Saturday, September 09, 2006

Lowes (LOW) Analysis

Lowes Companies Inc. is the second largest business in the home improvement busisness with specific emphasis on retail do-it-yourself (DIY) customers, do-it-for-me (DIFM) customers who utilize our installation services, and Commercial Business Customers. It is growing at a faster pace than Home Depot, its largest competitor.

From the 10-K, Lowes describes its market as follows:

We estimate the size of the U.S. home improvement market to be approximately $700 billion, $550 billion of which comprises product demand, and $150 billion for the installed labor opportunity. Data from a variety of primary and secondary sources, including trade associations, government publications, industry participants and other sources was analyzed as the basis for our estimate. This estimate includes import and export data and key end-use markets, such as residential repair and remodeling, and nonresidential construction and maintenance. This data also includes a wide range of categories relevant to our business, including major appliances and garden supplies.

As we continue to monitor economic data and the home improvement marketplace, there are many indicators demonstrating continued strength in consumer demand for the products and services we offer. The key indicators that we monitor include personal income, employment growth, housing turnover and home ownership levels. Demographic and societal trends also remain supportive of home improvement industry growth.

Personal income continues to grow, which is supported by data from the February 2006 Blue Chip Economic Indicators™, which forecasts real disposable income growth of 3.4% for calendar 2006, compared with 1.4% in calendar 2005.

Employment growth is a strong indicator of home improvement sales. The relatively low unemployment rate suggests Americans will likely be more confident in calendar 2006 about employment prospects than in the past several years.

Housing turnover is expected to continue at a historically high pace according to The National Association of Realtors®, which forecasts calendar 2006 housing turnover to be the third strongest year on record.

Near-record U.S. homeownership levels provide an established customer base for home maintenance and repair projects. The vast majority of our customers are homeowners and they are not willing to let what is often their most valuable financial asset deteriorate.

Out of the factors mentioned above, the disposable income has increased at 6.8% rate this year while inflation has been creeping up at 4.1%. Employment growth is also strong with unemployment at record lows. Interestingly enough, housing turn over may be unaffected by the housing slow down and defaults. The only factor that may affect lowes is that less people will have the money to spend in their stores. This was evidenced recently as Lowes earnings missed the estimates by one cent.

There are several factors in favor of Lowes as noted in the Home Depot analysis. Some of the factors in play for Home Depot are true for Lowes as well. Just to recap, the factors in favor of Lowes are:

Balance Sheet
Confluence of factors

In each of the above categories, Lowes is equal or better than Home Depot at the moment. It doesnt hurt that Lowes is growing at a faster pace.

Let us take a look at the balance sheets to compare Home Depot and Lowes. HD has a return on asset ratio of 13.5% and a forward earning yield of about 9%. Lowes on the other hand has an earnings yield of 8% and return on assets of 13.3%. HD has a larger per share in book value at 37.6% to Lowes 35%. However, Lowes is growing at a faster pace than Home Depot with the recent expansion to Candada being a good example. Lowes also carries a lower debt compared to Home Depot when normalized by market capitalization. In addition, Lowes has a higher per ticket average and increase in same store sales (3.3%) compared to lesser per ticket average and decline in same store sales in Home Depot.

Lowes balance sheet is sound and it spent a bundle of money buying back shares. This has helped stem the dilution through stock option offerings.

As noted in Lowes 10-K, the capital expenditure budget is as follows:

Our 2006 capital budget is $4.2 billion, inclusive of approximately $387 million of leases. Approximately 79% of this planned commitment is for store expansion and new distribution centers. Expansion plans for 2006 consist of 155 stores, including five relocations of older stores. This planned expansion is expected to increase sales floor square footage by approximately 12%. Approximately 63% of the 2006 projects will be owned and 37% will be ground-leased properties.

Depreciation and amortization will probably average around 2 billion dollars for 2006. Subtracting this amount from the capex budget, we see that approximately 55% of the earnings are deployed in maintenance. Some of this budget is used for expansion ( around 2 billion ) and the rest is used to buy inventory and other necessities.

Let us next look at the EPV of Lowes. Assuming no growth and the yearly profit to be around 4 billion in 2006. Subtracting capex and adding back depreciation and amortization ( not including the money used for expansion ) - one gets a value of around 3.8 billion. Adding 10% of the sales, general and adminstrative cost to keep/build the brand name, we have a value of 4.8 billion. Using a cost of capital of 8%, we get an EPV of 60 billion. Subtracting debt and adding cash and inventories, one gets a value of around 63 billion. This value indicates that the stock is selling at a 29% discount to its current market price.

Another approach where one takes the book value and puts a P/E multiple of ten to the current adjusted earnings will also put the value at around the same value as calculated above.

1 comment:

Amit Dhuleshia said...

Thi is Lazy Investing (

I think we did the same type of analysis on home depot.. undervalued even with no growth...

Did either Lowes or Home Depot break down their capex in their 10ks?

Also, where did you come up with the 10% of sales for lowes, 1 billion dollars, general adminstrative cost.. thats not part of cap ex..