Lowe’s (LOW) Earnings Beat Leading the Market

Lowe’s (LOW) home improvement stores reported first quarter earnings that were better than even the most bullish of analysts estimates. Of the 16 analysts that follow LOW, the expected range for first quarter EPS was $.20 to $.29 with $.25 as the general consensus. However, due to exceptional cost cutting efforts the second largest home improvement store brought in about $.32 per share and revenue decreased 1.5% to $11.8 billion. The drop in sales was a disappointment but still significantly better than the estimates which called for a decline of about 3.2%. The cost cutting lead to better gross margins which were 35.5% from 34.7% a year ago. The improvement in margins was a surprise somewhat as much of the sales were in small ticket items instead of the big ticket high margin items.

Even though same store sales were down 6.6% from last year, the improved performance spurred management to lift its full year EPS guidance to $1.13 to $1.25 from the previously reduced estimates of $1.04 to $1.20. Undoubtedly, this quarter was a success, even as net income and sales both were down from last year.

“…for maintenance, repairing and also growing their own gardens. That do-it-yourself trend is good news for the hard-hit home goods business. But these frugal habits are really a mixed blessing for Lowe’s because consumers still aren’t spending on the big ticket items like special order and installment businesses, which are weak. But relative strength did help Lowe’s beat earnings expectations by about 7 cents. Revenue, though, is down. That’s the problem. Stores sales fell 6.6% and Morgan Stanley’s analysts are now concerned that inventory isn’t shrinking fast enough. Even though there are fewer transactions, Lowe’s is making more profit on them. Gross margins improved and prices aren’t being slashed. So that has management willing to inch back up their earnings forecast, upping their high-end projections by about five cents. That’s giving shares of Lowe’s more than 6% pop on the day. It’s also lending strength to competitor home depot, which will report its earnings tomorrow.” CNBC’s The Call 5/18/2009.

LOW itself is up 9% at midday, but the results are also leading the market higher today as competitor Home Depot (HD) and home builders are all trading higher. We view this as a good quarter for Lowe’s which may foretell a earnings beat from Home Depot, but be careful not to proclaim this a sign of the housing bottom. Consumers are putting off big ticket purchases and renovations in favor of smaller improvements. The bottom in the housing market may still be months away, and as we all know Lowe’s and Home Depot do best when there are a lot of housing transactions. Sellers sprucing up the house and home buyers personalizing are two main drivers of revenue.

With a record number of foreclosures in April and housing prices still in decline, albeit less than prior months, there are still concerns that make us hesitant to recommend these retailers. However, a stabilization in the housing market appears closer now than at anytime in the last two years, and for these stocks (LOW, HD) if you wait until the housing market is roaring again you have probably missed your entry point. The Ockham valuation of LOW is currently Undervalued, in contrast to HD which is Fairly Valued by our methodology. There are a lot of things that are out of Lowe’s control (i.e. housing market) but the management is doing a very solid job through this difficult period. By cutting costs, increasing earnings and margins, and gaining market share from their rival, Lowe’s is doing all the right things to be a stronger, leaner company when conditions are more favorable.

Lowe’s Earnings Beat Leading the Market

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