we remain laser-focused on driving these PPI efforts and closely managing expenses through this tough sales environment.
These expectations result in full year earnings per share of approximately $12 to $12.30. Now, to assist you with your modeling, I'd like to take a moment and provide some color on the cadence of our expected results for the year. As a reminder, the steep pullback in DIY demand, which intensified in the third quarter of 2023, sets us up for different compares in the first and second half of this year. Given this, we expect first half comp sales to remain under pressure as the current DIY demand trends continue. But as we move into the second half, we expect comp sales to improve as we begin the cycle over the pullback in the third quarter. To be clear, we are not forecasting an improvement in demand trends this year rather, the compares are easier in the second half.
And while we are planning for a normal spring season, the timing of spring is unpredictable and always brings some variability to our first half performance. Given our customer mix, these DIY drivers disproportionately impact our business. Now, more specific to our first quarter, we expect comp sales to be consistent with our fourth quarter results approximately 300 basis points below the bottom of our full year guide. The combination of lower sales volumes as well as cycling a sizable legal settlement is expected to result in a Q1 operating margin rate approximately 200 basis points below the prior year adjusted rate. Before I close, let me remind you of our capital allocation strategy, which remains unchanged. Our first priority is to reinvest in the business with capital expenditures of approximately $2 billion.
Next, we continue to target a 35% dividend payout ratio. We also plan to use our free cash flow to repay a $450 million bond maturity and then return excess cash to shareholders through share repurchases. In closing, we are confident in our ability to execute through the near-term market uncertainty and remain focused on realizing the benefits of our Total Home strategy while continuing to drive sustainable shareholder value. And with that, we'll open it up for questions.
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