Lowe

1
Lowes Companies, Inc. (LOW)

• Jack Hainline Alex Stepien Sisi Lee Patrick
  Quirke
• PRESENTED ON TUESDAY, APRIL 26, 2011

2
Table of Contents

• Company Overview
• SWOT Analysis
• Management Assessment
• Industry Analysis
• Competitive Analysis
• Valuation
• Recommendation

3
Company Overview

• Founded in 1946
• NYSE listed (LOW) since 1961
• 2nd largest home improvement retailer in the
  world
• Headquartered in Mooresville, North Carolina
• Employs about 161,000 people
• Operates 1,749 stores, including 1,723 stores in
  the United States, 24 stores in Canada, and 2 in
  Mexico

Data from Yahoo Finance
4
Key Financials (FY 2010)

• FY 10 Sales 48.8B up 3.4
• Market Capitalization 34.76B
• P/E 18.55
• Current Share Price 26.34
• Gross Margin 35.14 up .28
• Operating Margin 17.31
• EBIT Margin 7.29 up .70
• Net Earnings Margin 4.12 up from 3.78
• ROA 5.8
• ROE 10.7

Data from Lowes 2010 Annual Report
5
Products and Services

• Home improvement appliances, lumber, paint,
  millwork, building materials, lawn landscape
  products, flooring, electric, etc.
• A typical Lowes store stocks approximately
  40,000 items with hundreds of items available
  through special order
• Installation services flooring, millwork,
  cabinets, and countertops (6 of sales)
• Extended protections repair services extended
  plans on many products in key categories

Source Lowes 2010 10-K
6
Selling Channels

• Stores retail home improvement stores generally
  open 7 days a week and average approx. 113,000
  sq. ft. of retail selling space, plus 32,000 sq.
  ft. of outdoor garden center selling space
• Lowes.com 24/7 shopping experience aimed to help
  reduce the complexity of product decisions and
  improvement projects by providing online product
  information, customer reviews, buying guides, and
  how-to videos (lt 1 of sales)
• Job site/In-home selling specialists available
  to consumers and commercial business customers to
  assist them in selecting products and services to
  purchase for a project

Source Lowes 2010 10-K
7
Sales by Product Category

• Lowes offers a diversified product porftolio

8
SWOT Analysis

• Weaknesses
• Large planned capital expenditures on technology
• Customer service model will increase SGA
• Duopolistic pricing
• Slowed store growth

• Strengths
• Strong product diversification
• Launched mobile site in December
• Duopolistic pricing
• Ability to stay in business through housing bust

9
SWOT Analysis (cont.)

• Threats
• Weak housing economy
• Consumers worrying the price of their home will
  still decline

• Opportunities
• Online expansion (1,000 SKUs per week)
• Updated call center with skilled employees
• Updated website with more personalization and
  exposure to Lowes designers

10
Management Discussion Analysis

• Capture market share in discretionary, small
  ticket purchases now
• to better capture market share of big ticket
  purchases when they return
• Invest in technological enhancements to improve
  efficiency
• Distribution
• Corporate infrastructure
• Base price optimization
• Selective new store openings, close
  underperforming stores
• Future store expansion in under-penetrated US,
  Canada urban markets

Source Lowes 2010 10-K
11
Management Discussion Analysis

• Transformation from a home improvement retailer
  to home improvement company
• Mobile site launch and mobile application launch
• MyLowes web portal with increased user
  functionality
• Upgraded call center
• Project Specialist Exteriors (PSEs) and District
  Commercial Account Specialists (DCASs)
• Normalize SGA structure
• 69 mix of FT versus PT employees, compared to
  HDs 59 mix of FT v PT
• January 2011 Lowes will replace 1,700 FT
  employees with 8,000 to 9,000 PT employees

Source Lowes 2010 10-K
12
Porters 5 Forces
Potential Entrants Moderate
Supplier Power Low
Buyer Power High
Industry Rivalry Low
Threat of Substitutes Low
13
Threat of New Entrants Moderate

• Large companies (LOW, HD) enjoy economies of
  scale
• Small companies compete effectively in niche
  areas
• Cater to contractors
• Offer specialty products and services
• Serve areas of limited customer concentration
  unattractive to larger companies

14
Supplier Power Low

• HD, LOW leverage consolidation in negotiations
• Higher supplier concentration
• Work with variety of suppliers to acquire
  essential inputs
• No single supplier accounts for more than 8 of
  Lowes total input purchases

Source Lowes 2010 10-K
15
Buyer Power Moderate

• Cautious consumer spending
• Pull back of discretionary, big ticket purchases
• Retailers increase private label penetration

16
Threat of Substitutes Low

• Market share protected by business segment
  cyclicality
• Cross/Up-Selling efforts reduce substitution
  initiatives
• Better tailor customer experience
• Increasing website functionality and usability

17
Rivalry Low

• Nearly duopolistic operating environment
• Substantial support to profitability
• Disciplined sales optimization in tough economic
  environment
• Benign competition

18
Industry Analysis

• Home improvement retail - trend
• The global home improvement retail sector shrank
  by 3.8 in 2009 to reach a value of 597.4
  billion.

