8/16/2010
By Brian Sozzi, Research Analyst

Today, Lowe's (LOW) released its 2Q10 earnings results to an investor base (and broad market for that matter) that was hungry for color on a few fronts.  First, with the first-time homebuyers tax credit having expired, and housing fundamentals softening since, how would this impact home improvement retailers?  Second, with specific programs targeted at the consumer already in a home (cash for appliances, etc.) having run their way through the system, to what extent would demand retrench?  Third, with the private sector still spinning its wheels on job creation, would home improvement retailers be able to continue to notch progress in larger ticket categories as seen in 4Q09 and 1Q10?  The report from Lowe's made one thing abundantly clear; a recovery in jobs (recovery is different than sub 100K private sector jobs created monthly), rather than stimulus injections, will be the requirement for home improvement retailers to deliver respectable earnings growth in 2H10 amid difficult comparisons and into 2011, where comparisons look tough in the first half.  Shares of Lowe's are down 31% since touching a 52-week high on April 60, underperforming Home Depot (HD) shares which have fallen 27% during that timeframe.  Is now a buying opportunity into a company aggressively repurchasing shares, recording sales and earnings growth, and boasting a low 28% debt to equity ratio?  Our initial take, it's not such an easy decision.

Lowe's reported net sales of $14.4 billion (consensus: $14.56 billion), +3.7% y/y.  We modeled for sales of $14.5 billion, an estimate we reduced on August 12 along with projected earnings.  The revenue miss is attributable to a shortfall on the comparable store sales line.  Lowe's reported a +1.6% comp, down from +2.4% in 1Q10, and below guidance offered on the 1Q10 earnings call of +2.0% to +4.0%.  The figure suggests Lowe's experienced a drop in both customer traffic (consumer confidence did take a hit during quarter) and a weakening in average ticket due to a slowdown in stimulus related spending.  Moreover, we view the comp as disappointing as Lowe's was cycling its easiest comparison of the year at -9.6% in 2Q09. 

Diluted EPS was $0.58 (consensus: $0.59) relative to guidance of $0.57 to $0.59.  We were at $0.60 per share for the quarter.  Lowe's repurchased $467 million in stock in the quarter, supporting EPS.  Above the EPS line, gross margin, although beating consensus slightly, was up a meager 2 bps y/y on not exactly a trying year earlier comparison.  There gross margin performance immediately raises flags as it pertains to the level of discounting (the company's inventory is on the high side compared to sales trends) and prices from the vendor base, which is attempting to recoup higher raw material costs.

The guidance from Lowe's, at this juncture (conference call will help), appears optimistic even though management tapered its FY10 ranges to account for the 2Q10 revenue miss.

Guidance Views

3Q10
* Net sales growth below consensus forecasts
* Minimal q/q comp improvement expected; in line to consensus
* EBIT margin expansion on the optimistic side; above consensus
* Generally in line EPS forecast

FY10
* Top end of sales growth guidance was downgraded (looks 2Q10 comp miss related)
* EPS range slightly narrowed

Brian Sozzi
Wall Street Strategies