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LOW AT A GLANCE

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Lowe's Companies (NYSE: LOW) is the second largest home improvement retailer in the world and one of the top ten largest retailers in the U.S. with $48.2 billion in sales in 2008. ^[1][2] Lowe's offers products and services across twenty categories in their home improvement stores, ranging from kitchen appliances to lumber to gardening tools. The company ranks second in home improvement retailing to Home Depot (HD), which had total sales of $71.3 billion in 2008 -- nearly one-and-a-half times that of Lowe's. ^[3] Although Home Depot's has dominated Lowe's since 2005, in 2008, both companies net incomes were nearly equal ($2.20 billion for Lowe's and $2.26 billion for Home Depot) ^[1][3] -- a big difference from 2005 when Home Depot's net income was more than double that of Lowe's.

Like all home improvement retailers, Lowe's is very vulnerable to interest rates and the continued housing market slowdown. The subprime mortgage crisis in the financial industry has also been a large factor behind Lowe's struggles. In 2008, even though Lowe's net sales decreased less than 1% from 2007 sales, net income decreased 22% to $2.2 billion and same store sales decreased 7.8% for the year.^[1][4] In addition, at of the end of fiscal 2008, Lowe's operated over 1,649 stores in the United States and Canada -- all but 11 of the stores were located in the US, ^[5] which gives Lowe's greater exposure to the struggling domestic US market. The economic downturn has also caused the company to slow down store expansion -- Lowe's only plans to open 60 to 70 new stores in 2009 compared to the 115 and 149 stores it opened in 2008 and 2007 respectively.^[5] Home Depot on the other hand operates 262 stores internationally and has stores in China, which act as a buffer to the domestic market. ^[6] Lowe's plans to expand internationally in 2009, but only into Mexico.

Company Overview

Lowe's started as a single hardware store in North Carolina in 1946 and since then has grown to the second largest home improvement retailer in the world behind Home Depot. Today, the company makes money in several different key areas:

Stores and Products

Lowe's provides a wide range of home building supplies (about 40,000 products per store) and services to its target customers. ^[7] The company sells national brand name merchandise ranging from Whirlpool to John Deere and proprietary brands exclusive to Lowe's such as Kobalt and Harbor Breeze.

In 2008, the company operated 1,649 stores in the United States and Canada -- all but 11 of the stores were located in the United States. Most retail outlets are big-box stores (averaging around 110,000 square feet of retail space) which are used in large markets, and some are smaller 94,000 square-foot stores used for smaller markets. In 2008, the company opened 115 new stores, 110 of which were in the United States. The company plans to expand internationally in 2009 by opening its first stores in Mexico. ^[5]

Business Segments

Lowe's reports its sales in one general business segment which has 21 different categories of products: ^[8]

• Appliances: 9% of net sales
• Lumber: 8% of net sales
• Paint: 7% of net sales
• Flooring: 7% of net sales
• Building Materials: 6% of net sales
• Millwork: 6% of net sales
• Lawn and Landscape Products: 5% of net sales
• Fashion Plumbing: 5% of net sales
• Hardware: 5% of net sales
• Lighting: 5% of net sales
• Tools: 5% of net sales
• Seasonal Living: 5% of net sales
• Rough Plumbing: 4% of net sales
• Outdoor Power Equipment: 4% of net sales
• Cabinets and Countertops: 4% of net sales
• Nursery: 4% of net sales
• Rough Electrical: 3% of net sales
• Home Environment: 3% of net sales
• Home Organization: 2% of net sales
• Windows and Walls: 2% of net sales
• Other: 1% of net sales

Since 2006, the business categories have represented nearly the same proportion of net sales despite a general decrease in overall net sales. ^[8]

Sales

Lowe's uses four methods to make sales:

• In Store Sales: Lowe's sells home improvement products in twenty different categories in its stores. In 2008, Lowe's top five selling categories accounted for 37% of total revenue.
• Installation Services: Lowe's caters to do-it-for-me customers by providing installation services across many product categories.
• Special Orders: In addition to the products available in Lowe's stores, customers have the option to special order items through Lowe's.
• Commercial Construction Products: Lowe's sells professional-grade building and construction products to commercial businesses.

Business Growth

FY 2008 (ended January 30, 2009)^[1]

• Lowe's net income dropped 21.9% in 2008 from $2.8 billion in 2007 to $2.2 billion in 2008. The large decrease can be attributed to the effect the housing crisis had on the home improvement industry and economic recession which made consumers cut back on spending.

