In recent months, cracks have emerged in the U.S. economy. Inflation is slightly down from its peak, but still elevated. And several more interest rate hikes are looking more likely than not.
Whether the U.S. will enter into an official recession, as determined by the National Bureau of Economic Research, remains to be seen. But regardless, investors can prepare by purchasing quality dividend stocks with proven track records, such as Dividend Kings.
With 60 years of dividend hikes under its belt, Lowe's (LOW -1.40%) is a Dividend King. And the stock looks like a purchase for income investors seeking rising dividend income. Here's why.
Resilient results considering the operating environment
With nearly 2,200 stores in the U.S. and Canada, Lowe's is the second-largest player in the $900 billion home improvement industry. In mid-August, the company shared its financial results for the second quarter that ended July 29th.
| Q2 2021 Net Sales | Q2 2022 Net Sales | Growth Rate |
|---|---|---|
| $27.6 billion | $27.5 billion | (0.3%) |
Lowe's recorded $27.5 billion in net sales during the quarter. For context, this fell short of the average analyst net sales estimate of $28.2 billion for the quarter. What was behind just the second net sales miss out of the past 10 quarters?
Lowe's faced a high bar to clear in the second quarter. This is because, unlike the year prior, the company didn't have the benefit of tons of economic stimulus in the hands of its customers. Couple that with a higher inflation rate, and consumers simply didn't have as much disposable income as they did a year ago.
This is why Lowe's comparable sales declined by 0.3% during the quarter. According to CFO Brandon Sink, product inflation and increased sales to professional contractors (Pros) helped lead the comparable average ticket 6.1% higher year over year. For context, Pros account for approximately 25% of Lowe's net sales and tend to spend both more heavily and frequently than do-it-yourself customers. A 6.4% decline in comparable transactions over the year-ago period was the result of consumers having less disposable income available due to higher inflation and economic stimulus drying up.
Given the exceptional operating results that Lowe's has delivered since the onset of the pandemic, the company was bound to post a flat quarter at some point. With the combination of headwinds that Lowe's encountered in the second quarter, I would argue that it held up quite well.
Massive share buybacks drove EPS higher
Lowe's reported $4.67 in diluted earnings per share (EPS) during the second quarter, which was 9.9% higher than the year-ago period. This came in slightly higher than the analyst diluted EPS consensus of $4.59 for the quarter, which was the 10th quarter in as many quarters that Lowe's has accomplished this feat.
| Q2 2021 Share Count | Q2 2022 Share Count | Percentage Change |
|---|---|---|
| 707 million | 639 million | (9.6%) |
A higher cost of sales stemming from elevated inflation was responsible for a 6 basis point drop in the company's net margin to 10.9% in the second quarter. Even though Lowe's net earnings were 0.9% lower over the year-ago period, the substantially lower share count helped diluted EPS to surge higher in the second quarter.
Thanks to the fact that Lowe's still has nearly $12 billion in shares that may be repurchased under its current share repurchase program, the company's share count is set to go much lower. Along with demand for its products and services that are set to grow over time, this explains why analysts are anticipating 9.4% annual diluted EPS growth for the next five years.
Image source: Getty Images.
An ultra-safe dividend
Lowe's arguably offers income investors the best of both worlds: The company's 2.1% dividend yield is above the S&P 500 index's 1.6% yield, and the dividend is poised to continue growing for the foreseeable future.
Lowe's dividend payout ratio is positioned to be just 27.4% in fiscal year 2023. This allows the company to retain more than enough capital for debt reduction, share repurchases, and bolt-on acquisitions to keep its diluted EPS moving higher in the years ahead. That's why I believe high-single-digit to low-double-digit annual dividend growth should be the norm over the medium term, which makes Lowe's an ideal income and dividend growth stock.
The stock is currently cheap
Lowe's is a fundamentally solid business. And based on its quality, the stock appears to be a great value pick.
That's because Lowe's forward price-to-earnings (P/E) ratio of 13.9 is moderately lower than the home improvement retail industry forward P/E ratio of 15.8. Since Lowe's is a leader in its industry, this is an enticing valuation for shares of the stock.
And the company also seems to be a good value based on the current phase of the economic cycle. The Shiller P/E ratio accounts for the variability of corporate earnings throughout a 10-year period, which is often a full economic cycle. Lowe's Shiller P/E ratio of 33.3 is a tad lower than its 10-year median of 35.9.
