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Is It Time to Build a Position in Lowe's?


The hardware retailer is basically showing the market a couple of things that suggest its fiscal-year guidance is attainable on the high end, and possibly even conservative.

Mother Nature was a friend to home improvement retailers during the holiday quarter, while most others in the retail sector faced the exact opposite experience. Furthermore, Mr. Market was a friend to Home Depot's (HD) stock (despite its climb up a straight wall over the last 52 weeks) when the company released its strong fourth-quarter earnings last week. Now the market looks prepared to extend that kindness to Lowe's (LOW) in today's session.

In light of the $0.06 EPS beat by Lowe's ex. items, and fiscal-year guidance that hints at upside relative to the presently held consensus, I would have thought a more robust pop in the stock price would be in the offing. Here's some insight as to why that has not happened:

Long-term sustainability of results/Home Depot reigning supreme: Lowe's move to everyday low prices -- along the lines of what is transpiring at Wal-Mart (WMT), which invested $100 million in the holiday quarter in the US division to reduce prices -- yielded a 3.5% increase in fourth-quarter same-store sales, light years from what Home Depot produced without having to adjust its stance on promotions in most instances.

The real story for Lowe's is on the gross margin line, which compressed 133 basis points year-over-year and missed consensus, evidence of the downshift in pricing architecture. (It was also disappointing news in the sense that Lowe's is using technology to capture price by tapping into specific market product demand).

Essentially Lowe's stronger than expected EBIT was fueled by two changes tied to its restructuring actions enacted in 2011: improved operating efficiencies and much lower depreciation expenses (the sustainability of the savings here is questionable).

I continue to prefer Home Depot over Lowe's as a long-term investment in the sector, but have to say that Lowe's shares could very well run near-term a bit off this type of quarter. Lowe's is basically showing the market a couple things that suggest its fiscal-year guidance is attainable on the high end (and potentially conservative if the housing market recovery pans out), barring no major downdraft in housing:
  • Lowe's has three quarters of easy year-over-year comparisons on operating and depreciation expenses due its restructuring initiatives. Combined with an improving same-store sales run rate, Lowe's has the potential to surprise the market with its EBIT earnings (and earnings per share as it repurchases its stock).
  • Cleaner inventory should lead to a declining severity in gross margin compression.
  • There is willingness by management to use its balance sheet to fund a stronger dividend payout ratio while maintaining share repurchases.
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No positions in stocks mentioned.
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