As expected, Lowe's (NYSE:LOW) this week revealed accelerating growth trends that were powered by a shift in seasonal sales into the second quarter from the first. However, in his first earnings report as CEO, Marvin Ellison had to deliver some bad news to investors, too. Specifically, the retailer faced inventory issues that meant it was only able to recover a portion of the seasonal sales that would normally have happened in the fiscal first quarter.
In the earnings call, Ellison and his new leadership team explained why that execution failure reduced their growth targets for the year. They also detailed their aggressive rebound strategy aimed at finally closing the market-share gap with Home Depot (NYSE:HD).
Good but not good enough
We have work to do ... specifically, we're significantly behind in our supply chain strategy, our in-store technology is dated, overall execution is impaired by complexity, we have a large number of out of stocks in our stores that must be addressed, and we need to increase the rigor with which we evaluate capital investments.
Lowe's operating and financial metrics again trailed Home Depot's by a wide margin this quarter. Comparable-store sales gains were 5%, compared to 8% for its larger rival. Lowe's 10% operating margin was far below Home Depot's 14.5%. And, most importantly, traffic only rose by less than 1%, versus a 3% spike for Home Depot. These figures imply persistent market share losses and show that executives face major challenges in their hopes of accelerating sales growth.
Big changes are on the way
While we have the foundational elements of an omnichannel network, we need to better connect and align our systems and processes to create a truly integrated ecosystem. But fortunately, I've been down this road before, and I have a clear understanding of the steps and processes required to build a world-class omnichannel environment.
Investors have grown optimistic about the stock lately despite the retailer's operating stumbles, and that's likely due to expectations that the incoming CEO would bring significant strategic changes to the business. Those hopes were confirmed this week, as Lowe's outlined several aggressive moves, including the closing of underperforming stores and a plan to refresh its inventory posture.
Ellison revealed the elimination of $500 million of planned capital spending that will instead go toward stock repurchases. Investors were also treated to promises that executives are working to "create a true expense reduction culture." These shifts are all part of Ellison's plan to make Lowe's a leading omnichannel retailer during his tenure.
Why the downgrade?
While we recovered approximately half of the seasonal miss in the second quarter, assortment issues in flooring, inventory out of stocks, and reset disruption continue to exert pressure on sales growth. As a result, we now expect a total sales increase of approximately 4.5% for the year, driven primarily by a comp sales increase of approximately 3%.
-- CFO Marshall Croom
Lowe's lowered its full-year sales outlook to 3% from the 3.5% gain executives had targeted back in May. That move stands in stark contrast to other national retailers, including Home Depot, which have ratcheted up their targets thanks to rising customer demand.
Executives see plenty of reasons to expect robust growth in the home improvement industry this year, including solid housing demand and rising employment. Yet management believes their in-stock challenges will take more time to work through.
The lost second-quarter sales from these issues won't be recovered, either. Thus, the retailer's 2018 operating results should look a bit weaker than originally expected as the new leadership team tries to implement all the changes they think will lay the groundwork for better long-term trends.
Demitrios Kalogeropoulos owns shares of Home Depot. The Motley Fool has the following options: short September 2018 $180 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.