Monday, February 27, 2006

Lowes Tops, Then Pops

Home retailing giant Lowe's (LOW) posted a 37% increase in fourth-quarter profit buoyed by commercial business revenue growth.

Earnings of 87 cents per share smashed what analysts had been expecting (80 cents per share). Revenues for the quarter galloped 26% to roughly $11 billion.

Lowes stifles the competition from home wares megaman Home Depot (HD) by focusing on store layout (some of whose elements Home Depot has ripped off), appealing to women (instead of just contractors), and returning free cash flow to shareholders through stock buybacks and dividends.

The company has also started making moves in the installed sales category, as well revamping what some considered to be shoddy customer service.

What we'll be watching going forward is how much success Lowes has in its Northeast penetration plan, where Home Depot has already made a respectable push. Likewise, it'll be interesting to see how quickly Lowes gets its new, higher margin products (imports,etc) off the shelves and averts inventory lulls.

As torrid as Lowes' margin and sales growth was during the last decade, we expect both to slow down (albeit modestly) as the firm naturally matures into its life cycle. With Canadian store openings on its roster, we do not expect Lowes to become a laggard by any means.

We believe that the home retail space can continue to support both players (LOW & HD), creating value for customers and investors alike. As far as Lowes is concerned, we'd like to see the firm become less leveraged ($2B cash vs. $4B in debt), as well stop over-rewarding its executives (In 2004, LOW was up 4.2%, but top execs got $2M in salary, excluding bonus and options).

We have a hold rating on Lowe's. Whereas Home Depot is trading at a dirt cheap 12x forward earnings, Lowes already trades at a 18x forward multiple, leading us to believe that Lowes stock could shake out some excess in the coming weeks.

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