• Net sales only fell 0.2%. Lack of growth was reflected by comparable store sale decrease of 7.2% for the year. However the company did have an increase in total customer transactions, which was up 2.8% from 2007, as a result of the store expansion program. In addition Lowe's also had strong building materials sales as a result of a higher demand for hurricane-related projects.

• Operating margin for the year was 7.3% compared to 9.3% in 2007, a 2.0% decrease as a result of higher operating expenses.

• There was an 7.2% decrease in comparable store sales in 2008, compared to a decrease of 5.1% in 2007.

• Lowe's only opened 115 stores in 2008 compared to 149 in 2007 and 151 in 2006.

Q3 2009 (ended October 30, 2009)^[9]

• Lowe's net income slipped 29.5% year-over-year, from $488 million in Q3 2008 to $344 million in Q3 2009 due to recessionary pressures from the economics downturn and the weak home market.

• Net sales was $11.4 billion in Q3 2009, down 3.0% from net sales of the prior-year quarter as consumers continue to delay large purchases until they feel better about the economic outlook.

• Comparable store sales decreased by 7.5% during Q3 2009 as consumers continue to cut on discretionary purchases.

• Operating profit for Q3 2009 was $528 million, and operating margin was 4.6% of net sales. This is a 200 bps decrease from Q3 2008, during which operating profit was $778 million, or 6.6% of net sales.

• Lowe's opened 12 new stores and close one store during the quarter

Trends and Forces

Lowe's Sales Face Slow Recovery After Housing Market Reaches Bottom

In June 2009, main competitor to Lowe's, Home Depot claimed that the worst of the housing market fallout had already passed. ^[10] However, this does not mean that the home improvement companies like Lowe's will suddenly see higher sales or net income -- Lowe's still expects a 2% decrease to a 2% increase in sales in 2009.^[11] Although the housing market might have bottomed out, the economy is still suffering from the recession. The household savings rate has reached a 15 year high ^[12] and the number of homes on the market due to foreclosures is very high. Homebuilders have to wait until foreclosed homes, which are selling at rock bottom prices, and for the economy to rebound before they see any increases in housing construction. In May 2009, the Department of Commerce reported that home construction in April reached a 50 year low falling 12.8%. ^[13] However, in June, the department reported that housing consruction increased by the largest amount compared to the prior three months, ^[14] perhaps a sign that the slow recovery is already beginning.

Changes in Housing/Interest Rates Affect Homebuilders which Lowe's Relies On

To read a more detailed discussion of how interest rates affect housing, see also Interest Rates.

In the past, a high correlation has existed between the rate of home purchases and buildings and interest rates. As interest rates fall, prospective home owners and builders can borrow money less expensively and therefore will be more likely to do so. When more homes are built and purchased, Lowe's sales to homebuilders and re-modelers increase. On the flip side, when interest rates rise, borrowing becomes more expensive and the number of building and home improvement projects decline, resulting in fewer sales for Lowe's. In addition, higher interest rates make home refinancing, a large source of funds for home improvement projects, more expensive.

Since 2006 the housing market has been struggling as a result of the credit crunch that began in 2007 in the financial industries with fallouts on subprime mortage-backed securities. As a result, national home foreclosure rates have gone up dramatically, with the hardest hit places being the Southeast and Southwest. ^[15] The foreclosure rate in February 2009 was 30% higher than the rate in 2008 and in places like Nevada, one in every 70 homes recieved a foreclosure notice ^[16] The more foreclosures there are, the more homes are on the market, which results in a decrease in demand for building new homes. Lowe's has struggled through this period seeing annual decreases in revenue and net income since 2006. In addition, same store sales have been even or negative in 2006, 2007, and 2008 at 0.0%, -5.1%, and -7.2% respectively. ^[4]

It should be noted that housing booms do not always occur when interest rates are low. This is especially true in the case of a geographic area housing boom. There are many reasons for such booms (e.g., a company may move to an area, providing a boon through new jobs creation). Because Lowe's has widespread locations throughout the U.S., they are in position to take advantage of such booms.

