Lowes Case Study
Lowe’s Company has been in business for over 60 years. The company is the second largest home improvement retailer in the world and employs more than 215,000 employees. The company’s home base is Mooresville, North Carolina. Standard & Poor ranks Lowe’s as #48 . Presently, Lowe’s stock, which is identified on the New York Stock Exchange as LOW, is selling for right under $20 a share. This price has been consistent and is comparable to their biggest competitor Home Depot, Inc whose stock has remained steady at $23.
Lowe’s, and other home improvement businesses, serve three types of customers; the Do-It-Yourself customer that is the individual who completes their own projects and installations. The Do-It-For-Me customer, who purchase supplies then hire third parties to complete the installation or project. Finally, there are the professional customers who are the remodeler, general contractor, repairman, small business owner and tradesmen. The slowdown of the market has affected all types if customers in the home improvement markets. The home improvement market takes in approximately $755 billion annually.
However, with the softening of the housing market, unseasonable drought and flooding, and last year’s variable mortgage interest rate hikes the industry has taken some hits. Although mortgage rates are decreasing, high gas prices has caused a recession and overall sales has decreased. California and Florida, which bring in a large portion of sales, experienced the biggest declines in home prices and the most pronounced slowdown in housing turnover. With that said, Lowe’s company was still able to report $48. 3 billion in net sales.
An analysis of the financial statements and financial prospects of Lowe’s Company was performed on the last two years (2007 and 2008). Financial statements which include the balance, income and cash flow statements for Lowe’s Company and Home Depot, Inc. were obtained to perform the financial analysis to see if Lowe’s is a worthy investment. When comparing Lowe’s against Home Depot, their most closely matched competitor, Lowe’s comes ahead in long term debt to equity ratio with 34. 6% whereas Home Depot has a negative outlook on long term debt with debt accounting for 64. % of total liabilities.
This and other factors are defined more closely in the financial statement analysis. According to Fortune 500, Lowe’s is still closing the gap with competitor Home Depot, whose dissatisfied customers were defecting. A Company subsidiary, Lowe’s HIW, Inc. , is a defendant in a lawsuit, for allegedly failing to pay overtime wages pursuant to the requirements of the California Labor Code. Though this lawsuit has been filed since 2001, and is in the early stages of class action proceedings, the Company has not estimated the range of loss that may arise from this claim.
II. Industry Summary Lowe’s Company is identified under the Standard Industrial Classification code 5211. SIC 5211 is Lumber and other Building Material industry. This industry is engaged in selling lumber and building materials. Hardware is one of the most important items sold. Lumber and building companies that do not sell to the public are classified as Wholesale Trade, Industry Group 503. Lowe’s closest competitor is Home Depot, Inc.
Home Depot is the world’s largest home improvement retailer and the second largest retailer in the United States (“U. S. ), based on Net Sales for the fiscal year ended February 3, 2008. Home Depot is ranked #22 by the S&P. Their home base is in Atlanta Georgia. Home Depot had 2,234 stores at the end of 2007 with plans to open 87 new stores in 2008. Home Depot has over 284 stores overseas to include 165 stores in Canada and 12 stores in China. In 2007 Home Depot sold HD Supply, the company received net proceeds of $8. 3 billion and recognized a loss of $4 million Home Depot also signed a $1. 0 billion guaranteed senior secured loan of HD Supply. Also, in connection with the sale, they purchased a 12. % equity interest in the newly formed HD Supply for $325 million .
HD Supply serves customers in the Infrastructure & Energy market which includes services in building and maintaining water systems, oil refineries and petrochemical plants, and for the generation, transmission and distribution of electrical power. Home Depot identified HD on their Consolidated Statement of Earning for discontinued operations. In 2007, Home Depot showed $431 million in profits from HD Supply. Since the selling of HD Supply the Company acquired Ohio Water & Waste Supply, Inc. and Geosynthetics, Inc.
These acquisitions operated were under HD Supply and were included in the disposition. The aggregate purchase price for acquisitions in fiscal 2007, 2006 and 2005 was $25 million, $4. 5 billion and $2. 6 billion, respectively, including $3. 5 billion for Hughes Supply in fiscal 2006. The home improvement retailer was hit with a double whammy last year: a housing market downturn and customer service problems that have plagued the company for years. Also on the company’s to-do list: preventing patrons from fleeing to competitor Lowe’s, which has been chipping away at HD’s lead.
In-store makeovers were a start, and the company also has been seeking skilled workers to replace inexperienced part-timers who’d previously been hired to help cut costs. As stated earlier, the home improvement industry takes in $755 billion annually. However, due to the softening of the housing market and declining home sales, companies in this industry has had to change their focus to continue to entice customers. A busy real estate market and rising house values encourage buyers, sellers and existing homeowners to invest more in their home.
