Lowe's Undervalued After Earnings Miss
Wide-moat Lowe's (LOW) second-quarter results were bolstered by the same factors seen at Home Depot--namely, strong housing market fundamentals that include low interest rates, low housing inventory, and a rising wealth effect, increasing consumers' willingness to spend on their homes. However, we think shares have ticked down in response to three factors. First, labor changes continue to pressure operating margins more than anticipated, leading management to now expect 2017 adjusted EBIT expansion of about 20 basis points (to 9.9%) versus 50 basis points previously. Second, a gap remains between Lowe’s and Home Depot’s same-store sales, with Lowe’s trailing Home Depot by 180 basis points this quarter (at 4.5%), and averaging a more than 200-basis-point deficit over the past four quarters, a factor we don’t necessarily deem as dour as most. Lowe’s has continued to post solid mid-single-digit same-store sales over the past four years, a level that is difficult for mature brick-and-mortar retailers to achieve consistently. Third, second-quarter consensus was a tad high, calling for sales of $19.6 billion and EPS of $1.63, versus our model that implied sales of $18.9 billion and EPS of $1.55, lower than actual results (sales of $19.5 billion and EPS of $1.57).
After incorporating this quarter’s results into our model, we don’t plan any material change to our $93 fair value estimate, and we view shares as undervalued. Our prior 2017 forecast included sales growth of 5% and same-store sales of 3.5%, which should remain in place. Lowe’s commentary that July same-store sales of 7.9% were on the upswing over the second quarter was positive, but guidance of 3.5% same-store sales for the year indicate the second half could deliver same-store sales of 3.5%-4%. Our long-term outlook includes same store sales that slow to a 2% pace, supporting low-single-digit revenue growth and slight annual operating margin expansion, leading to operating margins of 12% over the next decade.
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