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Is Lowe's an Attractive Investment After the Buyback Announcement?

- By Ishan Majumdar

The housing market was one of the sectors that was adversely affected by the U.S.-China trade war, and this led to a strong correction in home improvement retail stocks such as Lowe's Companies Inc. (LOW). After its recent fall, the company was again in the news for announcing a $10 billion share buyback, which made it seemingly attractive for yield investors. Given its current level of valuations and the buyback plan, Lowe's is an interesting candidate for evaluation from a long-term investment perspective.


An investment ride full of highs and Lowe's

Lowe's has seen a number of highs and lows, particularly over the last three years. But the good thing about the stock is that in each upswing, it has crossed its previous highs. The company went on to reach a high of over $116 and has corrected back to levels below $90. Many gurus such as Ken Fisher (Trades, Portfolio), Bill Ackman (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio) and Dodge & Cox saw the crash as an opportunity to add more shares to their portfolios.

In terms of valuation, the stock is currently trading at an EV-revenue multiple of 1.18, which is lower than that of its closest competitor, Home Depot (HD) . However, the company's price-earnings ratio is higher at around 19.42. In terms of yield, the five-year average of the dividend plus buyback yield is over 7%, but the current yield is around 5.78% after the announcement of the buyback program. While the 22% growth in the dividend over three years is attractive, the current yield does not really make Lowe's a yield stock, even after the $10 billion share buyback plan. Also, the volatility of the company is very high with a beta of 2.03.

Home Depot has always been financially stronger

There are a number of reasons why Lowe's has been an erratic performer in terms of margins compared to Home Depot. The company has aggressively increased its stores over the years, achieving a three-year revenue growth of 12.90%, which is higher than that of Home Depot.

However, not all the stores have performed well, and this has hit the bottom line of the company. Management has consistently been missing earnings estimates. Moreover, Lowe's operates at a net margin of 5.19%, which is nearly half of Home Depot's net margin.

In terms of return on equity, one may think that Lowe's 64.50% is high, but in fact, it is significantly lower than Home Depot's 585.60%. Also, Home Depot boasts a nearly perfect Piotroski F-score of 8 compared to Lowe's 5. Thus, it can be safely concluded that in terms of financial performance, Home Depot is a clear winner within the segment, and the management of Lowe's has to work hard in order to catch up with the market leader.

A positive effort by Lowe's management in the right direction

The management of Lowe's has worked towards a transformation of the company for the overall improvement of the top line and profitability. They have actively monitored the performance of all stores and taken some harsh decisions with respect to shutting down the underperformers. This has not only improved the profitability but has also made the management confident enough to expect 2.5% growth in comparable-store sales over the year.

The team is working hard towards the implementation of improved systems and processes along with the better use of technology to better serve its customers. It must be noted that the home improvement retail market is as large as $900 billion, and Lowe's is very well positioned in this market to capture a large chunk of this pie.

Conclusion

There is certainly expected to be a recovery in the U.S. housing market and the home improvement sector. However, long-term investors with a contrarian approach would prefer a fundamentally solid player like Home Depot over Lowe's. Despite the buyback offering and the price decline, the overall yield of Lowe's is not tempting enough. The management must be given credit for implementing the transformation plan and working towards strengthening the position of Lowe's in a growing market. However, as a stock, Lowe's should be avoided for the time being until it offers a better valuation and yield.

This article first appeared on GuruFocus.