Lowe's May Have Sunk Too Low

In the last quarter, shares of Lowe's (LOW) have declined nearly 15%. Year to date, the stock is down more than 8%. Why has this stock performed so poorly when housing is doing pretty well?

Lowe's poor performance goes back to mid-August, when the company reported a soft second quarter and lowered guidance for the rest of the year. Lowe's reported second-quarter earnings of $1.37 per share, 5 cents worse than the consensus estimate of $1.42. Revenue rose 5.3% to $18.26 billion, about $160 million less than expected. Same-store sales rose 2%. Analysts were expecting comps of 4.5%. (Last year, comps were 4.3%.) Second-quarter U.S. same-store sales were up just 1.5%.

On the conference call afterwards, management lowered fiscal 2017 guidance. The company expects earnings of $4.05, vs. the consensus estimate of $4.06. Investors were especially disappointed by the cut, because everybody had already come down from $4.11. Management raised revenue guidance to $65 billion from the previous guidance of $62.6 billion. Most of the increased revenue guidance comes from the 53 weeks in the fiscal year and the addition of 45 new stores (including 20 Orchard Supply stores and 12 stores in Canada). Lowe's expects same-store sales will be up 4% for the year. Management spent $1.2 billion on share repurchases.

The second quarter was a real disappointment, especially with a decent housing market and a strong do-it-yourself market. While Lowe's produced a 2% comp in the second quarter, Home Depot (HD) reported a 4.7% comp.

Management blamed the weather for the low comp. The company said same-store sales would have been 110 basis points higher and earnings would have been 23 cents better if the weather had cooperated. The company said an early spring shifted sales results from the second quarter to the first. First-quarter comps were 7.3%.

The professional customer outperformed the DIYer by 400 basis points. Inventory grew 9% vs. the 5.3% increase in sales. Operating margin was 11.7%, up 32 basis points.

For the third quarter, analysts are looking for earnings of 97 cents per share on $15.895 billion in revenue. For the year, analysts are looking for revenue to increase 9.7% to $64.82 billion.

The second-quarter report knocked 14% off the stock. Lowe's reports its third quarter on Wednesday, and a lot of investors are buying Lowe's ahead of the quarter because of the large valuation disparity between the two stocks of Lowe's and Home Depot.

Historically, in terms of valuation, Lowe's and Home Depot trade in tandem. Although Lowe's gets a lower multiple, it's usually only slightly less. Right now the difference between the stocks is pretty compelling.

At the current price, Lowe's is trading at 17.5 times fiscal 2017 estimates. Home Depot is at 20.4 times 2017 estimates. But since this is the third quarter and investors will be looking towards fiscal 2018, Home Depot is trading at 18 times forward estimates, while Lowe's is stuck at 9.9 times. That's a pretty compelling differential.

Lowe's is up against a 4.6% comp from last year and a 5.2% comp in the fourth quarter. If Lowe's is going to get to its 4% comp goal for the year, the weather better start cooperating. Fast. The third and fourth quarters both have to go over 4.0 for the stock to go higher.

With a solid third quarter, Lowe's should be able to close the valuation gap with Home Depot. If I'm right, Lowe's probably has upside to the low-to-mid $80s (or 17 to 18 times estimates).

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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