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The following segment was excerpted from this fund letter.
Lowe`s Companies Inc. (NYSE:LOW)
Lowe’s is a high-quality business with significant long-term earnings growth potential underpinned by a superb management team that is successfully executing a multi-faceted business transformation.
COVID-19 was a transformational event for the US housing market, causing homeowners to invest significantly in their homes as they shifted nearly all their daily activities to the home environment, including work, school, and leisure. The increased use of the home during COVID, in turn, increased the need for repair, maintenance and remodel activity, which significantly benefited Lowe’s same-store sales.
As consumers return to spending more time and money on out-of-the home activities the near-term demand for certain Do-It-Yourself (“DIY”) categories has decreased. Moderation in DIY demand combined with increased mortgage rates and decreased housing affordability has caused many market participants to become concerned that the home improvement industry may give up a significant part of their COVID pandemic sales gains.
While we expect that there will be some near-term volatility and continued moderation of DIY demand, growth remains strong for projects requiring professional installation (the “Pro” business) due to a substantial backlog of projects undertaken during COVID, which should support industry growth in the near-term. In addition, we believe the medium-term growth outlook for the home improvement industry remains strong as demand is likely to normalize at a materially higher level as compared to the pre-COVID era.
For the decade prior to COVID, home improvement industry sales were notably depressed relative to their long-term averages as a percentage of overall consumer spend and GDP and have only now returned to their longer-term historical levels.
Moreover, we believe COVID has permanently renewed consumers’ focus, appreciation, and utilization of their homes, which combined with higher home equity values, strong consumer balance sheets, low levels of home inventory for sale and an aging housing stock that requires an increasing level of maintenance, will likely result in a structurally higher level of ongoing home industry spending in the future. In the most recent quarter demand strengthened throughout the quarter as DIY consumers returned from summer vacations and focused on less seasonal home improvement projects.
While we believe the longer-term industry outlook remains strong, Lowe’s is likely to generate a strong level of earnings growth over a multi-year period even if the industry and macroeconomic environment is weaker due to management’s strong execution of the company’s ongoing business transformation.
A combination of market share gains (primarily from improving e-commerce execution and improving share of wallet amongst Pro customers) and a multitude of idiosyncratic self-help initiatives (primarily focused on improving in-store labor productivity and reconfiguring Lowe’s for a market based delivery model) are driving Lowe’s transformation.
Lowe’s operational transformation is further magnified by its aggressive share repurchase program, which is likely to see the company acquire a high-single-digit percentage of its market capitalization in this year alone. The materiality of Lowe’s Perpetual Productivity Initiative was on full display in their most recent quarter, whereby the company leveraged fixed expenses by 80 basis points, driving 10% earnings-per-share growth notwithstanding flat topline growth. The successful execution of Lowe’s continued business transformation should allow the company to generate accelerated earnings growth for the foreseeable future.
Notwithstanding our view on Lowe’s attractive long-term earnings outlook, Lowe’s currently trades at only 15 times forward earnings, a low valuation for a business of this quality, and a substantial discount to its direct competitor. We believe the current valuation reflects investors negative sentiment regarding the US housing market and incorporates the possibility of a greater than expected revenue decline. We believe the current valuation is highly attractive and anticipate Lowe’s will generate high rates of returns from current levels if as we expect it continues to successfully execute the company’s transformation.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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