Source Datamonitor
19
Industry Analysis

• Home improvement retail Segment 1
• DIY 34.7
• Building material 65.3

Source Datamonitor
20
Industry Analysis

• Home improvement retail Segment 2
• Americas
• 46.7
• Europe
• 34.4
• Asia-Pacific
• 17.1
• Rest
• 1.8

Source Datamonitor
21
Industry Analysis - Macro

• Unemployment rate
• 9.0 for 2011
• Home prices
• Decline another 5 to 8 during 2011
• Consumer credit
• Lower
• Real disposable personal income
• 2.6 for 2011

Source Lowes 2010 10-K
22
Industry Analysis - Macro

• Housing turnover
• Increase in 2011
• Home ownership levels
• 67.2 as of 2009 to 66.5 as of 2010
• Inflation as the prices of raw materials, oil and
  foreign manufacturing wages continue to increase
• Moderately improving consumer demand

Source Lowes 2010 10-K
23
Industry Analysis - Micro

• Factors that determine customer choice
• Location of stores
• 1/3 customer
• Customer service
• Price competition (promotion)
• Factors that determine individual company
  decisions
• IT investment (operational synergies)
• HD 34 for core technology
• Cash to Cash Cycle and other turnover
• Capital lease vs operating lease
• Balance sheet presentation
• Depreciation Leasehold improvements (tax shield)

Source 2010 U.S. Home Improvement Retailer
Satisfaction Study
24
Industry Analysis - Micro

• Expansion activities
• Domestic expansion new stores
• International expansion
• Merger acquisition
• Forward integration distributors
• Backward integration supplier
• Horizontal integration other home improvement
  companies
• Joint venture
• Lowes entered joint venture agreement with
  Australian retailer Woolworths Limited during
  2009
• CPEX expansion
• LOW 45 store expansion
• HD9 for new stores

25
Competitor Analysis
Description Market Global Market Share
Lowe's Companies Inc. (NYSELOW) The company offers a range of products for home decorating, maintenance, repair, remodeling, and property maintenance US Canada 7.95
The Home Depot, Inc. (NYSEHD) The companys stores sell a range of building materials, home improvement products, and lawn and garden products to DIY, and professional customers US, China Mexico 11.10
KingFisher plc (LSEKGF) It offers wallpaper, vacuum cleaners, shutters, tiles, storage systems, lighting products, light switches, shower enclosures, and bathroom products Europe Asia 2.70
Rona Inc. (TSXRON) Provide hardware, home improvement, and gardening products Canada
Lumber Liquidators Holdings, Inc. (NYSELL) Operates as a specialty retailer of hardwood flooring US
La-Z-Boy Inc. (NYSELZB) Incorporated manufactures, markets, imports, distributes, and retails furnitures US Canada
26
Competitor Analysis - Financial Ratios

• Margin for Lowes is about the industry average
  but it shows a lag in revenue growth

  LTM Gross Margin LTM Net Income Margin LTM Total Revenues Growth Rate ROA ROE 5 Year Beta
Lowe's Companies Inc. (NYSELOW) 35.1 4.1 3.4 6.03 10.72 1.0
The Home Depot, Inc. (NYSEHD) 34.3 4.9 2.8 8.24 17.44 0.79
KingFisher plc (LSEKGF) 37.4 4.7 (0.5) 5.05 9.50 0.65
Rona Inc. (TSXRON) 100.0 3.0 2.6 5.19 7.74 0.4
Lumber Liquidators Holdings, Inc. (NYSELL) 34.8 4.2 13.9 13.96 15.97 1.46
La-Z-Boy Inc. (NYSELZB) 30.1 2.4 0.5 4.08 7.83 2.38
Industry 35.16 4.39 25.62 6.94 15.34 N/A
Sector 37.46 4.44 -4.27 0.41 -2.30 N/A
SP 500 45.21 13.65 17.69 8.54 19.72 N/A
Source Capital IQ, One source
27
Competitor Analysis - Operational Efficiency

• Turnover ratios are satisfactory
• Expanding fast but sales per stores is lower than
  its major competitor

  Asset Turnover Cash-to-cash cycle (days) Square feet (m) Stores New Stores Sales/ SQ feet Sales/Store (m) Sales/Employee (m)
Lowe's Companies Inc. (NYSELOW) 1.46 45.72 197.00 1749 42 247.79 27.91 0.30
The Home Depot, Inc. (NYSEHD) 1.68 51.37 289.99 2248 8 234.48 30.25 0.36
KingFisher plc (LSEKGF) 1.07 N/A N/A N/A N/A N/A N/A 0.16
Rona Inc. (TSXRON) 1.68 N/A N/A 911 N/A N/A 5.11 N/A
Lumber Liquidators Holdings, Inc. (NYSELL) 2.77 100.21 N/A 223 37 N/A 2.78 0.52
La-Z-Boy Inc. (NYSELZB) 1.96 88.92 8.50 306 N/A 138.73 3.85 0.14
Source Company 10K, One source
28
Comparable Valuation