This has prompted advertisements and promotions by both Lowe’s and Home Depot to get their customers to concentrate on improving the home they have. Lowe’s Company shows a family getting keys made, with the slogan, “At heart we’re still a neighborhood store,” this is their attempt to concentrate on the big and small offerings. Home Depot’s approach to getting customers in the store has been its newest paint line. Both stores has launched aggressive campaigns on do-it-yourself projects, and selling of patio furniture in an attempt to turn backyards into an extension of the home.
This has been a major change for the two competitors, since 2000, both have doubled the number of stores they have. However, with existing home sales falling 2. 2% from November to December, and sales were down 23. 4% from the year before. With the problems from Fannie and Freddie Mac and the scandals in the banking industries the housing market will continue to remain soft. This may play into the favor of home industries market. S&P is still optimistic about a mild, but long, recession. Their web site stated the housing market started showing signs of life in June.
Some improvements to the economy were due to the stimulus checks being received earlier than expected and spent more quickly than expected. This also boosted the economy. In the first quarter of 2008, Lowe’s sales were down -1. 3% from the same time last year, however net sales were $12 billion dollars . This indicates Lowe’s in on track to have a successful year, with the current home mortgage markets. Home Depot did not fare as well with sales reported for the first quarter at $17. 9 billion but were down 3. 4%. Home Depot also had to take steps back and reevaluate their rationale to ontinue opening up new stores.
According to the CEO, Frank Blake, stores not expected to meet targeted returns were taken out of the pipeline. And, ‘By not building them, we’ll free up approximately $1 billion in cash over the next three years to invest in maintenance, merchandising resets and other areas within our existing stores. On a comparable level and based from Lowe’s and Home Depot’s 2007 financial report Table 11 illustrates the bulk of the products sold by both stores. Lowe’s has an advantage in sales in Plumbing, electrical, kitchen, hardware and seasonal items.
Home Depot has the advantage in sales in building materials, lumber, millwork, paint and flooring. Both companies’ give back to the community. Lowe’s recently gave the lake Norman Student Athlete Association a secured $25,000 grant to improve fields for the youth recreation leagues . Home Depot just closed the second quarter of their Housing Impact grant program. The Housing Impact Grants is designed to assist nonprofit organizations whose project involves affordable housing built responsibly in a timely manner. III. Financial Statement Analysis Table 1, is Lowe’s Company’s Consolidated Balance Statement.
Cash and cash equivalents decreased for 2007 by . 4%. Cash and cash equivalents include cash on hand, demand deposits and short-term investments with three months or less maturity. Payments from financial institutions for payment by credit card and debit card transactions process within two business days and are classified as cash and cash equivalents. This is significant because $1. 7 billion were received in credit/debit payments in 2007. Home Depot’s accounts receivable was $1. 2 billion for 2007 . Property increased . 9% in 2007; this was due to the 153 stores that were opened and the equipment to go along with it.
In June 2007, the Company entered into an Amended and Restated Credit Agreement (Amended Facility) which modified the previous loan agreement and extending the maturity date to June 2012. This provided up to $1. 75 billion that could be borrowed at 5. 41%. As of February1, 2008, there was $1. 0 billion outstanding under the commercial paper program. In September 2007, the Company issued $1. 3 billion of unsecured senior notes which breaks down into $550 million maturing in September 2012, $250 million maturing in September 2017 and $500 million maturing in September 2037.
During 2007, the Company repurchased 76. 4 million shares at a total cost of $2. 3 billion (of which $1. 9 billion was recorded as a reduction in retained earnings , after capital in excess of par value was depleted). As of February 1, 2008, the total remaining authorization under the share repurchase program was $2. 2 billion. Table 2, illustrates the Consolidated Statement of Earnings for Lowe’s Company. Overall, sales increased 2. 9% to $48. 3 billion in 2007 . There were minor variances to net sales for overall percentage between 2007 and 2007. There was just a -0. 8% decrease in Net earnings than in 2006.
Areas that showed the biggest variance in percentages were selling, general and administrative expenses at 1% increase in 2007 and store opening cost which just increased by . 3%. Pretax earnings were the most significant with 1. 4% decrease in 2007. Opening the 153 stores in 2007 accounted for most of the increase in sales. There was an overall decline in store sales by 5. 1%. The categories that performed above our average comparable store sales change included rough plumbing, lawn & landscape products, hardware, paint, lighting, nursery, fashion plumbing and appliances . For 2007, the gross margin was 34. 4% represented a 12-basis-point increase over 2006. This leverage was partially offset by de-leverage of13 basis points in transportation costs primarily attributable to rising fuel costs.
Store opening costs included payroll and supply costs prior to store opening as well as grand opening advertising costs that totaled $141 million in 2007, which was less than the $146 million in 2006. Table 3, identifies the Company’s cash flow statement for the last two years. Throughout the cash flow statements there are variances. Accounts payable has the largest individual variance with an 11. % decrease. However, the annual report states the company entered into a customer managed service agreement which will provide an accounts payable tracking system. This gives the suppliers the ability to finance payment obligations from the Company with designated third-party financial institutions.
