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3 Reasons Lowe's Companies Inc.'s Stock Could Fall

By Nickey Friedman – Oct 12, 2014 at 10:19AM

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The three concerns here have a common theme: What happens if the cycle suddenly takes a sharp turn down?

It's hard to find many people who would accuse Lowe's Companies (LOW -0.12%) of being a bad company, but with its stock flying high, you should be on the lookout for possible signs it could fall back to Earth. While you probably have little doubt about Lowe's continuing ability to rake in big money over the very long term, here are three reasons for concern that it could hit some speed bumps first.

Concern 1: How "Lowe" can it go?
Back in February during the earnings conference call, CEO Robert A. Niblock said, "We have taken a cautious approach to our 2014 outlook." Lowe's outlook for this calendar year (or the fiscal year ending the following January) was for revenue to grow 5% and same-store sales to grow 4%.

Niblock was so confident in hitting this "cautious" outlook that he defended it during the Q&A session by saying: "If you think about 2013, our initial comp outlook was 3.5%. We delivered 4.8%; that's roughly $650 million higher versus the expected comp plan."

He did acknowledge that the outlook had been tempered from forecasts earlier, but CFO Bob Hull came to his rescue by stating: "The first two weeks of February were tough. Trends have improved significantly since then, and we are very comfortable with our outlook for the first quarter and for the year."

Fast-forward to May, and Lowe's management reiterated the guidance but said little in the way of confidence this time around. Fast-forward again, this time to August, and that guidance for the year has been slashed from revenue gains of 5% to 4.5% and same-store sales growth from 4% to 3.5%. Could further reductions in outlook for this year and next year be coming? Confidence has slid four times now.

Concern 2: Save some for a rainy day!
I've always found it curious why companies take on debt and then execute a buyback and pay dividends. On one hand, you could say that doing so shows extra-high confidence; otherwise, it would be a reckless use of the bank account. But on the other hand, maybe that is kind of reckless, especially in the cyclical industry Lowe's operates in.

It sounds great to take in huge profits and return them to shareholders, and then some. But there could be long-term consequences if the economy goes into the tank. At the end of last quarter, Lowe's had around $1 billion in the bank, coupled with over $10 billion in long-term debt. Then on Sept. 9, Lowe's said it was taking on another $1.25 billion in debt.

Meanwhile, the company pays three-quarters of a billion dollars in annual dividends, has bought back $2 billion in stock so far this year, and has $4.3 billion left authorized in its stock buyback plan that it sure doesn't seem to be shy about tapping into. The company isn't leaving itself much of a cushion should something drastic and unforeseen happen to the company, or to the macro picture for home improvement or housing.

Concern 3: Bringing down the house
In the last earnings report, Niblock said, "We believe home improvement spending will continue to progress in tandem with strengthening job and income growth." That sounds wonderful, but it's a double-edged sword. "In tandem" means home improvement spending will go down if job and income growth fail to materialize.

Everybody seems to have an opinion on where the housing market is heading, and even the so-called experts have more wildly opposing views than ever before. Lowe's is affected not just by home improvement spending but also by the sale of new or existing homes. These multiple factors just make the psychic forecasting all the more difficult.

Even Lowe's management is having trouble with its own internal forecasts, so guessing where the macro picture is ultimately heading is an exercise in futility, not to mention a concern going forward. Should the macro picture unexpectedly take a severe downturn, Lowe's guidance doesn't account for it, and its cash/debt situation might not be in the best position possible.

Nickey Friedman owns shares of Apple. The Motley Fool recommends and owns shares of Apple and Bank of America. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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