• The trading multiples yield a mean stock price of
  26.78/share

Comparables Comparables Comparables Comparables Comparables
  Market Capital TEV/Total Revenues LTM TEV/EBIT LTM P/Diluted EPS Before Extra LTM
The Home Depot, Inc. (NYSEHD) 60,023 1.02 11.86 18.69
KingFisher plc (LSEKGF) 10,598 0.62 9.3 13.23
Rona Inc. (TSXRON) 1,881 0.46 9.57 12.65
Lumber Liquidators Holdings, Inc. (NYSELL) 657 1 14.44 25.55
La-Z-Boy Inc. (NYSELZB) 565 0.43 15.58 21.02


Low's Valuation Low's Valuation Low's Valuation Low's Valuation Low's Valuation
  TEV/Total Revenues LTM TEV/EBIT LTM P/Diluted EPS Before Extra LTM Average
Maximum 31.57 36.41 35.77  
Minimum 11.01 20.13 17.71  
Median 17.63 26.76 26.17  
Weighted Average 29.16 26.02 25.15 26.78
Source Capital IQ
29
Discount Rate
Capital Structure Capital Structure
   
Market Price 26.34
Shares Outstanding 1,320.00
Market Capitalization 34,768.80
   
   
Total Debt 6,573.00
Total Common Equity 34,768.80
Total Capital 41,341.80
   
Weight of Debt 15.90
Weight of Equity 84.10
WACC WACC
   
Beta (Google) 1
Beta (Yahoo) 1.08
Beta(Reuters) 1
Beta Average 1.03
   
Market Return 10.00
Risk-Free Rate 3.50
Market Risk Premium 6.50
   
Cost of Equity (CAPM) 10.17
Cost of Debt 5.80
Tax Rate 37.70
   
Weighted Average Cost of Capital 9.13
WACC (ROE) WACC (ROE)
Cost of Equity 12.19
Cost of Debt 5.80
   
   
WACC (ROE) 11.17
WACC (ROE) WACC (ROE)
ROE (2008-2011) 12.19
   
ROE 12.19
Discount Rate (Goal Post Theory) Discount Rate (Goal Post Theory)
Cost of Equity 11.18
Cost of Debt 5.80
   
   
Discount Rate 9.98
30
Sensitivity Analysis
Discount Rate Discount Rate Discount Rate Discount Rate
26.13 10.17 10.67 11.17 11.67 12.17
2.00 26.93 25.11 23.51 22.09 20.82
2.50 28.54 26.52 24.74 23.17 21.78
Growth Rate 3.00 30.39 28.11 26.13 24.38 22.84
3.50 32.51 29.92 27.69 25.74 24.03
4.00 34.97 32.01 29.47 27.27 25.36
31
Discounted Cash Flow Value
  For the Fiscal For the Fiscal For the Fiscal For the Fiscal For the Fiscal For the Fiscal For the Fiscal For the Fiscal For the Fiscal For the Fiscal
  Year Ended January 31 Year Ended January 31 Year Ended January 31 Year Ended January 31 Year Ended January 31 Year Ended January 31 Year Ended January 31 Year Ended January 31 Year Ended January 31 Year Ended January 31
  2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Net Income 3,105 2,809 2,195 1,783 2,010 2,872 2,765 2,991 2,930 3,031
             
Depreciation Amortization 1237 1,464 1,667 1,733 1,684 1,760 1,742 1,829 1,820 1,875
             
Changes In NWC   (757) 330 761 451 (1,214) 156 (257) 195 (648)
             
Capital Expenditures (3,916) (4,010) (3,266) (1,799) (1,329) (1,760) (2,987) (2,091) (1,300) (1,607)
             
Free Cash Flow 426 1,020 266 956 1,914 4,085 1,364 2,986 3,255 3,946
             
Terminal Value           49,743
             
Time   1 2 3 4 5
             
PV of Free Cash Flow   3,715 1,128 2,245 2,225 2,453
PV of Terminal Value                   29,294
Growth Rate 3
5 Year Discount Rate 9.98
Terminal Discount Rate 11.17
Firm Value  
Total PV of FCF 41,059
Less Debt 6,573
Equity Value 34,486
of Shares 1,320
Intrinsic Value 26.13
10 28.74
-10 23.51
32
Recommendation

• DCF Value 26.13
• 10 28.74
• -10 23.51
• Comps Value 26.78
• Sensitivity Analysis Price Range 20.82 - 34.97
• Price as of Close 4/25/2011 26.34
• Recommendation Place on Watch List