Published by Bob Ciura on October 22nd, 2017
Every year, we review each of the 51 Dividend Aristocrats, a group of companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
Next in line, is home improvement retailer Lowe’s Companies (LOW).
Lowe’s has a tremendous history of dividend growth. In addition to being a Dividend Aristocrat, Lowe’s is on the exclusive list of Dividend Kings.
The Dividend Kings have raised their dividends for an amazing 50+ years in a row. You can see all 22 Dividend Kings here.
Lowe’s dividend yield is only about average, when compared with the S&P 500 Index. However, Lowe’s is a high-growth dividend growth.
For 2017, the company raised its dividend by 17%. At this rate, Lowe’s dividend would double every 4 years.
Lowe’s has a 2% dividend yield, and the potential for 10%+ annual dividend increases. This article will discuss Lowe’s business model, growth potential, and valuation.
Business Overview
Lowe’s was founded in 1946. In the 71 years since, it has grown into the #2 home improvement retailer in the U.S., behind only The Home Depot (HD). Today, Lowe’s generates $65 billion in annual sales.
The company operates more than 2,100 stores in the U.S., Canada, and Mexico. Lowe’s offers a wide range of products, for maintenance, repair, remodeling, and decorating the home.
Source: Investor Presentation, page 5
It has a wide selection of leading national brands, as well as a large number of private brands.
Lowe’s has shrugged off the poor performance of the broader retail industry. It continues to perform well, as consumers remain willing and able to spend on their homes.
Lowe’s comparable-store sales increased 4.2% in fiscal 2016, and grew 3.4% over the first six months of 2017.
Sales growth came from increased transactions, as well as higher average tickets.
Source: Q2 Earnings Presentation, page 4
Combined with cost controls and share repurchases, Lowe’s adjusted earnings-per-share increased 16% in the first half of 2017.
Lowe’s has benefited from several fundamental tailwinds. The economy continues to grow, as does the housing market. Rising wages and home prices are incentivizing more consumers to invest in their homes.
Going forward, Lowe’s sales and earnings should continue to rise, due to growth at existing stores, as well as new stores, in the U.S. and elsewhere.
Growth Prospects
Lowe’s primary growth catalysts include new stores, including international expansion, and growth in new channels.
The U.S. economy continues to grow at a steady, albeit modest, pace. Important economic indicators for Lowe’s–which include unemployment and housing prices–are trending in a positive direction.
Conditions remain favorable for growth in consumer spending.
Source: Investor Presentation, page 2
Lowe’s expects GDP growth of at least 2%+ in the U.S., which is still supportive of growth for the company. In addition, the unemployment rate has declined to 5%, the level generally viewed as full employment.
And, in 2016 home prices neared their pre-Great Recession peak of 2007. This is why Lowe’s continues to open new stores.
For 2017, the company expects to add approximately 25 home improvement and hardware stores.
Lowe’s has targeted Canada as a key growth market. Last year, Lowe’s acquired Canadian home improvement retailer Rona, for $2.3 billion.
Adding Rona gives Lowe’s access to the large, and growing, Canadian home improvement market.
Source: Investor Presentation, page 4
Rona’s footprint is concentrated in Quebec, which is home to 25% of the country’s home improvement market. Lowe’s forecasts 4% annual growth for the Canada home improvement market, through 2018.
The acquisition should be significantly accretive to earnings. Lowe’s expects to generate over $1 billion of cost synergies, from the Rona deal.
Lastly, Lowe’s is building its own digital platform, to keep up with e-commerce retailers. The company’s omni-channel strategy is working, as comparable sales increased 43% on lowes.com last quarter.
For 2017, Lowe’s expects sales growth of 5%, thanks to 3%-4% growth of comparable sales. The company estimates earnings-per-share in a range of $4.20 to $4.30, which would represent 5%-8% growth from 2016.
Competitive Advantages & Recession Performance
The retail industry typically does not offer many competitive advantages. This is a highly challenging retail environment, as the rise of Amazon (AMZN) and other Internet retailers threatens to undercut brick-and-mortar stores.
Consumers have shifted spending dollars toward e-commerce, for the convenience and low prices. However, Lowe’s is a specialty retailer, which provides it with a competitive advantage.
Home improvement projects are often complex. Consumers seem willing to travel to stores, to inspect products in person, and ask questions to staff members. This has helped protect home improvement retailers from Amazon so far.
And, Lowe’s has the scale to compete on price, even with Internet retailers. Lowe’s operates in an industry that is essentially a duopoly. Lowe’s dominates home improvement retail, along with Home Depot.
Lowe’s has the scale to reap significant efficiencies in distribution, and with suppliers. It can leverage its size to keep costs low, which it can then pass on to customers in low prices.
That said, Lowe’s is not immune from recessions. Consumer spending typically declines during economic downturns. Lowe’s depends on a financially-healthy consumer. The Great Recession was a particularly steep downturn, which took a significant toll on Lowe’s bottom line.
Lowe’s earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $1.86
- 2008 earnings-per-share of $1.49 (20% decline)
- 2009 earnings-per-share of $1.21 (19% decline)
- 2010 earnings-per-share of $1.44 (19% increase)
- 2011 earnings-per-share of $1.69 (17% increase)
Lowe’s earnings fell sharply during the recession, but the company still remained profitable. This helped it continue increasing its dividend each year. And, it bounced back just as quickly: by 2013, Lowe’s earnings had surpassed 2007 levels.
Valuation & Expected Returns
Lowe’s has a trailing price-to-earnings ratio of 22.5. This is slightly below-average; the S&P 500 Index currently has an average price-to-earnings ratio of 25.7.
A price-to-earnings ratio above 20 could be too high for a retailer, which typically hold lower valuations. According to ValueLine analysts, in the past 10 years, Lowe’s stock has held an average price-to-earnings ratio of 17.5.
As a result, a declining price-to-earnings ratio, could reduce future returns. Excluding impacts of a rising or falling valuation, Lowe’s returns will be generated from earnings growth and dividends.
In the past decade, Lowe’s grew earnings-per-share by 8% per year, compounded annually. The company expects 5%-8% earnings growth for 2017. It should be able to reach a similar level of earnings growth over the long term, due to sales growth, margin expansion, and share repurchases.
A potential breakdown of future returns is as follows:
- 2%-4% comparable sales growth
- 1% margin expansion
- 2%-3% share repurchases
- 2% dividend yield
This forecast would result in 7%-10% total annual returns. If comparable sales growth exceeds this level, returns could be higher. However, a contracting price-to-earnings ratio would negatively impact future returns.
The current annual dividend payout of $1.64 per share represents just 38%-39% of expected 2017 earnings-per-share. This is a fairly low payout ratio, and is a positive catalyst for future dividend growth.
Final Thoughts
Lowe’s has a relatively low dividend yield, but it makes up for this with high dividend growth rates. The company consistently provides double-digit dividend growth each year. The current environment is difficult for retail, but Lowe’s operates in a niche that should withstand e-commerce competitors.
Lowe’s is still growing sales and earnings, which should allow for continued dividend growth. And, it has a low dividend payout ratio, which also supports high dividend increases. The stock may not be enticing for investors interested in high yields, but Lowe’s remains a strong dividend growth stock.
