It’s usually pretty easy to get caught up in market news and buzz at any given moment. The truth is that it’s hard sometimes as an individual investor to sort through all of the noise and speculation that is going on and to find good opportunities. That can be true no matter what condition the economy is in, or what the market has been doing lately.
As of this morning most of the news seems to be positive. The latest jobs report from the Labor Department was released before the market opened, with the numbers beating estimates by more than 50%. Add to that the Fed’s interest rate cut earlier in the week, and little in the way of trade news to discourage investors about progress between the U.S. and China, and it looks like the market has everything it needs right now to keep moving higher.
A healthy economy, strong jobs data, and generally improving incomes means that a lot of retailers are expecting good things as we move into the holiday shopping season. That positivity extends into home improvement stocks like Lowe’s Companies (LOW). More than just enthusiasm about holiday sales, a strong economy implies that homeowners are more likely to invest in home improvement projects – painting walls, re-carpeting floors, and finishing basements, for example. That means plenty of trips to the hardware store for supplies and equipment.
Strong economic data throughout the year, along with an aggressive transformation plan by new management at LOW have spurred the stock to a strong, albeit volatile performance over the past year. The stock is up almost 21% year to date. The volatility means that the stock has swung widely between trading extremes; the last move began in mid-August following its last earnings report and has seen the stock bounce higher from about $93 to its current price a little above $112. That’s a 20% move all by itself over that period, which easily puts LOW at the front of market movers since that time. Do the stock’s fundamentals justify such an impressive performance, or is the move really just about market momentum? Let’s find out.
Fundamental and Value Profile
Lowe’s Companies, Inc. (Lowe’s) is a home improvement company. The Company operates approximately 2,370 home improvement and hardware stores. The Company offers a range of products for maintenance, repair, remodeling and decorating. The Company offers home improvement products in categories, including Lumber and Building Materials; Tools and Hardware; Appliances; Fashion Fixtures; Rough Plumbing and Electrical; Lawn and Garden; Seasonal and Outdoor Living; Paint; Flooring; Millwork, and Kitchens. The Company also supports the communities that focus on K-12 public education and community improvement projects. The Company serves its customers in the United States, Canada and Mexico. LOW has a market cap of $86.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by about 3.9%, while sales were mostly flat, but positive at 0.5%. In the last quarter, earnings increased dramatically, by a little over 76% while revenues increased by more than 18%. The company operates with a narrow margin profile that is showing useful signs of improvement, as Net Income was about 3.52% of Revenues for the last twelve months, versus 7.98% in the last quarter.
Free Cash Flow: LOW’s free cash flow is generally healthy, at a little over $2.9 million. That translates to a Free Cash Flow Yield of 3.39%. It is worth noting that this number has declined over the course of the year, from a little more than $5 billion in January of this year.
Debt to Equity: LOW has a debt/equity ratio of 7.8. This is much higher than I usually prefer to see, but isn’t unusual for stocks in this industry; nonetheless this is a big red flag because it does represent a significant drag on the company’s financial flexibility. The company’s balance sheet indicates that operating profits are adequate to repay their debt, however with more than $20.5 billion in long-term debt versus $2 billion in cash and liquid assets, and both of these numbers moving in the wrong direction (increasing debt and declining cash) liquidity is a concern.
Dividend: LOW pays an annual dividend of $2.20 per share, which translates to a yield of about 1.97% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for LOW is $3.42 per share. At LOW’s current price, that translates to a Price/Book ratio of 32.65 at the stock’s current price. The stock’s historical average is 10.22. A move to par with the historical average would put the stock at just about $35 – more than -68% below the stock’s current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line on the chart above marks the stock’s upward trend from November of last year to its peak at around $118 in April of this year. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. From its high, LOW dropped to a low in June at around $92 before rebounding. It revisited that level in August before pushing to a new short-term high at at around $115 in early September. The stock has bounced between about $106 at support and $113 at resistance from that point, but look like it could be building bullish momentum to break that resistance. If it does, and can maintain momentum past $118, the stock should retest its 52-week high at around $118. If, on the other hand the stock breaks down, a drop below $105 should certainly see the stock test its next support at around $102 where the 38.2% Fibonacci retracement line sits.
Near-term Keys: I think it’s pretty clear that there is no way to paint LOW as a useful value stock under current conditions; I also think that it’s a bad bet to make on any kind of long-term basis; the company’s high debt levels, with limited liquidity and declining Free Cash Flow are reason enough to say that the stock is absolutely as overvalued as my Price/Book analysis suggests. The only kind of trades that make sense for this stock are short-term in nature; if you want to be aggressive, you can use a break above $113, you might consider buying the stock or working with call options, but I would suggest being quick to take profits at around $115 rather than holding out for a test of the stock’s highs at $118. Despite the distance from the stock’s current price, I think the higher-probability bet is on the downside; a break below support at $105 would provide an interesting signal to consider shorting the stock or working with put options with any eye on $102 as a profit target point.