Could Lowe's Companies, Inc. Be a Millionaire-Maker Stock?

12/4/17

By Adam Levine-Weinberg, MotleyFool

Lowe's (NYSE:LOW) is one of the two biggest home-improvement retailers in the world. Both it and its largest competitor, Home Depot (NYSE:HD), have seen phenomenal returns over the last 10 years. Whereas the S&P 500 has returned 79% over the last decade, Lowe's shares increased over 250% and Home Depot's are up over 500%.

While Home Depot has outperformed Lowe's in the recent past, there are a few reasons to believe Lowe's may not only be a better investment today, but could be a stock that helps investors become millionaires in the future. Lowe's has a wide moat to defend against competitors both offline and online. It has a strong growth outlook for both the top and bottom lines, as well as an excellent capital return program including a growing dividend and share buybacks. It's also priced right for an investment today.

Lowe's storefront with riding lawnmowers in front.

IMAGE SOURCE: LOWE'S.

Building a moat

As the second-largest home-improvement retailer in the world, Lowe's benefits greatly from its scale. Lowe's is able to exercise greater pricing power with inventory suppliers as well as advertising outlets. That pricing power allows Lowe's to attract more customers through advertising and then keep customers by passing along its lower costs in the form of lower retail prices.

Lowe's is also able to offer customers a better shopping experience, training staff to be able to help solve customers' problems. This specialized staff provides protection against broader brick-and-mortar merchants and online sales. Customers can walk into Lowe's, describe their problem, and get pointed in the right direction. Home Depot is the only major competitor that can provide similar service.

Lowe's has done an excellent job of building relationships with customers through its pricing and service. That's likely to keep them coming back even if new competitors enter the market.

Improving revenue and profits

Lowe's produced better-than-expected third-quarter numbers as a result of the hurricanes that hit the United States this summer. Still, they weren't as great as Home Depot's and management didn't raise its full-year guidance. That led to some mild investor disappointment.

Nonetheless, the long-term outlook for Lowe's is very good. Management expects modest same-store sales growth of around 3% and it's opening 15 to 20 new stores per year across North America, providing another 2% in revenue growth. It's also been busy acquiring smaller competitors such as Rona, Central Wholesalers, and Maintenance Supply, adding further revenue growth.

Meanwhile, it has room to improve its margins. A growing sales base and effective shift management are helping leverage SG&A expenses to improve operating margin. Management expects operating margin to expand 150 basis points over the next three years.

Gross margin has room to improve, as Lowe's acquisitions and typical customers have resulted in sales shifting to more lower-margin products like lumber and hardware. Lowe's expanding line of private brands could be a boon in that regard. Nevertheless, gross margin is improving, albeit slowly.

Home Depot currently produces a much better operating margin of 14.5% compared to Lowe's 9.8%. Home Depot's bigger scale is one reason why, but it shows there's still room for improvement at Lowe's. Management is aiming to close the gap over the long term.

Capital returns

Lowe's is dedicated to its dividend. Shareholders have received a raise for 54 years straight, which puts a lot of pressure on management to keep that streak alive. CFO Bob Hull noted the dividend is a priority, with only strategic investments in the company coming before it. There's also a hefty share buyback, with $2.1 billion remaining on its share repurchase authorization as of the end of the third quarter.

Capital returns are supported by strong free cash flow. The company generated $4.6 billion in free cash flow over the last four quarters. It paid out about $1.25 billion in dividends, giving plenty of room to continue increasing it. Lowe's aggressive share repurchases are starting to slow, and the company estimates it will buy back about $3.5 billion worth of shares this year.

Lowe's is returning practically all of its free cash flow to shareholders through its dividend and buyback. Obviously, that's unsustainable, but Lowe's can manage to return a lot of cash to shareholders thanks to its high return on equity (about 50%) and relatively low organic revenue growth. Its debt load is high but manageable, and the flexibility of the share buyback gives management room to invest strategically.

A good value

Lowe's is a strong company with a good outlook for the future, and its stock presents a good value at its current price.

The company currently trades for 18.4 times forward earnings estimates. That's a pretty steep discount compared to Home Depot stock, which is currently priced around 24 times forward earnings estimates. The same holds true from an EV-to-EBITDA standpoint: 10.1 times for Lowe's versus 13.7 times for Home Depot.

What's more, analysts expect Lowe's earnings to grow faster than Home Depot's going forward. They anticipate the former to average 13.4% earnings-per-share growth per year while the latter is predicted to grow earnings just 12.9% per year over the next five years.

Trading at a significant discount to its closest competitor with excellent potential for growth and a great capital return program make Lowe's a stock worthy of consideration for future millionaires.

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