Lowe’s Stock: Key Items To Watch Before Q2 Earnings Report (NYSE:LOW)

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My investment rating for Lowe’s Companies’ (NYSE:LOW) stock is a Hold.

I discussed about LOW’s five-year business outlook and reviewed its Q1 2022 financial performance in my earlier article for the stock published on May 20, 2022. In the current update for Lowe’s Companies, I preview LOW’s upcoming earnings for the second quarter of this year.

I expect Lowe’s actual Q2 2022 earnings to fall short of market expectations, considering key items like the mix between DIY and professional customers, operating deleverage, and the intensity of promotional activity. This explains my decision to reduce my rating for LOW from a Buy previously to a Hold now.

LOW’s Upcoming Earnings Release Date

Lowe’s will be reporting its Q2 2022 financial results on Wednesday, August 17, 2022 before the market opens, as indicated by the company in a media release issued on August 10, 2022.

Analysts’ Current Expectations Of Lowe’s Earnings

The market’s consensus is that Lowe’s bottom line growth should decelerate in the second quarter of 2022.

LOW’s normalized earnings per share or EPS is estimated to grow by +8.0% YoY to $4.59 in Q2 2022, based on the sell-side analysts’ consensus forecasts taken from S&P Capital IQ. This equates to an expected slowdown in Lowe’s YoY EPS growth. As a reference, LOW achieved relatively higher normalized EPS growth of +9.3% and +13.3% for Q1 2022 and Q2 2021, respectively on a YoY basis. More significantly, if the sell-side analysts are right, Lowe’s will register its slowest quarterly bottom line growth for the past three years in the second quarter of 2022. LOW last recorded a slower pace of earnings growth in Q2 2019, when its normalized EPS increased by +3.9% YoY in that quarter.

In my view, the reduction in consumers’ discretionary spending and weaker profitability are the key factors that have led to expectations of a deceleration in Lowe’s EPS growth for Q2 2022.

LOW’s YoY top line growth previously ranged from +24.1% to +30.1% in the Q2 2020-Q1 2021 time period, but Lowe’s revenue growth has subsequently moderated to between -3.1% and +5.1% on a YoY basis for the Q2 2021-Q1 2022 period. The company is projected to generate a +2.2% top line expansion in Q2 2022, as per S&P Capital IQ. The Wall Street analysts also predict that LOW’s EBIT margin will contract by -30 basis points YoY from 15.3% in the second quarter of last year to 15.0% in the second quarter of this year.

I determine the likelihood of LOW’s actual Q2 2022 earnings coming in above or below expectations in the next section of this article.

LOW Is Likely To Deliver An Earnings Miss

I think that Lowe’s will disappoint the market when it announces its quarterly earnings next Wednesday. In my opinion, the consensus estimates for LOW’s Q2 2022 revenue growth and profit margins are too optimistic.

The sell-side’s consensus Q2 2022 top line growth forecast of +2.2% is much lower than what LOW achieved between Q2 2020 and Q1 2021, but this still represents a substantial improvement on a QoQ and YoY basis. Lowe’s Q2 2021 revenue increase was a lower +1.0% YoY, while the company’s sales actually declined by -3.1% YoY in Q1 2022.

My view is that Lowe’s revenue growth for Q2 2022 will be below +2.0%, as the resilience of the Pro customer base is insufficient to offset weaker demand from DIY customers. At a virtual fireside chat held on June 21, 2022, LOW emphasized that “our Pro customer is as healthy as they’ve ever been busier than ever”, but acknowledged that it expects “the DIY (customer segment) to pull back this year.” Notably, the mix between DIY and Pro customers for Lowe’s is about 3:1, so the company will be very much affected by the weakness associated with the DIY customer segment.

LOW’s Customer Segments

With respect to profitability, operating deleverage and promotions should have a larger-than-expected negative impact on Lowe’s Q2 2022 profit margins.

I highlighted earlier that I expect LOW’s top line expansion to be below expectations in the second quarter of this year. This will also translate into weaker-than-expected profitability for Lowe’s due to the negative effects of operating leverage.

Separately, it is inevitable that the intensity of price promotions in the home improvement market will have increased in recent months. Lowe’s noted at the late-June virtual fireside chat that it isn’t going to “elevate our promotional cadence or get into any kind of dramatic pricing changes”, and it highlighted that the home improvement market is a “really rational environment when it comes to pricing and promotions.” Although LOW’s management comments are encouraging, it is also an admission that price promotions aren’t going away or easing in this current market environment.

Specifically, the market is forecasting that Lowe’s gross profit margin will decrease by -39 basis points YoY and -64 basis points QoQ to 33.4% in the second quarter of the current year. My own estimate is that LOW’s gross profit margin should contract by more than -1 percentage point QoQ to below 33% for Q2 2022.

In summary, I come to the conclusion that there is a high probability of LOW suffering from an earnings miss when it releases its Q2 2022 results next Wednesday.

Lowe’s Valuations As Compared With Its Key Peer

LOW’s key peer and competitor is The Home Depot, Inc. (HD).

The market currently values Lowe’s at a substantial discount to Home Depot. HD trades at a consensus forward next twelve months’ normalized P/E multiple of 18.7 times according to S&P Capital IQ valuation data. LOW is valued by the market at a much lower 14.7 times consensus forward next twelve months’ normalized P/E, which represents a -21% discount as compared to Home Depot.

Lowe’s does deserve to trade at some form of valuation discount to Home Depot for two key reasons. Firstly, LOW is smaller than HD in terms of revenue base. Lowe’s trailing twelve months sales is less than two-thirds of that for Home Depot as per S&P Capital IQ. Secondly, Lowe’s has a relatively lower proportion of Pro customers at around 25% as indicated above. As I discussed previously, Pro customers boast relatively more resilient demand as compared to DIY customers. In comparison, Home Depot derives close to half of its revenue from Pro customers.

Nevertheless, LOW’s current -21% forward P/E multiple discount relative to HD appears to be excessive. As recent as late-2018 and early-2019, the forward P/E valuation discount for Lowe’s relative to Home Depot was as narrow as -5%.

Concluding Thoughts For LOW

LOW’s stock is rated as a Hold. A Buy rating isn’t warranted, as an earnings miss for Q2 2022 is likely. On the flip side, a Sell rating will be too harsh, as Lowe’s is already trading at a substantial discount to its closest peer based on the forward P/E valuation metric.