Is LOW cheap enough yet?

December 13, 2018

Is LOW cheap enough yet?

Over the course of this last quarter of the calendar year, one of the areas of the market that has come under the most pressure is the Consumer Discretionary sector. From April until September, this sector was one of the market leaders, as a generally healthy economy drove retail stocks across a range of industries like Kohl’s (KSS), Target Stores (TGT), Home Depot (HD), and Lowe’s Companies, Inc. (LOW) to all-time high levels; but as anxiety about global tariffs combined with questions about whether the economy was finally starting to reach a peak, this sector dropped well into correction territory and is down a little over 12% since the beginning of September.

Home improvement stocks like HD and LOW seem to be an interesting economic barometer, especially as it relates to consumer-level impact. A healthy economy generally means increasing home ownership, both for new homes as well as existing, older homes. That is usually a good thing for this industry, since homeowners naturally have to spend money to maintain their homes. Another element that plays a role, of course is interest rates.  Low rates not only motivate higher borrowing for mortgages, but also spur increased home improvement sales as consumers spend and borrow money to upgrade and improve existing homes.

The fact rates have been increasing isn’t a positive for this industry, and in fact is one of the things that I believe have played a role in pushing HD and LOW into bear market territory over the last three months; but recent economic data seems to be giving the market reason to believe that the Fed may slow the pace of interest rate increases. On a historical basis, rates remain relative modest, which means a slower pace, or even a pause in rates could give this industry a boost in 2019. LOW is an interesting company, in the midst of a corporate transformation, with a new management team that is mapping out a new strategy that includes selling non-core businesses, lowering costs and improved store execution. They are down more than 20% over the quarter, which means that the stock is underperforming versus the broader sector and is in bear market territory. There are some interesting fundamental qualities that I think make LOW worth watching; but I’m not sure the long-term outlook for the stock is quite as positive as I would like to see.



Fundamental and Value Profile

Lowe’s Companies, Inc. (Lowe’s) is a home improvement company. The Company operates approximately 2,370 home improvement and hardware stores. The Company offers a range of products for maintenance, repair, remodeling and decorating. The Company offers home improvement products in categories, including Lumber and Building Materials; Tools and Hardware; Appliances; Fashion Fixtures; Rough Plumbing and Electrical; Lawn and Garden; Seasonal and Outdoor Living; Paint; Flooring; Millwork, and Kitchens. The Company also supports the communities that focus on K-12 public education and community improvement projects. The Company serves its customers in the United States, Canada and Mexico. LOW’s current market cap is $75.3 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings declined about -1%, while sales grew almost 4%. The last quarter didn’t improve the earnings picture, since earnings declined almost -50%, while sales dropped close to -17%. The company operates with a very narrow margin profile that seems to be getting even narrower; Net Income versus Revenues over both the past year was 5.18%, but decline in the most recent quarter at about 3.6%.
  • Free Cash Flow: LOW’s free cash flow is one of most impressive aspects of their fundamental profile, at $5.3 billion. That translates to a Free Cash Flow Yield of 7.2%. Another positive is the fact Free Cash Flow has increased significantly since the beginning of the year, when it was about $4 billion.
  • Debt to Equity: LOW has a debt/equity ratio of 2.68 and makes them one of the most highly leveraged companies in their industry. While their balance sheet indicates operating profits are sufficient to service their debt, liquidity is a question mark; cash is a little over $1.8 billion while long-term debt is almost $14.5 billion.
  • Dividend: LOW pays an annual dividend of $1.92 per share, which translates to a yield of about 2.1%.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for LOW is only $6.72, and which translates to a Price/Book ratio of 13.76 at the stock’s current price. Their historical average Price/Book ratio is 10.36, which means that even with the stock down 20% since September, it remains almost 25% overvalued right now. The fact is that based on Price/Book ratio, the stock can’t really be considered a good value until it drops to about $55. The last time the stock was in that price range was October of 2014.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: LOW isn’t far from the 52-week lows it established earlier this year in the $81 to $83 price range. The momentum of the stock’s downward trend right now means that the stock would have to break above resistance at $95 to mark any kind of consolidation range right now, with a break above $100 a good technical reference for an actual bullish trend reversal. If the stock breaks below its current pivot support around $86, look for strong consolidation in the $81 to $83 range. A drop below that level would mean the downward trend will likely continue for the foreseeable future, with the next most likely support level around $75. 
  • Near-term Keys: A push above $95 could set up an interesting bullish swing trade using call options, with a near-term target price at around $100. If the stock breaks its current support, you might consider shorting the stock or buying put options with an eye on the stock’s 52-week low around $81 as an exit point for that trade. The fact is that the stock’s value proposition right now just isn’t interesting enough to justify any kind of long-term position on this company. They are interesting potential turnaround story, it is true; but I would prefer to wait to see new management’s strategy paying off in the form of improving general fundamental strength, lower debt levels, and improving Book Value.