Lowe's Unafraid of Higher Rates

The stock is punished despite assurances the consumer won't stop buying.
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Updated from 11:12 a.m. EDT

The threat of rising interest rates has been greatly exaggerated and shouldn't hurt the home-improvement retailing sector this year, said

Lowe's

chief executive Robert Tillman on a conference call Monday.

Mooresville, N.C.-based Lowe's reported a 22% increase in revenue during the first quarter and an 8% rise in earnings (including the impact of an accounting change), as sales of big-ticket items remained strong. The firm also raised second-quarter and full-year estimates.

Yet shares of Lowe's were declining, as investors continued to worry that higher energy prices and rising interest rates would crimp consumer spending this year. On a conference call Monday, Chairman and CEO Robert Tillman dismissed these concerns.

"As I've said before, a moderate and measured rise in interest rates, and corresponding mortgage rate increases, will not have a significant impact on our business," he said.

The

Federal Reserve

has said it would raise rates "at a pace that is likely to be measured." But the market has begun to price in a full percentage point of tightening this year, and many economists now expect the first move to come as early as June.

Tillman said Lowe's has undergone a dramatic transformation since the last two periods of rising interest rates. In 1994 and 1995, an estimated 15% of the firm's business came from new home builders, compared with "essentially none" today. Business is also "quite different" from what it was in the 1999 and 2000 rate cycle.

The firm has gone from "a commodity-focused retailer of lumber and building materials to a company keenly focused on the retail customer as well as a select targeted group of commercial customers," Tillman said. "That change in focus is often overlooked when analysts use our history to describe the perceived vulnerability of Lowe's to rising interest rates."

Even if housing turnover were to slow down, consumers will continue to buy products from Lowe's to maintain their homes and make major repairs, he said. "Very few Americans will allow the degradation of their single largest asset."

Tillman also noted that if mortgage rates were to rise by 100 basis points this year to an average of 7% in 2004, that would still be the third-lowest average annual rate in the last 37 years, which is "hardly prohibitive to home ownership and home-improvement spending."

Interest rates are on the rise in part because of an improving employment picture, which should put more money into consumers' pockets, he added.

While oil prices are "obviously a negative" for the economy and consumer, Tillman said, the home improvement sector is somewhat insulated from the impact of rising fuel costs. If consumers decide not to go on vacation this year, they might decide to spend money improving the home instead.

Lowe's fell 2%, or $1.04, to $49.54 Monday while competitor

Home Depot

(HD) - Get Report

was off by 0.7%, or 25 cents, to $33.55. Home Depot, which is expected to post quarterly results on Tuesday, has fallen over 5% this year while Lowe's is off more than 10% compared with a 2.4% decline for the

S&P 500

.

Still, trends in the home retailing sector are largely positive. Home sales are expected to remain at historically high levels over the next few years driven by favorable demographic trends, including strong immigration. Tillman noted that young people are buying homes earlier and that baby boomers are expected to purchase 150,000 new homes each year over the next decade. "Those trends don't stop with rising rates," he said.

Lowe's earned $455 million, or 57 cents a share, in the quarter ended April 30, compared with $421 million, or 53 cents a share, last year. Revenue jumped to $8.68 billion from $7.12 billion last year. Same-store sales rose 9.9% in the latest quarter compared with a year ago.

Analysts were forecasting earnings of 54 cents a share on revenue of $8.51 billion.

Lowe's earnings were reduced in the most recent quarter by an accounting rule related to vendor payments by manufacturers. The company earned $581 million, or 73 cents a share, before the change, up about 38% from earnings in the year-ago quarter.

"Strength in every product category and across every geographic region drove solid earnings growth in the first quarter," Lowe's said in a release. "Continued strong sales in big-ticket categories such as outdoor power equipment and kitchen cabinets are an indication that consumers are not only willing, but are enthusiastic about investing in products and projects that maintain and enhance their greatest asset -- their home."

For the current second quarter, Lowe's expects to earn 89 cents to 91 cents a share on a 19% jump in overall sales and a 6% to 7% jump in same-store sales. The sales increase comes out to a forecast of roughly $10.44 billion, based on year-ago sales of $8.77 billion. Analysts were forecasting earnings of 89 cents a share on sales of $10.22 billion in the quarter.

For full-year 2004, Lowe's expects to earn $2.69 a share to $2.72 a share on an 18% jump in overall sales and a 6% to 7% jump in same-store sales. The sales guidance comes out to about $36.39 billion. Analysts were forecasting earnings of $2.66 a share on revenue of $36.16 billion.

"Consumer focus on the home remains constant, and Lowe's remains uniquely positioned to satisfy that need and capitalize on the growth of the home-improvement market," the company said.