LOWE’S Company – Priced to Buy for Long Term Holdings

LOWE’s Company (LOW) is a home improvement retailer. It focuses on retail do-it-yourself (DIY) customers and do-it-for-me (DIFM) customers who utilize LOW’s installation services, and commercial business customers. Its product lines include products and services for home decorating, maintenance, repair, remodeling, and the maintenance of commercial buildings. It has approximately 1650 retail stores in US and Canada.

LOW is member of Dividend Aristocrats, Mergent’s Broad Dividend Achiever Index, and S&P500 Index. The most recent dividend increase was in July 2010.

Trend Analysis
Here I am looking at trends for past 9 years of company’s revenue and profitability. These parameters should show consistently growth trends. The trend charts is shown in image below.

• Revenue: In general, a growing trend since 2000. The average revenue growth for last 9 years has been approximately 14 (std dev of 6.8%). Growth has slowed down in last few years and expected to be negative in 2009.
• Cash Flows: Overall, until 2008, a growing trend of operating cash flow. It is above net income. The free cash flow is consistently less than net income.
• EPS from continuing operation: In general, it had an increasing trend until 2007. Negative since 2008 and it is reflection of economic downturn.
• Dividends per share: Growing trend.

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.43. This is a low risk category as per my 3-point risk scale. Other than negative EPS growth, all other parameters are positive.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

• Dividend growth rate: The average dividend growth of 49% (stdev. 15%) is more than average EPS growth rate of 20% (stdev. 16.4%).
• Duration of dividend growth: Consecutive dividends growth for more than 25 years.
• 4 year rolling dividend growth rate for past ten years: Less than 10%.
• Payout factor: It has been less than 25% since 2000.
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.0%; and (b) MMA yield is 1.75%. With my projected dividend growth of 8.2%, the dividend cash flow is 2 times the MMA income in 10 years time period.
  

Fair Value Calculation
This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 15 year DCF: $26.0
• Average high yield price calculated based on past 10 years: $26.8
• Pricing based on past 10 year relative price-to-earnings ratio. $39.0
• Pricing based on price-to-earnings ratio of 12: $22.3
• Graham number: $22.7

The range of fair value is calculated as $24 to $27.3.

Qualitative Analysis
LOW is a founded in 1952 and is the second largest retailer in home improvement segment. Its growth model consists of growing market share by expanding more markets.

• Its revenue is pretty much focused in US markets (with some presence in Canada and Mexico).
• It continues to have very stable gross and operating margins. It continues to generate operating cash flows.
• One would expect that with housing market crash, LOW’s earnings would also crash (similar to financial sector banks). However, it was not the case, and it indicates the strength of its business model.
• Even though the housing market is grim, I believe the repair and maintenance segment will continue to generate revenue and income for LOWs.
• The risk factor is that continued slackness in housing market.

Conclusion
Lowe’s Corporation is a stable and slow growing company in long term. It is expected to continue to have a sustainable cash flow over next few years. One issue with Lowe’s is that, historically, it has had a very low dividend yield of less than 2%. At such a low yield, it is less attractive relative to any high yield bond or CDs. However, LOW shares bought at fair value or below would make up of the lack of dividends. In addition, the low payout factor and low dividend risk provides stability for dividend cash flow. The current pricing of $22.19 is less than my buy range. I would continue to add to my existing position based my allocation levels.

Full Disclosure: Long on LOW.
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