We plan to lower our fair value estimate modestly on wide-moat Lowe's in response to sluggish results as well as the tempered outlook for the remainder of 2016.
Struggling with slower comps in the first two months of its third quarter (1%-2%), Lowe's
delivered sales and earnings results that tracked short of our full-year estimate. Sales growth of 9.6% and same-store sales of 2.7% were shy of our low-double-digit top-line and 3% comp pace, indicating the final quarter is likely to slow and reduce our full-year outlook, which included revenue growth of 10% and EPS of $4.04. Lowe’s financials stood in stark contrast to Home Depot’s results, which indicated that both August and September were solid, with Home Depot capturing 3.8% and 6.5% comp growth, respectively. We plan to lower our $85 fair value estimate modestly in response to results as well as the tempered outlook for the remainder of 2016. We remain concerned that while housing market growth still seems to have legs (as indicated by Lowe’s and Home Depot commentary, as well as home prices and turnover), higher interest rates ahead could prove a headwind for home improvement retailers (mortgage applications were down 9% in the last week as rates bounced).
Jaime Katz, CFA, is a senior equity analyst for Morningstar.
Both gross margin and selling, general, and administrative metrics tracked below our expectations--both fell short by about 50 basis points, implying operating margin performance that was lower than we needed to meet our full-year outlook by about 100 basis points. Lowe’s full-year outlook includes revenue rising 9%-10% (down from 10%), comp store sales rising 3%-4% (from 3% prior), and EPS of $3.52 excluding charges (or $3.97 excluding charges, versus $4.06 prior). This puts the company’s 2017 outlook of $4.70 per share largely at risk, even when including both Rona sales and share repurchases of $2.5 billion. Our operating margin outlook for 2017 had been below the 11% offered in the past, at 10.2%, as we expected Rona’s cost structure to drag on the enterprise and Lowe’s operating margin expansion to rise more slowly than the firm expected. We plan to maintain a 2017 operating margin outlook close to 10%.
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