Lowe's: Where It Stands And Where It Can Go

Lowe's ( LOW ) is a home improvement retailer which operates primarily within the United States. The company operates through a network of around 1,700 big-box stores (megastores) that stock all sorts of home-related items, ranging from electrical appliances, plumbing equipment to wallpapers and flooring materials. The company is the second largest retailer of its kind after close rival Home Depot ( HD ), which has a chain of around 2,000 stores in the United States.

See our complete analysis of Lowe's here

A Top Line View

Since Lowe's offers products for home development and improvement, the company's earnings are closely tied to the state of the U.S. housing market, especially new home constructions. The correlation can be seen quite clearly in the company's top line. Lowe's earned around $48 billion in revenue in 2008, just before the big housing crash. Year 2009 saw revenues decline to $47 billion. With the gradual recovery of the housing market 2010 onwards, the company's top line has also moved upwards, figures for 2011 stood at $50 billion.

The decline in the housing market caused a serious crunch in the total spending available for Lowe's and Home Depot to grab during 2009-11 period. Lowe's turned to innovative strategies during this period of uncertainty, as it looked to wrest market share from its larger rival.

Some key strategic steps completed by Lowe's during this period were:

1. Shift towards an online store model with 'MyLowes' : In 2011, Lowe's launched a new online shopping platform called 'MyLowes', which allows consumers to set up online profiles in order to manage purchases, track purchased goods and work on home development ideas, through collaborations with Lowe's experts. The company also launched mobile applications for the online platform.

2. Introduction of new pricing model 'Everyday Low Prices' : Instead of relying on traditional promotions and pricing incentives such as discounts, the company moved to a new pricing model with 'Everyday Low Prices'. Through this program, the company effectively offers the lowest possible prices on stocked goods. Lowe's guarantees consumers that they will offer 10% lower prices on all products that customers find in rival stores.

3. Improving in-store shopping experience: Realizing that the economic downturn would mean that more customers would want to start new home projects on a do-it-yourself (DIY) basis, Lowe's has been focusing on improving in-store experience. The company has focused customer service through staff training as well as in-store design elements such as product labeling and aisle arrangements.

Despite such internal reinventions, Lowe's has performed relatively poorly compared to Home Depot during the period 2009-11. Q3 2012 marked the eight straight quarter in which Lowe's trailed Home Depot in change in same-store sales. This indicates that it has been losing market share to its rival during the last three years. One of the key factors holding back Lowe's today is that its new pricing policy hasn't gone down very well with consumers, who are more familiar with traditional pricing strategies revolving around discounts and promotional coupons. Home Depot's wider network of stores in the U.S. has also allowed it to leverage the recovery in the housing market, in a more effective way than Lowe's.

Compared to Lowe's 3% year-over-year revenue growth in 2011, Home Depot grew by around 4%, that too on a base that is larger by around $20 billion. However, going forward, we are optimistic about Lowe's prospects vis-a-vis its key competitors. As consumers become more familiar with the new pricing strategy and the 'MyLowe's' platform, we expect the company to become more effective in leveraging the rebound in the housing market. This should arrest the company's decline in market share in the near future.

A Bottom Line view

Facing a stagnant market and declining revenues, Lowe's focus should, ideally, have been on reducing expenses during the market turmoil of 2009-10. But the company did not fare too well in this aspect. Despite flagging sales, Lowe's continued to pump in capital into new stores, well into 2010. The company added around 100 stores during the two-year period even as average revenue per store dropped to levels which were 10% lower than 2008. As a result of this, the company's operating margins fell by 1.5 percentage points even as Home Depot improved its own margins by around 3% over the same period.

This wrong turn was corrected in 2011, when the retailer finally halted its store expansion policy and even closed down 4 stores in the US. The launch of Lowe's online platform also provided the retailer with enough confidence to shift away from its traditional, capital-intensive model. Moreover, since 2010, the company has also made significant progress through various restructuring programs aimed at improving inventory management and ensuring speedier delivery of products and services. Such efforts finally seem to be paying off for the company, as it recorded a 76% rise in profits in Q3 2012. Going forward, we expect the company's revised policy to continue to pay rich dividends for investors.

What The Future Holds

As we have mentioned, our outlook for the company is largely positive, and we expect Lowe's to continue to improve upon past results. As customers become more comfortable with Lowe's new pricing model and the company's corrections regarding store expansion policies pick up pace, we expect both the bottom line and the top line to steadily improve in the future. The company also has international expansion plans. It is setting up stores in Mexico in order to earn its fair share of the country's booming housing market. The company has also set up stores in Australia in partnership with Australian retailer Woolsworth.

How these developments work out for the company remains to be seen, but its performance in the domestic market looks a surer picture with the continued resurgence of the housing market. Home Depot, which has consistently outperformed Lowe's over the last two years, should start feeling a lot more nervous now.

We have a Trefis price estimate of $36 for Lowe's stock, which is in line with the market price.

Understand How a Company's Products Impact its Stock Price at Trefis

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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