Earlier today, we added Lowe’s (LOW:NYSE) to the Action
Alerts PLUS portfolio. We did this for several reasons.
The company stands to benefit from extended low interest
rates (which the Fed basically outlined today in its
latest minutes), low oil prices, and stronger consumer
confidence -- all which should lead to higher retail
We’ve already heard from the likes of Wells Fargo
(WFC:NYSE) and SunTrust Banks (STI:NYSE) that lower
interest rates have led to a recent pickup in their
refinancing activity and we would expect, with the 10-
year Treasury at 1.7% and the 30-year at 2.29%, this will
only continue, leaving more money in consumers' pockets.
In fact, the most recent housing data has been better
than expected – notably the weekly mortgage application
rate and new home sales. We like the duopoly between
Lowe’s and Home Depot (HD:NYSE), both of which should
benefit from these trends.
Lowe’s is the second largest home improvement retailer in
the world, with annual revenue of more than $53 billion,
1,840 stores in North America, and a 13% market share.
The company offers products and services for home
decorating, maintenance, repair, and remodeling.
The sheer size and scale of the company gives it
purchasing power and low-cost advantages, And with its
much improved supply chain and logistics platforms, it
has a competitive advantage which in turn can be passed
on to its customers.
The company has undergone extensive company-specific
fixes, improving its value proposition, product
differentiation and in-stocking positioning. It has also
focused on tailored local merchandising, while profitably
expanding its store base in underpenetrated markets.
Finally, management has emphasized solutions-based
programs for its customers and, namely, the professional.
This has positive margin implications, as improved
consumer confidence leads to higher levels of spending
from more contractors to complete entire projects vs.
In retail, we always look for operating leverage --
higher margins and lower investment spending, which leads
to stronger earnings power. And in this story we have it,
with management targeting 150 basis points of operating
margin improvement from 2015 to 2017 (from 9.5% in 2015
to 11% in 2017), earnings per share of $4.70
(representing a 21% CAGR), same-store sales at 4% and a
return on invested capital (ROIC) of 19%.
Total shareholder return in the next three years is
expected to be at least $14 billion, or 22% of market cap
or $9.20 per share. This includes at least $10 billion in
stock buybacks and $4 billion in dividends, which is a
35% payout or about 26% annual growth.
Longer term, over the next five years, we believe overall
sales can grow by 5%, gross margins can expand 150 bps to
36% and SG&A can lever 200 bps to 22%, driven by the
company's size and scale advantages. This should lead to
a 12% operating margin rate, making the 11% target by
2017 achievable. Much of these goals will be driven by
improved penetration of the professional customer market
through new brands and the relaunch of LowesForPros, an
ecommerce initiative. Also, new innovative products,
services and improved omnichannel initiatives will drive
consumer loyalty and store relevancy as well as better
inventory and utilization rates.
Should the company be able to deliver on its plans, both
medium and long term, we see multiple expansion
equivalent to Home Depot and thus, a higher share price.
The stock trades at 19.6x fiscal year 2016 earnings
estimates, below long-term levels in the low-20s. It has
a free cash Ffow yield of 5.5% and a 1.3% dividend yield,
which we see going higher over time. Our target is $80.
Jim Cramer, Stephanie Link, and TheStreet Research Team
DISCLOSURE: At the time of publication, Action Alerts
was long LOW and STI.
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We pick up Lowe's, add to SunTrust and DG and jettison Vale.
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