The calendar year 2020 was a phenomenal year for Lowe's (NYSE:LOW). The company thrived by serving a population stuck at home indefinitely. All of a sudden, people had to do more things at home that they were accustomed to doing elsewhere; think exercising, remote learning, and remote working.
All the changes required adapting your home with fixtures and additions that Lowe's provided exceptionally well. Customer demand has remained elevated even as economies reopen, and one of the new challenges for Lowe's is to deliver on that demand. That's becoming increasingly more difficult as supply chain disruptions and rising costs are hitting businesses worldwide. That's why operating profit margin is one thing investors will focus on when Lowe's reports third-quarter earnings on Nov. 17.
Productivity improvement is expanding profits for Lowe's
Interestingly, for the fiscal year 2021, Lowe's management guided investors that it would run its business with an operating profit margin of 12.2%. The company has historically trailed its largest competitor, Home Depot (NYSE:HD), in that metric. Therefore, it has been a focus of management of late to close the gap against its rival.
So far, in the first two quarters of 2021, Lowe's is exceeding its target. Operating income as a percentage of sales is 14.34%, a total of 210 basis points ahead of plan. Management attributed the outperformance to a focus on improving productivity. One such improvement the company has implemented is digital pricing labels storewide. That way, associates no longer have to walk throughout the store changing prices. This feature is increasingly paying dividends as volatile price fluctuations on lumber and other commodities lead to frequent price adjustments. The cost for employee time is also increasing, as rising wages are hitting businesses broadly.
Supply chain disruptions and commodity price inflation have been well publicized in recent months. Management talked about dealing with the difficulties in its second-quarter conference call:
Supply chain costs also pressured margin by 35 basis points as we absorbed some elevated distribution costs and continued expanding our omnichannel capabilities. Our supply chain team continues to leverage our scale and carrier relationships to minimize the impact of these distribution costs experienced across the retail industry.
Indeed, with larger purchasing power, Lowe's can hold sway in negotiations with suppliers. A merchant can make more money selling to Lowe's at lower prices because Lowe's buys large quantities. As such, a supplier is not apt to risk losing Lowe's as a customer and is more willing to absorb higher costs.
Will a good performance in Q3 boost Lowe's stock?
Analysts on Wall Street expect Lowe's to report revenue of $21.7 billion in Q3 and earnings per share (EPS) of $2.30. The EPS estimate represents an increase of 16% from the figure in the same quarter last year. It appears that Wall Street expects productivity improvements for Lowe's to flow to the bottom line in a meaningful way.
Lowe's stock is already up 46% year to date, so it's uncertain if continued improvement on operating profit margin has room to boost it higher. But if anything can send a stock that's already hot even higher, it's increasing profits.