Updated on January 25th, 2019 by Josh Arnold
Every year, we review each of the Dividend Aristocrats, a group of companies in the S&P 500 Index with 25+ consecutive years of dividend increases.
In this installment, we’ll take a look at home improvement retailer Lowe’s Companies (LOW).
Lowe’s has a tremendous history of dividend growth. In addition to being a Dividend Aristocrat, Lowe’s is on the exclusive list of Dividend Kings, which have raised their dividends for an amazing 50+ years in a row. You can see the entire list of Dividend Kings here.
Lowe’s dividend yield is average when compared with the S&P 500 Index. However, Lowe’s is a high-growth dividend stock. Lowe’s 2018 dividend payout was more than double that of 2014.
Still, Lowe’s dividend is very safe. We explore Lowe’s dividend safety in the following video:
Lowe’s has a 2% dividend yield, and the potential for 10%+ annual dividend increases for a very long time to come. This article will discuss Lowe’s business model, growth potential, and valuation.
Lowe’s was founded in 1946. In the 73 years since, it has grown into the #2 home improvement retailer, behind only The Home Depot (HD). Lowe’s generates $72 billion in annual sales.
The company operates more than 2,300 stores in the U.S., Canada, and Mexico. Lowe’s offers a wide range of products, for maintenance, repair, remodeling, and decorating the home. It has a wide selection of leading national brands, as well as a large number of private brands.
This is a difficult time for most retailers. The brick-and-mortar industry is under fierce pressure from e-commerce competition. Lowe’s has shrugged off the poor performance of the broader retail industry. It continues to perform well, as consumers remain willing and able to spend on their homes.
And, whereas consumers are all-too-willing to shop for many items online, they still value the in-store shopping experience for home improvement products. This is how Lowe’s has continued to grow over the past few years, even though many other retailers are struggling.
Lowe’s comparable-store sales have increased for years since the Great Recession, and are expected to rise 2.5% in fiscal 2018.
Sales growth has come from higher transaction counts and ticket sizes. Lowe’s reported its third-quarter financial results on November 18th. Revenue of $17.4 billion increased 3.9% from the same quarter last year. Average ticket size grew 2.3%, but the number of transactions declined 0.8% for the quarter.
Source: Earnings Presentation
Revenue growth was driven by 1.5% comparable sales growth, which measures stores open at least one year. Online sales rose 12%, reflecting the company’s aggressive investments in building its own e-commerce platform to help compete against Amazon in the increasingly important digital space.
Profit margins compressed slightly last quarter, due to higher transportation and labor costs, which dragged on earnings. Earnings-per-share declined 1% in the third quarter, to $1.04 per share. The company returned $1.01 billion to shareholders last quarter through dividends and share repurchases.
The company also updated guidance for the full year. Fiscal 2018 revenue is expected to increase 4%, including 2.5% comparable sales growth. Lowe’s also expects to open eight net new stores.
Lowe’s is expected to post mid-teens earnings-per-share growth in fiscal 2018, comparable to recent years. A lower tax rate is helping but Lowe’s also continues to see operating leverage from rising revenue and prudent expense controls. This margin expansion is something we expect will continue for the foreseeable future, but only if comparable sales continue to rise.
Lowe’s has benefited from several fundamental tailwinds. The economy continues to grow, as does the housing market. Rising wages and home prices, as well as interest rates, are incentivizing more consumers to invest in their current homes rather than move. These tailwinds should continue to fuel growth for Lowe’s in the years ahead.
Lowe’s opens a small amount of new stores each year, so that is not a meaningful driver of growth. However, it continues to find ways to capitalize on strong housing and construction spending, and we see these as growth drivers moving forward.
The U.S. economy continues to grow. Positive GDP growth is arguably the most important economic indicator for Lowe’s, as the company is highly reliant on consumer spending. Other important economic indicators for Lowe’s – which include the unemployment rate and housing prices – are trending in a positive direction as well.
In 2018 home prices neared or surpassed their pre-Great Recession peak of 2007 in many regions of the U.S. This is keeping homeowners in their houses longer, and thus, they spend on improvements instead of selling and buying anew.
