Dividend Aristocrats: Time to Buy Lowe's?

Source: Lowe´s 

Dividend Aristocrats are a select group of high-quality dividend stocks. In order to be included in that exclusive club, a company needs to meet certain requirements -- it must be a member of the S&P 500 Index, have a float-adjusted market capitalization of more than $3 billion and, most importantly, it must have a track record of 25 consecutive years or more raising dividends without interruption.

Lowe's (LOW -0.47%) is much more than an average Dividend Aristocrat: the company has raised dividends over the last 52 years uninterruptedly, which is quite an exceptional track record of dividend growth, especially for a business operating in an industry as cyclical and competitive as home improvement retail.

However, even if history says a lot about a company's soundness and strength, investment decisions need to be based on future potential, not past performance. With this in mind, is now the right time to buy Lowe's stock?

On solid ground
With more than 1,835 home improvement stores in the U.S., Canada and Mexico, Lowe's is the second-largest player in the industry behind Home Depot (HD -0.57%), which owns 2,266 retail stores. In terms of sales, Lowe's is roughly 30% smaller than Home Depot; Lowe's produced revenue of $54.6 billion over the last twelve months versus $80.6 billion for Home Depot over the same period.

Broad geographic presence and brand recognition are key sources of competitive strength for Lowe's, and the company capitalizes on its scale to leverage its negotiating power with suppliers and obtain lower prices for its products. The company also differentiates itself from smaller competitors in areas such as its integrated supply chain and its big distribution network, which would be notoriously hard to replicate by smaller players trying to carve a niche in the industry.

While Lowe's comes behind Home Depot when it comes to its relationship with contractors and other professionals, the company is actively going after that lucrative segment of the industry. Lowe's is increasing its depth of inventory and making the necessary adjustments to better fit the needs of professionals. The company is also improving the quality and speed of its service to attract more pros; this includes initiatives such as dedicated specialists and loaders for professionals and account executives visiting pros at their place of business for convenience and more personalized service.

The company is launching a new website for pros, which will provide specific functionalities such as tools to develop requisition lists and the ability to view purchase history, as well as customized product catalogs. The site can also be integrated with the purchasing systems used by pros to manage their own business and keep their day-to-day operations better streamlined.

According to management, its ProServices business is outperforming other areas of the company, and CFO Bob Hull said in the latest earnings conference call that Lowe's has made "great progress with pros for 12 consecutive quarters", so the company seems to be clearly moving in the right direction in this crucial segment of the market. 

Building houses and cash flow
Lowe's has proven its financial strength by raising dividends through good and bad economic times. The company even increased its payments by 6.25% in 2009, when the economy was going through one of the deepest recessions in history and the housing market was downright collapsing. Competitor Home Depot, on the other hand, kept its dividends steady from 2007 to 2009.

Even better, dividend growth rates have accelerated materially since those times. What was a quarterly dividend of only $0.08 at the beginning of 2009 has almost tripled to a quarterly payment of $0.23 per share. This includes a vigorous increase of 28% in 2014.

The company produced $3.9 billion in operating cash flow during the six month period ending on August 1, while capital expenditures absorbed only $384 million of that money, so reinvestment needs are fairly low and the company gets to keep most of its operating cash flows as free cash flows, maintaining their availability for capital distributions to investors.

Dividends amounted to only $369 million during the last six months, so Lowe's has enormous room to continue increasing payments in the years ahead. The company allocated $2.05 billion to share buybacks over that period, showing that management is clearly committed to rewarding shareholders via both growing dividends and big share repurchases.

The dividend yield is not particularly high at 1.8%. However, strong dividend growth and generous share buybacks bode well for investors over the coming years.

The bottom line
With more than five decades of consecutive dividend increases, Lowe's has a truly extraordinary track record of dividend growth. The business generates tons of free cash flows, which leaves abundant room for further dividend increases and share repurchases in the future. Lowe's stock is not particularly cheap, but high quality Dividend Aristocrats don't need to be purchased on sale to deliver solid returns.