Slumping Housing Market Forces Decreased Domestic Expansion and Increased International Expansion

• Domestic:

By the end of 2008, Lowe's was operating 1,638 stores in the United States, having opened 115 new stores during the 2008 fiscal year. ^[5]Approximately half of Lowe's retail stores are located in one of the top 100 markets in the US, which are comprise about two-thirds of total revenue in the home improvement market. Lowe's store expansion in the future focuses on expanding in the Northeast and West regions of the U.S. However, because of the turmoil of the U.S. Housing Market and reduced consumer spending due to the recession, Lowe's has drastically decreased its rate of expansion. The company only plans to open 60 to 70 new stores in 2009, compared to the 115 stores in 2008 and 149 stores opened in 2007. ^[5][17]

Lowe's currently has two types of retail stores, a larger one for areas with higher demand and a smaller store type for areas with less demand. This lets Lowe's prevent building up excess inventory by matching an area's demand with the appropriately sized supply of products and services. Matching demands and cutting costs are essential for Lowe's because its main competitor Home Depot has 1,971 stores in the U.S and is competing for the same customers. ^[18]

• International:

In addition to domestic expansion, Lowe's is starting to focus on expanding internationally as well. Home Depot already has a large presense outside of the US in countries like Canada, Mexico, and China. Not only do these markets provide a new customer basis and more sales, they also act as a buffer to the slumping US domestic economy. Lowe's sees international expansion as a means to increase revenue and keep up with Home Depot.

Lowe's opened its first stores outside of the U.S. in Canada during FY2007 with seven stores in the greater Toronto area. In FY2008, the company opened five more stores in Canada, increasing its international stores to 11. Lowe's also has plans to venture into Mexico with three to five stores in and around Monterrey in 2009. ^[5]

Home Depot, on the other hand, is already established outside of the United States with over 150 stores in Canada and 60 stores in Mexico. It is important to note that Home Depot's international stores generate less revenue per store than domestic stores. This differential is likely tied to the fundamentals of international markets (i.e., lower disposable incomes, lower average home prices). As such, Lowe's faces the risk of having lower overall store efficiency as it steps outside of the U.S .in the next few years.

Increased Installed Sales Due to Older Population

One quickly growing contributor to revenue for Lowe's is their Installed Sales division. Through this division, the company provides installation services to customers who prefer the concept of do-it-for-me (DIFM) rather than do-it-yourself (DIY). Lowe's sells to DIFM customers products as well as home installation. For example, Lowe's installs the new flooring purchased in its retail stores. The company offers installation services in over 40 categories and has an association of over 10,000 professional installers nationwide. Sales from this division have increased at a compounded annual growth rate of approximately 22% since 2004 with segment revenue achieving 6% of net sales in 2008 (approximately $2.9 billion). ^[19]

As the demographics of the U.S. change, specifically baby boomers getting older, there will be an increased amount of demand for DIFM services. The 77 million baby boomers provide a growing market for Lowe's DIFM business line -- in 2005, the DIFM business increased by 20.5%.^[20] This is good for Lowe's because they reap additional revenue in this segment from installation charges that they do not accrue from DIY (do-it-yourself) customers.

Private and Proprietary Brands Give Lowe's an Edge

Each Lowe's store stocks proprietary brands exclusively sold by Lowe's and national brand name items sold by other retailers and suppliers. Some notable brands unique to Lowe's include: Premier Living, Kobalt, and Portfolio. The contracts that give Lowe's exclusive rights to sell certain brands generate dual value, especially in regards to the professional customer base.

• When craftsmen become accustomed to one type/style of tool they generally replace that tool with one of the same style/type because of the utility gained from saving money, time or just from personal preferences. This is an example of customer lock-in, a theory that says a customer has to rely on a particular vendor for his needs in order to avoid a high increase in costs.
• Private label brands have a higher net income contribution for Lowe's.

Internet-based protest campaign

September 2007 saw Lowe's become the subject of an online protest site lowes-sucks.com (no longer active) complaining about the quality of work by contracted installers. Whilst the underlying complaint (about the quality of a fence installation) seems trivial, the issue has snowballed and become more about Lowe's complaint handling and legal responses, rather than their quality of work. All this received considerable media interest, and is an example of the often unexpected side of The Internet Impact on companies.

Competition

Lowe's vs. Home Depot

Lowe's is in second place behind Home Depot (HD) in a two horse race in the home improvement retail industry (both are among the top 10 overall retailers in the U.S.). To illustrate the competition between the two companies, nearly a quarter of Lowe's retail stores are located within 10 miles of a competing Home Depot retail store. ^[21]

Lowe's and Home Depot are by far the most known of the home improvement retail industry, but together they make up only about 18% of the estimated $725 billion home improvement market, which includes pure product demand as well as installation labor demand. The rest is distributed between other "big-box" retailers such as Wal-Mart Stores (WMT), smaller hardware store chains, construction firms, and other small businesses.