Outside of the U.S., Lowe’s has targeted Canada as a key growth market. In 2016, Lowe’s acquired Canadian home improvement retailer Rona, for $2.3 billion. Adding Rona gave Lowe’s access to the attractive Canadian home improvement market, which grew at a 4% annual rate from 2014 to 2018. Rona’s footprint is concentrated in Quebec, which is home to 25% of the country’s home improvement market.
Lowe’s has enjoyed not only the sales growth that came with the Rona acquisition, but synergies as well, totaling hundreds of millions of dollars annually. The Canada business continues to perform well and Lowe’s is investing in that country to fuel future growth as the core U.S. business is maturing somewhat.
Lastly, Lowe’s is building its own digital platform, to keep up with e-commerce retailers. The company’s omni-channel strategy is working, as comparable sales increased 12% on lowes.com last quarter. This is a marked slowdown from prior years, but this is to be expected given that the web business is much larger than it used to be.
The combination of opening new stores in the U.S., continued expansion in e-commerce, and growth in Canada should allow Lowe’s to reach its financial targets.
Competitive Advantages & Recession Performance
The retail industry typically does not offer many competitive advantages. This is a highly challenging retail environment, as the rise of Amazon and other Internet retailers threatens to undercut brick-and-mortar stores.
Consumers have shifted spending dollars toward e-commerce for the convenience and low prices. However, Lowe’s is a specialty retailer, which provides it with a competitive advantage.
Home improvement projects are often complex. Consumers are willing to travel to stores, to inspect products in person, and ask questions to staff members. This has helped protect home improvement retailers from Amazon thus far.
In addition, Lowe’s has the scale to compete on price, even with Internet retailers. Lowe’s operates in an industry that is essentially a duopoly; Lowe’s dominates home improvement retail along with competitor Home Depot.
Lowe’s has the scale to reap significant efficiencies in distribution, and with suppliers. It can leverage its size to keep costs low, which it can then pass on to customers in low prices. This helps drive operating leverage.
That said, Lowe’s is not immune from recessions. Consumer spending typically declines during economic downturns. Lowe’s depends on a financially-healthy consumer and housing/construction market. The Great Recession was a particularly steep downturn, which took a significant toll on Lowe’s bottom line.
Lowe’s earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $1.86
- 2008 earnings-per-share of $1.49 (20% decline)
- 2009 earnings-per-share of $1.21 (19% decline)
- 2010 earnings-per-share of $1.44 (19% increase)
Lowe’s earnings fell sharply during the recession, but the company still remained profitable. This helped it continue increasing its dividend each year. And, it bounced back just as quickly: by 2013, Lowe’s earnings-per-share had surpassed 2007 levels.
Valuation & Expected Returns
Lowe’s has a price-to-earnings ratio of 18.4. This is in excess of our fair value estimate of 17 times earnings, so we see the stock as slightly overvalued after a recent rally. We believe a lower price-to-earnings ratio is prudent given that comparable sales are slowing and that the risk of recession is rising as the economic recovery enters its 10th year.
A breakdown of Lowe’s historical stock valuation can be seen below:
Note: Lowe’s price-to-earnings ratio currently sits at 18.4.
Lowe’s stock currently trades above our fair value estimate. As a result, a declining price-to-earnings ratio could reduce future returns by approximately 1.6% per year. In addition to valuation changes, Lowe’s returns will consist of earnings growth and dividends.
We see longer-term earnings-per-share growth at 8% annually, combined with the current 2% yield, and a slight headwind from a declining valuation. That would produce overall total annual returns in the 8.4% range, which is certainly respectable, but only good enough to warrant a hold recommendation at current prices.
The dividend remains at less than 40% of earnings, so there is certainly plenty of room for additional growth in the coming years. We see Lowe’s as one of the better large cap dividend growth stocks in the market today, but the stock appears overvalued at the present time.
Lowe’s has a relatively low dividend yield, but it makes up for this with high dividend growth rates. The company consistently provides double-digit dividend growth each year. The current environment is difficult for retail, but Lowe’s operates in a niche that should withstand e-commerce competitors.
Lowe’s is still growing sales and earnings, which should allow for continued dividend growth. And, it has a low dividend payout ratio, which also supports high dividend increases. The stock may not be enticing for investors interested in high yields, but Lowe’s remains a strong dividend growth stock.