Lowe’s (NYSE:LOW) released its Q4 2022 earnings last Wednesday March 1, and the market reacted by pushing the share price down more than 5%.
Did its earnings report really merit such a hit to the company’s value?
Should investors be as spooked as the market appears to be?
Earnings beat estimates in Q4 2022
Lowe’s reported adjusted earnings than expected at $2.28 for the quarter – above market expectations of $2.21 per share and an increase of 28% vs Q4 last year.
You might expect the shares to have reacted favorably to this number, yet these earnings weren’t so much of a surprise because the company had already told the market to expect higher earnings during an analysts’ day in December 2022.
Sales rise, and margins increase as Lowe’s focuses on costs and productivity
Sales were higher, and operating margins widened.
Q4 2022 revenues increased to $22.4 billion from $21.3 billion in Q4 2021.
With a focus on boosting productivity and managing costs, operating margin rose by 88 basis points in the quarter. Bill Boltz,
“As one of the larger importers in the US, we continue to leverage our scale and carrier relationships to secure capacity and reduce our import and domestic transportation costs. As the cost of transportation and raw materials come down, we are working with our suppliers to ensure that our prices are competitive to support sales and to protect our margins. We have sophisticated cost optimization tools that track prices of the underlying components of the products we sell…..
“We are also holding our suppliers accountable to drive out costs through their productivity just as we are doing throughout our own organization.”
For the full year, sales rose to $97.1 billion with an adjusted operating margin of 13%. At $13.81, adjusted earnings per share were up by 15% on the previous full year.
But sales and earnings may not be all they first appear
Sales up. Earnings up. Or are they?
The headline numbers mask an important fact. One the market knew about, but, even so, when considered it puts a different shade on the Q4 release:
The fourth quarter included an extra week. The year was 53 weeks instead of 52.
That extra week added around $1.4 billion in sales for both the quarter and the year. Were this to be discounted, Q4 sales would have turned out at $21 billion – below the comparable quarter a year earlier, with comparable sales down by 1.5%.
Lowe’s online business is growing
Lowe’s is working hard to grow its online business, Lowes.com. It is streamlining the customer journey, improving payment options, and cutting out the expensive and inefficient store delivery model. Its efforts are delivering results, too, with online sales growth of 5% on top of the 11.5% growth reported in the same quarter last year – representing a two-year compound growth of 17% with more than 11% market penetration.
The results of its online strategy should offer opportunities to improve margins, customer satisfaction, and provide avenues for growth in future years. As President and CEO Marvin Ellison said on the earnings call:
“In the market-based delivery model, big and bulky products flow from our supply chain directly to customers’ homes, replacing our inefficient store delivery model. This delivery model is enabling us to further consolidate our industry leadership position in appliances and it positions us for profitable growth and other big and bulky product categories like grills, riding lawn mowers, and stock cabinets.”
Out of Canada, focused on the United States
After announcing the intention to sell its Canadian retail business in November last year, with a definitive sale agreement signed with Sycamore Partners, Lowe’s reported that it had closed the deal during Q4.
This will give it a greater focus on the United States, where it hopes to benefit from what it estimates to be a $1 trillion addressable home improvement market.
This simplification of the business model appears to be a solid strategic move, but has come at a cost. Lowe’s bought its Canadian business in 2016 for $2.4 billion. The sale recoups just $400 million of this. And we should also remember that the Canadian side contributed around 7% of full year sales to Lowe’s.
It’s the outlook that really hit the share price
The real driver of the share price fall was the guidance for 2023 – and this is very confusing.
For example, on the one hand, Ellison spoke about the high level of consumer savings (“still roughly $1.5 trillion higher than pre-pandemic”) and record levels of equity enjoyed by homeowners (“nearly $330,000 on average”). He opined that this equity would not be meaningfully eroded even with a modest decline in home prices. He also highlighted an aging housing stock. All factors should be positive for Lowe’s in a home improvement market that he estimates at $1 trillion.
But Ellison also spoke of recession-wary consumers (“reflected in some of the discretionary pullbacks we experienced during the holiday season”).
Brandon Sink, Executive Vice President and CFO, delivered a contradiction to Ellison’s previous bullish comments, saying:
“In 2023, residential investment will be under some pressure. Given elevated levels of inflation, higher interest rates, and a more cautious consumer, we are forecasting a slight decline in the home improvement market.”
The bottom line? Lowe’s expects sales of $88 to 90 billion in 2023, with comparable sales flat to 2% down on 2023.
And as for earnings? These will depend on operating margins, that Lowe’s expects to push higher to between 13.6% and 13.8%. It plans to do this by driving productivity improvements across the company and at its suppliers. And it will need to – Lowe’s also announced intentions to ‘invest’ $350 million in incremental wages for frontline associates on top of the $170 million in permanent wage investment made in December 2022.
What now for income investors?
In 2022, the company returned $16.5 billion to shareholders through share repurchases and dividends. It is committed to continuing to reward shareholders via these routes, and we have no reason to expect they shouldn’t be able to. Its payout ratio is a miserly 36% on a trailing annual dividend of $3.70 per share.
2023 will be challenging for Lowe’s, with earnings forecast of between $13.60 to $14 for the year. And since the management has already noted that sales is likely to be flat or -2% in the new year, there shouldn’t be any wild expectations from the market.
But we know from experience that the economy revolves. The tightening cycle will end. In the meantime, any share price volatility could provide opportunities for income investors to buy shares in a well-managed company that has a long history of delivering consistent and growing dividends.