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Lowe's struggles as investments hit margins

By Aishwarya Venugopal
FILE PHOTO - A Lowe's hardware story is show in Carlsbad, California, United States May 23, 2016. REUTERS/Mike Blake/File Photo

By Aishwarya Venugopal

(Reuters) - Lowe's Companies Inc's quarterly profit and margins fell well short of Wall Street estimates on Wednesday as the No. 2 U.S. home improvement chain's investments to convert shoppers' visits into sales did not pay off as much as expected.

The company's shares tumbled 9 percent after Lowe's forecast a drop in margins this year - due to heavy investment in a very competitive U.S. market.

A forecast that same-store sales growth would also slow this year suggested that investment would not bear fruit soon and left it trailing sector leader Home Depot.

"We made an investment in the third quarter to bolster conversion rates ... we need to make the incremental investments to ensure that we convert that traffic into transactions," Chief Executive Officer Robert Niblock said on a conference call.

Despite a rise in store traffic, the number of customers making purchases dropped, and the purchases included expensive items with lower profit margins, such as lumber and washing machines. For investors, the benefit of higher same store sales were undermined by lower profit margins.

"Big ticket sales continued to be a driver of much of the top-line gains, with appliances coming at a double-digit pace and tickets over $500 rising at 5.5 percent," Morningstar analyst Jamie Katz said.

"However, appliances tend to have lower gross margin than some other categories at the business, adding pressure to profitability."

The company's gross margins fell to 33.73 percent, missing analysts estimates of 34.27 percent, according to Thomson Reuters I/B/E/S. The company attributed sales of lower-margin products as well as money spent on initiatives such as advertising and home deliveries for the drop.

Operating margins also dropped and Lowe's said it expected a drop of about 30 basis points this year.

Same-store sales, however, rose 4.1 percent, topping market expectations. But that was well below the 7-percent growth posted by market-leader Home Depot Inc , which also reported higher customer transactions and average spend.

Lowe's net sales fell nearly 2 percent to $15.49 billion, but topped estimates of $15.33 billion.

Net income fell 12.5 percent to $554 million. Its adjusted earnings of 74 cents per share were well below analysts' estimate of 87 cents.

The results from the home improvement chain, which also owns Canadian home goods retailer Rona, come at a time when rising mortgage rates and the impact of the U.S. tax reforms on higher-priced homes have begun to worry investors in construction-related businesses.

Lowe's shares were down 6.3 percent at $89.81 in mid-day trading, easing from a session-low of $86.75. Both Lowe's and Home Depot's shares have risen about 28 percent in the past year.

(Reporting by Aishwarya Venugopal in Bengaluru; Editing by Savio D'Souza)