Lowe’s Companies, Inc., (NYSE:LOW) together with its subsidiaries, operates as a home improvement retailer in the United States and internationally. The company offers a line of products for construction, maintenance, repair, remodelling, and decorating.
In the first half of 2022, we have published two articles on the firm, rating its stock as a hold both times. The primary reasons for our neutral view have been on one hand the challenging macroeconomic environment, on the other hand LOW’s ability to generate attractive returns to investors.
Today, we are revisiting Lowe’s to provide an update about how the macroeconomic environment has changed over the past months, and how these changes may impact the company in the coming quarters. We will be discussing a set of macroeconomic factors with regards to their impact on profitability and efficiency.
Let us start our discussion, by analysing how the firm’s profit margin has evolved over the past 5 years, and how it is likely to continue based on the current environment.
Net profit margin
Net profit margin is a measure often used to assess the profitability of a firm. The measure is calculated by simply dividing net profit by revenue.
Over the past 5 years, LOW’s net profit margin has actually expanded, despite the more than 1% contraction in 2022. The decline in the prior year has been primarily driven by a set of macroeconomic factors, including consumer confidence, energy- and raw material prices, inflationary pressures and the unfavourable FX environment. We understood already last year that these factors will be creating headwinds for the firm and will negatively impact its financial performance in the near term.
Let us see how these macroeconomic factors have developed since our last writing.
The following chart shows the gasoline prices in the United States in USD/Liter.
We can see that the price level has decreased substantially from the peak reach in 2022. We believe that prices are not likely to increase back to their prior year highs. For this reason, we believe that going forward this development is likely going to have a positive impact on LOW’s margins.
Core inflation rate
The following chart depicts the historic core inflation rate in the United States.
While inflation remains elevated, it has already shown signs of improvement. As the Fed is committed to bringing down inflation to historic levels, we believe that this measure is likely to keep decreasing in the coming quarters. We expect this to have a positive impact both on the cost and on the revenue side.
Another factor what we would like to mention, but not directly related to the macroeconomic environment is inventory management.
Many retailers have been struggling with inventory management in 2022, especially the ones, which are selling non-essential, durable goods.
Lowe’s however appears to be an exception. While the growth in LOW’s inventory has somewhat exceeded the revenue growth, it does not appear to be critical. Inventory levels have not skyrocketed like by many other firms.
Why is it important? If Lowe’s has no excess or obsolete inventory, it means that they may not need to be using discounting or promotional activity to propel demand. Therefore, margins are not likely to be hurt.
All in all, looking forward, we expect Lowe’s profitability to improve based on these factors.
Let us go a step further, and have a look on the company’s efficiency.
Asset turnover (or sometimes called asset utilisation) is a well-known efficiency ratio. The ratio measures how efficient a firm is in generating revenue from its assets. An increasing or stable ratio is normally a good sign.
In the past years, LOW’s asset turnover has been in general improving, excluding the 2019-2020 period. The ratio has bottomed in 2020, during the Covid-19 pandemic.
The improvement has been driven by the fact that LOW’s revenue on a quarterly basis has substantially outpaced the growth in total assets.
So what do we expect going forward and what macroeconomic factors could help answer this question?
Consumer confidence is often used as a leading economic indicator, which could be used to gauge the coming changes in the consumer spending behaviour.
When we wrote our articles last year, consumer confidence has been at historic lows. Since then, the sentiment has substantially improved. It is an important development, because it could signal that the demand for LOW’s products may increase in the coming quarters. The reason being: When consumer confidence is high, people are more likely to spend on discretionary, durable goods, while during times of poor consumer sentiment people are more likely to save.
We believe that this development is likely to have a positive impact on LOW’s sales going forward.
All firms that have international operations are exposed to different currencies and therefore are impacted by the FX environment. In 2022, the USD has been relatively strong compared to other currencies.
Since our last article, however, the dollar index has declined substantially. While only a small portion of the firm’s revenue is being generated outside of the United States, we believe it may still have a slight positive impact on the financial results.
Now that we have seen factors that could have a positive impact, we have to also look at some factors, which may keep negatively impacting the demand and therefore potentially the sales of Lowe’s. These factors are primarily related to housing.
The housing market has not shown any signs of improvement in the past months. The number of building permits have kept decreasing along with housing starts and existing home sales.
We believe that these factors indicate that there may be risks related to our thesis of improving demand. Less home sales, less housing starts and less building permit may be indicating that the demand for products for construction, maintenance, repair, remodeling, and decorating may be weak.
Since our last writing, the macroeconomic environment has materially improved. The improvement in factors like consumer confidence, inflation, gasoline and raw material prices may signal stronger demand for LOW’s products in the coming months.
On the other hand, the housing market remains relatively weak, which could offset the aforementioned positive impacts.
In the next earnings report, we will be definitely keeping an eye on the development of inventory and sales to get an indication of the demand development.
Due to the substantial improvements, however, we upgrade our rating to “buy” from “hold”.