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Don't Buy the Lowe's Spin -- There Are No Excuses

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You get the feeling that the Lowe's (NYSE: LOW  ) disappointing Q2 earnings report surprised even Chairman and CEO Robert Niblock. With positive, macroeconomic indicators like housing starts and construction working in the company's favor, how in the world does Lowe's miss expectations -- let alone announce declining earnings year-over-year? According to Niblock, there are a couple of reasons. But are they nothing more than CEO-speak, or is there a method to his madness?

First, the results
The $747 million in net earnings that Lowe's reported on Monday was a 10% drop vs. a year ago. The earnings results were somewhat muted by diluted earnings of $0.64 a share, similar to Q2 of 2011. But after Home Depot's (NYSE: HD  ) recently announced stellar quarter, simply maintaining the status quo won't do.

The nearly 37 million shares that Lowe's repurchased last quarter were intended to boost shareholder value and show confidence in a turnaround. Unfortunately, management's attempts were overshadowed by the lack of growth. Nice idea, but buybacks only work when shares are undervalued and when the company is delivering in other key areas, like sales and earnings growth. In the case of Lowe's, its $31.38-a-share stock price in early April means that the shares its bought back are in the red, at least for now.

Lowe's comparable store sales, a key metric for any retailer, declined 0.4% in Q2 vs. 2011. As noted in an earlier article, the lack of growth in Lowe's stores, especially compared with Home Depot, isn't new. Declining gross margin, from 34.5% to 33.9%, is indicative of another ongoing problem. Gross margin, net profit, and operating margins also lag those of Home Depot, and are only slightly better than Lumber Liquidators' (NYSE: LL  ) .

At $1.26 billion in market cap, Lumber Liquidators isn't quite in the same ballpark as Lowe's and Home Depot, but it's performed admirably. Lumber Liquidators has no debt, is improving operating cash flow, and is growing earnings. In the near term, it could prove to be a better growth option than Lowe's.

The lack of sales and earnings growth from Lowe's is really distressing when you review recent housing numbers. Other than slight hiccups in April and June, reports for 2012 have been impressive. July's positive housing report didn't impact Lowe's Q2, of course, but the cutting of estimates for the balance of the year, with those housing figures still resonating, was especially painful.

Now, the why's
According to Niblock, there are two key factors that affected Q2 2012 results. The first -- a 53-week fiscal year in 2011 vs. 52 in 2012 -- lowered diluted earnings $0.03 per share. The difference in timing warrants consideration; unfortunately the $0.03 doesn't change the big picture. There was also the $15 million charge in Q2 for corporate layoffs. The one-time expense shaved $0.01 a share off earnings, but again, it doesn't alter the underlying problems.

The bigger issues facing Lowe's is the shift in strategy from in-store "sales" and "specials," along with stocking slow-moving inventory, to "everyday low prices" and a focus on high-volume items. Changing a company's business strategy takes time, for employees and customers -- just ask J.C. Penney. But with competitors performing and housing improving, the timing couldn't be worse.

From here
To its credit, Lowe's recognized the need for a leaner company. The lack of margin growth, plus keeping up with Home Depot (and even Lumber Liquidators in some areas) in key management efficiency areas like ROA and ROE, necessitated drastic shifts in strategy. But as the housing market takes hold, how long should Lowe's investors have to wait? That's an easy one.

To take advantage of the improving retail housing market, look no further than Home Depot. For existing long-term shareholders that believe in the "new" Lowe's, don't panic, your time will come. Lowe's 2.3% dividend yield will help while you wait, but don't buy into the CEO-speak just yet.

As economic numbers continue to improve, it shouldn't be long before we begin to see stronger consumer sentiment and spending, too. When that happens, the retail industry as a whole will benefit. For two of the best alternatives in the sector, take a look at the special free report "The Death of Wal-Mart: The Real Cash Kings Changing The Face of Retail."

Fool contributor Tim Brugger currently holds no securities positions, including any mentioned in this article. The Motley Fool owns shares of Lumber Liquidators Holdings. Motley Fool newsletter services have recommended buying shares of Lumber Liquidators Holdings and The Home Depot. Motley Fool newsletter services have recommended writing covered calls on Lowe's Companies. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Tim Brugger

Tim has been writing professionally for several years after spending 18 years (Whew! Was it that long?)in both the retail and institutional side of the financial services industry. Tim resides in Portland, Oregon with his three children and the family dog.

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5/23/2016 4:02 PM
LOW $78.87 Down -0.95 -1.19%
Lowe's CAPS Rating: ****
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Home Depot CAPS Rating: ****
LL $11.90 Down -0.12 -1.00%
Lumber Liquidators CAPS Rating: ***