Dividend Aristocrats Part 35: Lowe’s Companies, Inc. (LOW)

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Dividend Aristocrats Part 35: Lowe’s Companies, Inc. (LOW) by Ben Reynolds, Sure Dividend
Two home improvement stores dominate the industry in North America:

  • Lowe’s (LOW) which has a market cap of $70 billion
  • Home Depot (HD) which has a market cap of $169 billion

Lowe’s is the second largest company in a well-consolidated industry. Lowe’s is the ‘Pepsi’ to Home Depot’s ‘Coke’.

Large businesses in consolidated markets tend to generate greater margins than more fragmented industries. Lowe’s has a long history of rewarding its shareholders… A very long history.

Lowe’s was founded in 1946 and has paid rising dividends for 53 consecutive years. This makes Lowe’s one of only 17 Dividend Kings – dividend stocks with 50+ years of consecutive dividend increases.

Lowe’s owns and operates over 1,845 home improvement stores in the United States, Canada, and Mexico – the vast majority of company stores are in the United States. In total, Lowe’s employees more than 265,000 people.

In 2009, Lowe’s acquired a 33% stake in Australian home improvement retailer Woolworth’s.  Lowe’s owns 33% of Woolworth’s 38 home improvement stores in Australia.

Lowe’s Competitive Advantage

Lowe’s 53 year streak of consecutive dividend increases is evidence of a durable competitive advantage.  The company’s competitive advantage comes from its recognizable brand, large scale, and number of locations.

New entrants to the home improvement retail market would be hard-pressed to compete with Lowe’s and Home Depot. Lowe’s established brand lets consumers know they can expect quality products at low prices when shopping at Lowe’s. The sheer quantity of Lowe’s locations in the United States leaves little room for new entrants in this mature market.

Lowe’s has generated over $58 billion in revenue in the last year.  The company’s large scale allows it to put pressure on suppliers to reduce costs and drive more customers to its stores.  This creates a virtuous improvement cycle that smaller competitors cannot match.

Lowe’s Dividend Growth Rate & Growth Prospects

Lowe’s dividend growth rate over the last decade is a phenomenal 23.5% a year.

Don’t let this number fool you, Lowe’s is not growing at 20%+ a year over a full economic cycle. If it did, it would be worth a trillion dollars in about 16 years. That’s not happening.

The reason Lowe’s dividend has grown so rapidly over the last decade is because the company has hiked its payout ratio from around 10% a year to over 30% a year. Lowe’s has held its payout ratio around 30% since 2010. Shareholders should not expect further rapid dividend growth from payout ratio expansion.

Lowe’s grew its earnings-per-share at a more modest 5.7% a year over the last decade. This is a more reasonable growth rate and more indicative of what shareholders should expect.

The company’s growth comes in fits and starts. Earnings-per-shares have more than doubled from 2009 through expected 2015 results. On the other hand, earnings-per-share were higher in 2004 than they were in 2009 for Lowe’s.

Why is this?

Lowe’s performance is dependent upon the United States housing market specifically, and the overall economy in general. When the economy is in recession, people do not move as often, and spend less on home repairs and maintenance.

Lowe’s net profits in 2006 were $3.1 billion. 2015 profits are expected to be $3.1 billion as well. Lowe’s has not managed to grow the profitability of its underlying business. The company has rewarded shareholders with share repurchases, however.

From 2006 through 2015, Lowe’s has reduced its share count by over 6% a year. Lowe’s has returned nearly all of its earnings to shareholders through share repurchases alone since 2006. The company’s debt levels have increased (but are still reasonable) as management has used debt to fund dividends and growth while paying out earnings as share repurchases.

Going forward, I expect Lowe’s to deliver shareholders total returns of 7.5% to 10.5% from the following sources:

  • Share repurchases of 4% to 6% a year
  • Organic growth of 2% to 3% a year
  • Dividends of 1.5% a year

Recession Performance

As mentioned earlier in this article, recessions affect Lowe’s. The Great Recession caused Lowe’s margins to compress.

Lowe’s had earnings-per-share of $1.99 in 2006.  The company did not hit new earnings-per-share highs until 2013, 7 years later.  Holding on to a stock for 7 years is a long time to wait for a recovery.

Lowe’s did remain profitable through the Great Recession, but earnings-per-share fell sharply.

The company’s earnings-per-share from 2006 through 2013 are shown below to give an idea of how recessions impact Lowe’s:

  • 2006 earnings-per-share of $1.99 (high at the time)
  • 2007 earnings-per-share of $1.86 (start of recession)
  • 2008 earnings-per-share of $1.49
  • 2009 earnings-per-share of $1.21 (recession low)
  • 2010 earnings-per-share of $1.44 (start of recovery)
  • 2011 earnings-per-share of $1.69
  • 2012 earnings-per-share of $1.76
  • 2013 earnings-per-share of $2.16 (new high at the time)

Lowe’s Stock Price Valuation

Lowe’s is currently trading at a price-to-earnings ratio of about 23 times expected 2015 earnings.

The company has historically traded at a premium to the S&P500’s price-to-earnings ratio of about 1.1x – when the United States housing market is strong.

The S&P 500 is currently trading for a price-to-earnings ratio of 21.8. This implies a fair price-to-earnings ratio of around 24.0 for Lowe’s in today’s overpriced (relative to historical averages) market.

When the United States housing market is weak Lowe’s trades at a discount of about 0.8x to the S&P500’s price-to-earnings ratio.

It is best to purchase shares of Lowe’s during weak housing markets, and sell the stock when its price-to-earnings multiple expands and housing markets are strong.  Now is not the time to start a position in Lowe’s.

Final Thoughts On Investing In Lowe’s

Lowe’s does not rank particularly well using The 8 Rules of Dividend Investing.  The company has a below-average 1.5% dividend yield and an above average stock price standard deviation of 31%.

On the bright side, the company does offer investors decent total return potential thanks to its large share repurchases and shareholder friendly management. Additionally, Lowe’s has a conservative payout ratio which makes continued dividend growth very likely.

In the final analysis, investors looking for exposure to the North American home improvement market should consider Lowe’s when the housing market is struggling and the company’s shares can be picked up at a discount, not during bull markets.

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