Prepared by Stephanie, Analyst at team BAD BEAT Investing
We really like Lowe’s Companies (LOW). We had long preferred the competition in Home Depot (HD) but we currently favor LOW. We maintain a price target of $200, which would bring valuation closer in line with Home Depot, at about 24X FWD earnings for this fiscal year, and 22X FWD earnings given our preliminary 2021 estimates which we will discuss. The company has been firing on all cylinders. This includes giving employees big rounds of bonuses, managing cash with a recent notes offering, and there is the potential for buybacks to pick back up in Q4 and into 2021. Lowe’s has generated some solid returns since the COVID selloff, and we think there is more room to run as the stock has taken somewhat of a breather since August. While we still believe Home Depot has dominance in the space, Lowe’s is catching up here. After the most recent earnings report, which we will discuss, we stand by our target of $200 per share by the start of 2021.
The top line has and will continue to be strong
The items we discuss in this report should be noted as they matter when Q3 is reported. Looking back to Q2, sales were a solid $3.05 billion above consensus estimates. The top line was up 30% from last year. We expect slow growth in share prices even if sales volume normalizes. This is a good investment, and the dividend has been raised again.
Lowe’s had been very inconsistent in the past few years, but has made a lot of moves to improve operations, and in turn, reward shareholders. Lowe’s is in the process of making a push for the professional market by making acquisitions to boost its presence in that regard. We are looking forward to seeing this progress when Q3 is announced. It has been catching up and closing the gap for the professional crowd compared to Home Depot. Lowe’s has tried to make headway here and is starting to gain ground. That said, the name did report Q2 sales that blew away expectations.
This great sales growth was driven almost entirely by physical U.S. stores but also supported by investments into technology, store environments and the Pro business, as mentioned above.
Revenue for the quarter rose to $27.3 billion, from $21.0 billion last year and this was driven by strong comps. We think it is key to point out that comparable sales increased an amazing 34.2%.
Comparable sales for the U.S. home improvement business increased 35.1% for the second quarter, which led to a massive top-line gain. The comparable sales performance suggests that the consumer is still healthy and the company is executing well. With revenues higher than expected, we saw a huge earnings beat, which was also driven by expense control and better margins.
Expenses were well-managed, though gross margin continued to be pressured overall versus last year, but was better than expected. Despite the fact that the cost of sales has risen, operating margins improved and the company reduced its share count through repurchases since last year, though right now, those are on hold.
Right now, share repurchases are on hold to improve liquidity but we think they could start again in Q4. The retailer’s gross margin rate came in at 34.1% of sales vs. 32.1% a year ago.
We also want to point out that operating income improved to $3.96 billion from $2.38 billion last year. The second-quarter net earnings hit $2.8 billion, or $3.74 per share, which was a big $0.80 beat versus expectations. That was driven by comps, by higher-than-expected revenues and controlled expenses. It is a significant growth from last year’s $2.14 per share.
It is somewhat tough to handicap results as we do think growth normalizes post-COVID, but we do believe that elevated sales persist for a few more quarters. Right now we think sales will grow 20% in 2020, but we will know more after Q3.
We believe the company will continue to manage expenses and help improve operating income. We are anticipating growth to $8.30-8.80 in EPS in 2020. This translates to around 30% growth in EPS year over year. With that being said, at our price target of $200, this would mean you could acquire shares at 24X forward EPS, which is still a decent valuation given the growth. Into 2021, we are targeting about $9.50 as an early estimate, so the growth will be normalizing, but is still attractive.
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Disclosure: I am/we are long LOW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.