Lowe’s (LOW)

Lowe’s (LOW) was founded in 1946 and is the world’s second largest home improvement retailer. The company operates over 2,100 home improvement and hardware stores (almost all in the U.S.) and helps homeowners, renters, and other customers complete a wide array of projects.

The company’s stores are famous for being a one-stop shop for both do-it-yourself (DIY) customers, as well as professional contractors. A typical Lowe’s store stocks more than 35,000 products across virtually every home improvement product category (lumber, paint, appliances, flooring, tools, cabinets, etc.).

Less than 5% of Lowe’s sales are made online today, but the company’s strategy is focused on omni-channels sales to capitalize more of the e-commerce trend.

Business Analysis

Home Depot (HD) and Lowe’s dominate the U.S. home improvement market. Each of these companies benefits from brand recognition, prominent store locations, a comprehensive line of products, economies of scale, massive distribution channels, and a strong focus on customer service.

Smaller competitors are unable to match the broad assortment of inventory and in-store product presentations that Lowe’s can afford. They also have much less bargaining power with suppliers, making their products less price-competitive. Consumers have few reasons not to head to Lowe’s or Home Depot for their home improvement needs.

Lowe’s has also been improving its competitive positioning by investing more in technology and product presentation. Through the use of technology and helpful in-store displays and service, customers have even fewer reasons to try out competitors’ stores.

Combined with a relatively Amazon-proof niche, Lowe’s has been able to avoid the kind of disruption that many traditional retailers are facing. And thanks to the company’s aggressive investments into its online omni-channel sales platform (nearly half of company-wide capital expenditures going forward), this will likely continue being the case going forward.

With the U.S. housing market now having mostly recovered from its 2008-2009 collapse, management is especially focused on the company’s long-term growth plans, which include steadily increasing economies of scale and rising margins and returns on shareholder capital.

Despite improving profitability over the years, Lowe’s still has a long way to go before its margins and returns on capital match its industry peers, especially Home Depot (14% operating margin last year versus 9% for Lowe’s).

In other words, management believes that the company has plenty of room to improve its profitability going forward. In fact, over the next three years Lowe’s hopes to grow its operating margin by nearly 30%, thanks to increased emphasis on automation in its distribution centers, as well as other cost reduction initiatives.

Part of that plan involves further growth to achieve maximum economies of scale through a gradual increase in U.S. store count, more aggressive expansion into Canada and Mexico, and further improvements to its brand portfolio.

For example, in 2016 the company spent $2.4 billion to acquire RONA, Canada’s largest home improvement chain, with 539 national stores and $4.6 billion in annual revenue.

In addition, Lowe’s has recently been investing heavily into the maintenance, repair and operations (MRO) market so it can better serve professional contractors.

That involved purchasing Central Wholesalers in 2016 and more recently Maintenance Supply Headquarters for $512 million. This last purchase added 14 distribution centers and $400 million in annual revenue and is expected to be immediately accretive to earnings per share.

And these are just two of many MRO-focused acquisitions that Lowe’s has done over the years.

The reason that Lowe’s is pushing so aggressively into the MRO segment is because more Americans than ever have been renting instead of buying homes since the financial crisis.

As a result, rental prices have been outpacing inflation for many years. Going forward, Lowe’s wants to diversify its business and take advantage of the strong boom in new apartments, which requires a larger presence in the professional contractor market.

Another benefit of greater exposure to the MRO industry is that contractors (30% of revenue) generally buy larger orders, which has helped Lowe’s to improve its sales per square foot.

Management believes the company’s most recent acquisitions will help continue this positive trend, resulting in steady same-store sales growth of 3% to 3.5% a year and overall top line revenue growth of 4% through 2019.

Combined with its margin expansion plans and aggressive share buybacks (5% a year through 2019), Lowe’s believes it can achieve 15% annual EPS growth in the coming years. And thanks to management’s 35% dividend payout ratio target, this should result in very healthy double-digit annual dividend growth.

Finally, it’s worth pointing out that the home improvement market is verylarge (Lowe’s estimated the U.S. home improvement market was valued at $690 billion in 2014) and slow-changing. Mature industries dominated by several large players are very difficult to crack into, and Lowe’s seems likely to continue its dominance for many years to come.

Key Risks

With any brick-and-mortar retailer these days, it’s important to consider the risks posed by lower-cost e-commerce competitors such as Amazon. Home Depot and Lowe’s both sold off in 2017 on news that Amazon was acquiring Sears’ Kenmore appliance line, for example.

However, in Lowe’s case, this risk still seems lower because many of its products are for unique home projects. Physically going into the store to review paint colors, cabinets, flooring options, and more is critical to getting the project right. As a result, not many of Lowe’s product categories seem vulnerable to online competition.

Lowe’s has also noted that approximately 60% of online purchases made by its customers are picked up directly in its stores, further demonstrating the importance of having physical locations in this market. As the company continues investing heavily in its own e-commerce capabilities, Lowe’s should continue positioning itself to ward off this threat.

Perhaps most importantly, Lowe’s is sensitive to the housing market. When the job market is weak, consumer spending is down, housing prices have fallen, mortgage rates are high, and housing turnover is low, there is less demand for home maintenance, repair, and upgrade projects. The housing market has been recovering for a number of years now, but the best time to buy Lowe’s would have been during the depths of the housing crisis.

Aside from macro factors related to consumer spending and the housing market, Lowe’s doesn’t seem to face many other major risks. Growth in big box retail locations could become more difficult in an increasingly digital and saturated market, but this threat is unlikely to jeopardize Lowe’s plans for the future.

The home improvement retail industry is slow-changing in nature, and Lowe’s benefits from economies of scale, strong brand recognition, quality merchandise selection, and decent store locations. Simply put, it’s hard to imagine the company being disrupted for the foreseeable future.

Closing Thoughts on Lowe’s

Lowe’s appears to be a high quality home improvement retailer with numerous enduring competitive advantages. The company is benefiting from a mix of company-specific actions to improve profitability and macro tailwinds that are helping the housing market.

Lowe’s dividend growth potential is also very attractive given the company’s conservative payout ratio, decent earnings growth potential, and reasonable balance sheet. Lowe’s strengths have allowed it to pay a dividend each quarter since going public in 1961, including more than 50 consecutive years of payout increases, and it should have no trouble continuing its impressive streak.

To learn more about Lowe’s dividend safety and growth profile, please click here.