The Company’s goal with this endeavor is to enter into ‘arrangement is to capture overall supply chain savings, in the form of pricing, payment terms or vendor funding, created by facilitating suppliers’ ability to finance payment obligations at more favorable discount rates, while providing them ith greater working capital flexibility. . As of February 1, 2008, the Company had placed $77 million of payment obligations on the accounts payable tracking system, and participating suppliers had financed $48 million of those payment obligations to participating financial institutions. During 2007, the Company repurchased 76. 4 million shares at a total cost of $2. 3 billion (of which $1. 9 billion was recorded as a reduction in retained earnings, after capital in excess of par value was depleted) . As a result there was a 537% increase in repurchase of common stock between 2006 and 2007.
IV. Cost of Capital Table 6 has the formula that was used to come up with the Weighted Average Cost of Capital for 2006. Cost of Debt: According to Lowe’s annual report, their income tax rate for 2007 was 37. 7% and 37. 9% in 2006 . The decrease in the effective tax rate was due to increased federal tax credits associated with Welfare to Work and Work Opportunity Tax Credit programs. Lowe’s long term debt totaled $5. 5 billion in 2007 and $4. 3 billion in 2006. The overall cost of debt for Lowe’s in 2006 was 14. 4%.
Cost of preferred stock: The Company has 5. 0 million ($5 par value) authorized shares of preferred stock, none of which have been issued. Cost of common stock: Authorized shares of common stock were 5. 6 billion ($. 50 par value) at February 1, 2008 and February 2, 2007. Dividend per shares for 2006 were $. 18 and total market value was $29. 97 per Lowe’s Company 2007 annual report page 48 under dollars per share (Weighted average shares, assuming dilutions). Common stock for 2006 was . 6%. Weighted Average cost of capital for 2006 was 7. 5%.
This answer came from dividing the cost of debt and cost of stock by 2 to calculate the WACC since preferred stock was not issued. Table 7 illustrates the New cost of Capital. Weighted Average cost of capital for 2007 was calculated using the same references mentioned for computing the WACC of 2006. The Cost of Debt for 2007 was computed by using 38% tax and $5. 5B for long term debt. The cost of debt for 2007 was 11. 3.
The cost of common stock was computed by taking DPS and dividing it by 31. 98 which was the market value for 2007. It computed to . %. The weighted average cost of capital for 2007 was 6. 1%. V. Capital Structure and Dividend Policy For Fiscal Year 2007, Lowe’s capital structure was made up of 47. 9% debt and 52. 1% common stock. Table 1 show the breakdown based on the information provided by the Company’s annual report. This is actually a 4. 5% increase in liabilities since the previous year. The Company has not issued its 5. 0 million shares of preferred stock. During February 2, 2007 and February 1, 2008, 5. 6 billion shares of common stock were authorized ($. 50 par value).
The board of directors has authorized up to $2 and $3 billion in share repurchases for the next two years. Shares purchased under the share repurchase program are retired and returned to authorized and unissued status. During 2007, the Company repurchased 76. 4 million shares at a total cost of $2. 3 billion (of which $1. 9 billion was recorded as a reduction in retained earnings, after capital in excess of par value was depleted).. This is reflected on Table 1 with a -6. 3% variation. On May 30, of this year Lowe’s provided notice through
The Bank of New York Trust Company, N.A. , as trustee, to the holders of its outstanding convertible notes issued in February 2001 and its outstanding senior convertible notes issued in October 2001, of its election to redeem all outstanding convertible notes and senior convertible notes. Lowe’s has approximately $579 million aggregate principal amount of senior convertible notes outstanding and approximately $20 million aggregate principal amount of convertible notes outstanding. Lowe’s planned to redeem all senior convertible notes issued in October 2001 outstanding on June 30, 2008 at $875. 3 per note. VI. Stock Recommendations Compared to stock prices in June of 2007, which were an average price of $33. 03, stocks have taken a major dive by 60%. Reuters and yahoo finance recommends to hold on to your stock.
The recommendation is the same for Home Depot who has experienced almost the exact fall in the stock. Table 14, which is provided by yahoo. finance illustrates the last 6 months of 2008. On the graph it is obvious that the company’s reaction to the stock market is exactly the same for this industry.
If you do not have Lowe’s stock, I suggest monitoring it. Reuters has already projected the recession to worsen. Once the price drops lower I suggest buying it. I don’t recommend buying Home Depot stock at this time however. Their total liability is 60% in debt . If the recession takes a turn for the worst, Home Depot may experience problems with meeting their long term debt obligations. And, they may have problems receiving payments due to their high rate of account receivables. Lowe’s is a stock to watch and a Company that will be around.