Lowe's ranks behind Home Depot in terms of overall revenue--$71.3 billion vs $48.2 billion in 2008. ^[1][3]Despite this, Lowe's has been catching up with and even exceeding Home Depot across several measures while trailing in the international markets:

• Same Store Sales Growth: Lowe's has consistently been ahead of Home Depot in same store sales growth since 2004. Same store sales growth lends the best comparison of sales growth between the two companies by looking at the same stores year over year for both companies. By doing this it does not allow new store openings to affect the comparison. In 2008, same store sales of HD decreased by 8.7% ^[3] whereas same stores sales of LOW decreased only by 7.2%. ^[1]

• Operating Margin: Lowe's had been behind Home Depot in terms of operating margins for several years until 2006 when Lowe's won a slight advantage over Home Depot. However, Home Depot surpassed Lowe's again in 2007. Home Depot's operating margin fell to 6.1% compared to Lowe's 7.3% mark in 2008. ^[22]

• International Markets: Home Depot has 262 stores ^[18]outside of the US (mostly in Canada and Mexico) which is 19 more stores than it had in 2008. On the other hand, Lowe's expanded internationally with just 11 new stores in Canada in 2008. ^[5] Lowe's hopes to continue this expansion to catch up to Home Depot's global sales by opening new stores in Mexico in 2009.

One key driver of the difference in operating performance is Lowe's store environment, which is often noted to be more more customer friendly than Home Depot's. Consumers wanting less of a "warehouse style" home improvement retailer often choose Lowe's over Home Depot.

In light of the housing market troubles and the economic recession, Lowe's has fared comparatively better than Home Depot (HD). In 2008, Home Depot saw sales and net income drop 7.8% and 48.6% respectively from 2007, ^[23] while Lowe's only suffered minor losses at 0.1% and 22% respectively. ^[22]

Smaller Competitors

Lowe's also faces competition from smaller independent mom & pop stores. Although these stores usually cannot match the prices of the industry giants Home Depot or Lowe's, they make up for higher prices with customer care, tradition, and perhaps convenience. ^[24] In addition, the presence of big companies like Lowe's and Home Depot in some areas has even caused customers to boycott the giant firm and to shop at local businesses. ^[25] The advantage that Lowe's has against these smaller competitors is that they stand a better chance at outlasting the economic downturn and in the mean time attracting old customers of fallen businesses.

One example of a small competitor is Builders FirstSource (BLDR), a company that makes and sells structural and related building products for residential new construction. The company is based in the United States and operates in the United States.^[26]

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4 1.5 1.6} LOW 2008 10-K, Exhibit 13, pg. 21
2. ↑ Stores "2008 Top Retailers"
3. ↑ ^{3.0 3.1 3.2 3.3} HD 2008 10-K, pg. 28
4. ↑ ^{4.0 4.1} LOW 2008 10-K, Exhibit 13, pg. 5
5. ↑ ^{5.0 5.1 5.2 5.3 5.4 5.5 5.6} LOW 2008 10-K, Part 1, pg. 5
6. ↑ HD 2008 10-K, pg. 8
7. ↑ LOW 2008 10-K, Part 1, pg. 6
8. ↑ ^{8.0 8.1} LOW 2008 10-K, Exhibit 13, pg. 44
9. ↑ ^{9.0 9.1} LOW Q3 2009 Report
10. ↑ Motley Fool "Home Depot Calls a Bottom" 11 June 2009
11. ↑ LOW 2008 10-K, Exhibit 13, pg. 12
12. ↑ MSNBC "Americans saving more, spending modestly" 26 June 2009
13. ↑ Times Online "New US housing starts fall to a 50-year low" 19 May 2009
14. ↑ Fox News "Housing Construction Jumps by Largest Amount in 3 Months" 16 June 2009
15. ↑ Housing Zone "Rising Foreclosure Rate Restrains Housing Starts" 5 June 2009
16. ↑ CBS "Foreclosure Rate Up 30% From Last February" 12 March 2009
17. ↑ MarketWatch "Lowe's cuts new-store plan; is cautious on outlook" 24 Sept 2008
18. ↑ ^{18.0 18.1} HD 2008 10-K, pg. 8 and 9
19. ↑ LOW 2008 10-K, Part 1, pg. 6
20. ↑ CNN Money "Baby Boomers: Do-It-For-Me generation" 11 May 2005
21. ↑ Hartford Courant "Construction woes hammer Lowe's, but it stays strong" 18 Nov 2007
22. ↑ ^{22.0 22.1 22.2 22.3} Google Finance: LOW Overview
23. ↑ ^{23.0 23.1} Google Finance: HD Overview
24. ↑ Juneau Empire "Surviving Home Depot" 17 Feb 2008
25. ↑ Costal Point "Home Depot plan stirs talks of boycott" 11 Aug 2006
26. ↑ ^{26.0 26.1} Google Finance: BLDR Overview