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Lowe’s Companies, Inc. Stock Has a Clear Runway to $100

Home improvement retailer Lowe’s Companies, Inc. (NYSE:LOW) was a big winner when the tax reform narrative dominated the markets in the last 2 months of 2017 and first month of 2018. During that stretch, Lowe’s stock rallied from $75 to a high of nearly $110.

But trouble has struck Lowe’s stock. Trade and inflation concerns have gripped the markets. Both of those concerns pose theoretical risk to the Lowe’s growth narrative. Consequently, LOW stock has dropped from its $100 high all the way down to below $90.

This sell-off looks like an opportunity to buy the dip.

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The trade and inflation risks which have derailed Lowe’s stock recently are overblown. Home improvement retail stores remain a red-hot destination for consumers. There are still massive tailwinds in play in the form of hurricane rebuilding efforts, tax reform, and a strengthening economy.

All together, I think Lowe’s stock has a pretty clear runway back to $100 and up.

Here’s why.

Fundamentals Remain Strong

The fundamentals supporting LOW stock remain strong.

Headline risks from inflation and trade concerns are overblown. Inflation hasn’t really materialized in any meaningful way since the January wages number. Meanwhile, all the trade war stuff feels like a bunch of talk and no walk thus far.

Beyond those two risks, the rest of the Lowe’s growth narrative remains very strong.

Americans are finally starting to spend again after years of saving (after hovering around 5-6% for the better part of the past decade, the personal savings rate has been in the 2-3% range for the past several months). That creates a favorable consumer spending backdrop. Moreover, because Americans saved so much for so long, they have a ton of money to spend.

That means Americans will be exploring big ticket purchases, like home improvement projects.

This is why home improvement stores remain a red-hot destination for consumers. Over the past 3 months, building material stores have seen their sales rise 6.9%. That mark is bested only by digital retailers (+10.3%), gas stations (+8.9%), and miscellaneous retailers (+7.1%).

Meanwhile, consumer confidence and sentiment are also soaring. Unemployment rates remain at historic lows. Hurricane rebuilding efforts are underway after one of the worst hurricane seasons ever.

Overall, the U.S. economic backdrop is quite favorable for Lowe’s to continue to post strong numbers into the foreseeable future.

Lowe’s Stock Is Undervalued

Because of this favorable backdrop, I don’t see growth rates at Lowe’s coming down much over the next several years.

Comparable sales have risen by roughly 4% per year over the past several years. That has led to roughly 6-7% overall revenue growth per year. This year, comparable sales are expected to rise 3.5%, and management is targeting 4% and up revenue growth per year in the long-term. Given the favorable economic backdrop, it is pretty likely management meets and even exceeds those targets.

My best guess is that Lowe’s can grow sales by roughly 5% per year over the next five years. That would put revenues at $83 billion in 5 years.

Operating margins are under pressure due to strategic investments and some pricing pressures. But these aren’t long-running concerns. Operating margins are expected to compress 30 basis points this year to around 8.7%, but then grow from there over the subsequent several years.

Considering LOW’s has grown operating margins from 6.5% to 9% over the past 5 years, I think the company can get to 10% operating margins over the next five years. Taking out a percent for interest expense, that would put pre-tax profit margins at 9%, or about $7.5 billion.

About 25% of that will go to taxes, so net profits in 5 years could easily be $5.6 billion. The diluted share count will likely be somewhere around 700 million by then (LOW’s buys back a ton of shares). That combination implies roughly $8 in earnings per share in 5 years.

A simple 20-times multiple on those $8 earnings implies a 5-year forward price target of $160 (LOW stock usually trades at 24-times earnings, so a 20 multiple is a big discount). Discounting that $160 price target back by 10% per year, you arrive at a present value of just under $100.

Bottom Line on Lowe’s Stock

The risks which have knocked LOW stock off its 52-week highs have been overblown. Meanwhile, the fundamentals remain strong, and imply that the stock is currently undervalued.

As such, this looks like a good opportunity to buy the dip in a wide-moat, healthy-growth stock.

As of this writing, Luke Lango was long LOW.

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