If your investment objectives have led you toward a strategy based on income investing, it's crucial that you invest in businesses that can continue to pay dividends.
Home improvement retailer Lowe's Companies (LOW -0.04%) hasn't just maintained its dividend; year after year, for 49 years straight, the company has raised the payout. That puts Lowe's just a year away from becoming a verifiable Dividend King. But does this mean the stock is a good fit for your portfolio? Let's discuss Lowe's fundamentals and valuation to help decide.
Second-quarter results don't break the investment thesis
Completing 17 million weekly customer transactions in the U.S. across 1,700-plus home improvement stores, Lowe's is a major player in the home improvement retail industry. Thanks to its strong brand recognition and scale, the company's $133 billion market capitalization is topped only by the $329 billion market value of Home Depot within its industry.
| Metric | Q2 2022 | Q2 2023 |
|---|---|---|
| Comparable sales growth rate (YOY) | (0.3%) | (1.6%) |
| Net margin | 10.9% | 10.7% |
| Diluted share count (in millions) | 639 | 585 |
Data source: Lowe's. YOY = year over year.
Lowe's net sales declined by 9.2% over the year-ago period to $25 billion during the fiscal second quarter ended Aug. 4. Initially, these results seem discouraging. However, a closer look justifies the argument that Lowe's results were fine.
Two outliers explain the company's lower top line for the fiscal second quarter. For one, the company completed the sale of its Canadian retail business to the private equity firm Sycamore Partners in February to narrow its focus exclusively on the U.S. market. For context, prior-year sales for this business were $1.7 billion. There was also one fewer week in the second quarter than in the prior-year period, which was a $335 million headwind to sales.
Aside from these one-time events, Lowe's comparable sales slightly decreased in the fiscal second quarter. The company's comparable average ticket grew by 0.3% year-over-year during the quarter. But due to pressure in do-it-yourself discretionary purchases resulting from higher interest rates and elevated inflation readings, consumers had less discretionary income available. That caused a 1.9% dip in comparable transactions.
Lowe's diluted earnings per share (EPS) fell by 2.4% over the year-ago period to $4.56 for the fiscal second quarter. A slower decline in selling, general, and administrative expenses than net sales pushed the net margin roughly 20 basis points lower in the quarter. These factors couldn't be completely countered by a sizable reduction in its share count from its share buyback program. That explains how diluted EPS still dropped, albeit at a lesser pace than net sales during the quarter.
The Federal Reserve will likely begin lowering interest rates sometime in 2024. As home improvement spending and homebuilding activity inevitably pick up, Lowe's will greatly benefit from an improved macroeconomic environment. That is why analysts anticipate the company will deliver 5.6% diluted EPS growth annually for the next five years. And since Lowe's tends to outperform expectations, this could even be a lowball consensus growth estimate.
Image source: Getty Images.
The payout could have many years of growth left
Lowe's 1.9% dividend yield tops the 1.5% yield of the S&P 500 index. If that weren't appealing enough for dividend investors, the company has more than doubled its quarterly dividend per share in the last five years to the current mark of $1.10.
Since Lowe's dividend payout ratio is poised to clock in at approximately 32% in the current fiscal year, there seems to be room for future payout growth. The company is retaining enough funds to grow its operations, repurchase shares, and reduce debt.
An iconic company at a discount
Shares of Lowe's have rallied 14% higher so far in 2023. Yet the stock still appears to be cheaply valued: Lowe's forward price-to-earnings (P/E) ratio of 15.7 is clearly below the home improvement retail industry average forward P/E ratio of 18.8. This arguably makes the stock a solid buy for dividend growth investors at the current $228 share price.
