By: Margin of safety equity research

Lowe’s Companies Inc. Analysis. Near-Term Headwinds but Above-Average Long-Term Potential


Incorporated in 1952, Lowe’s Companies Inc (LOW) is the world’s second largest retailer in home improvement. Currently, it has a network of over 1,750 retail outlets across the U.S., Mexico, and Canada.

Its products include appliances, lumber, paint, millwork, building materials, lawn & landscape products, flooring, plumbing, seasonal living, tools, hardware, lighting, nursery, outdoor power equipment, cabinets & countertops, home organization, rough electrical and home fashion. Lowe’s stocks popular national brands and exclusive private brands across different categories. Its service lines are structured around installed sales (flooring, millwork and cabinets & countertops), protection and repair services and credit financing through GE Money Bank, Lowe’s Project Card and Lowe’s Visa Card. Services under the installed sales package are offered through a number of independent contractors. Appliances form the majority (11%) of sales, followed by lumber and paint (7%), millwork, building materials, lawn & landscape products, flooring and rough plumbing with 6% each.

Lowe’s achieved sales of $48.82 million in FY 2010, registering y-o-y increase of 1.3% in comparable stores sales. The projected decrease in comparable stores sales for FY 2011 is ~1%. Total sales for the year are expected to increase by 2-3% and diluted EPS is likely to fall in the range of $1.37-1.40.


Lowe’s Companies Inc, a Fortune 50 company, is a dominant player in the home improvement retail segment. On the back of its efficient supply chain management, cost-reduction strategies, branding, economies of scale, and integration of the latest technologies into its supply chain and distribution network; Lowe’s has secured a durable competitive advantage. Lowe’s faces stiff competition from its main competitor, Home Depot (HD). The market currently imposes several entry barriers for new entrants, including high capital requirements, resources required for penetration, a downturn in the housing market, and dominance of the leading players. This fragmentation leaves room for domestic expansion by both Lowes and Home Depot, who are better placed than their smaller peers in terms of economies of scale, wider reach and financial strength. A crucial part of Lowe’s economic moat is its network of 14 regional distribution centers, which incorporate state-of-the-art technology to maximize automation. The firm has constructed an efficient supply chain to efficiently manage its multibillion dollar inventory of merchandise to its stores throughout North America. In addition, Lowes runs 15 flatbed distribution centers for merchandise that requires special handling. However, key competitors, such as Home Depot are fast catching up on most of these fronts that have traditionally been the areas of strength for Lowe’s. Therefore, apart from successfully implementing its growth strategies, Lowe’s has to continue innovating to attain higher customer engagement and cost-economies. For the two main rivals with largely similar offerings, pricing and customer services will become the key differentiators going forward.

Presently, Lowe’s is reeling under pressure on several fronts as reflected by its relatively weak FY 2011 results. The Company has cited external factors, such as high fuel prices, a weak economic recovery, sagging consumer confidence, bad weather conditions, and withdrawal of Government stimulus, as contributing to its current weak performance. Continued weakness in the housing market, contraction of lending by financial institutions, geopolitical instability, and high unemployment rates have put a damper on US consumer confidence and are suppressing investments in the home improvement sector. To address these headwinds, Lowe’s is implementing a turnaround strategy that is expected to streamline its organizational and operational structures to bring in more functional and managerial efficiency. The restructuring included the layoff of almost 1,700 middle-levels managers across stores and hiring of 8,000-10,000 part-time salespersons. The ~1.5% increase in selling hours is meant to cater to the additional ~1.4% potential transactions that arise during the weekends due to higher foot traffic. Lowe’s is belatedly waking up to the reality that tough market conditions are here to stay and is bracing itself for hard times ahead. Accessibility to physical stores has been a weak area for Lowe’s. The Company operates only 1,750 stores as compared to ~2,250 stores by Home Depot. To consolidate its physical presence, Lowe’s is targeting newer and more convenient locations for opening stores, while scaling back operations in low performing geographies. The Company is expected to open 26 new stores and close 27 for the full year 2011.

Lowes survived the last global recession by enhancing its operational efficiencies and taking strategic initiatives for growth. The efficiencies resulting from these actions over the last couple of years have become its key differentiator against its competition. The Company revamped its supply chain to achieve greater trailer utilization, reduced distances travelled, and higher number of mode conversions, bringing in cost reduction of ~$490 million over the last six years. A superior IT-based inventory management system is an area where Lowe’s is a step ahead of Home Depot. In 2010, Lowe’s reduced its reliance on third-party vendors, bringing in IT systems for onsite repairs in-house, this is expected to save $14 million per annum on a recurring basis. The company expects further savings through the introduction of after-sales services for major appliances in the outdoor power equipment or OPE category. These repair services bring cost-reductions in the form of a lower rate of OPE returns, while boosting repeat clientele. This combined with Lowe’s economies of scale, allows it to price its offerings competitively and absorb the impact of its promotional schemes, such as the 5% daily discount on purchases made through consumer credit cards. The Company is also increasing the number of its service stores and regional distribution centers to achieve cost-efficiencies related to transportation and faster shipping to enhance customer satisfaction.

As its finishes FY 2011, the Company plans to revise its market segmentation and pricing strategies based upon the local factors using Base Price Optimization, patch area expansion and market assorting through the implementation of Integrated Planning and Execution. This program is designed to customize its offerings based on the specifics of each store location: demographics, customer preferences, and store employee knowledge will all factor in to its IPE strategy. Differential pricing will be another factor that can help Lowe’s increase local market share over the longer term. To make inroads into newer customer segments in the flooring and other offerings, the Company plans to cover various pricing points in the near-to-medium term. This includes economical offerings to cover lower income groups and cater to changing customer preferences in favor of low-priced items in these challenging economic times. Understanding the market’s requirement for personalized services, Lowe’s is actively improving upon its client interface through its Project Specialist Exterior (PSE) and District Commercial Account Specialist (DCAS) programs. Both PSE and DCAS have shown some measurable results in installed sales (10% y-o-y increase in FY 2010) and Commercial Business Customer sales (higher increase than company average), respectively. The Company is also benefitting from its newly introduced customer care centers that handle after-sales services and customer complaints. After a pilot in 100 stores, it expects the model to continue generating repeat sales in the long-term.

The growing significance of online and mobile technology for the

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