Lowe’s Companies, Inc. (NYSE:LOW) is the second largest home improvement retailer in the world with a market cap of over $60 billion dollars. While the majority of its business is in the U.S., Lowe’s is trying to increase its presence in Canada by taking advantage of Target’s departure in the Canadian market. It has bought 13 of Target’s 38 vacated leases in Canada. We look today to see if their stock will outperform in the next twelve months.
With consumer confidence improving, housing starts beginning to rise, and unemployment at its lowest levels, we believe that Specialty Retail stocks are primed to outperform. Our model suggests that LOW has significant upside potential given its strong growth profile which is supported by high quality earnings.
Lowe’s has had very sold price performance over the last 12 months, gaining over 40% in that time. That puts it in the 88th percentile of the market in 12-month price performance. Historically, the average excess return for stocks between the 80th and 89th percentile in that metric has been 1.46%. Although 6 month price performance has been weak at 2.63%, LOW’s return on equity ranks in the 87th percentile of the market. Historically, the average excess return for stocks with return on equity between the 80-89th percentile is 1.58%. Adding in their other growth metrics, our model predicts a growth alpha of 2.73%.
A look at LOW’s earnings quality suggest sustainable growth in the future. Earnings accruals is calculated by taking the difference between net income and operating cash flow and dividing by total assets. Their ratio of 0.24% is right in line with the market and group (specialty retail) median. The financing to assets ratio is calculated by summing LOW’s net equity and debt financing and dividing by average total assets. The large negative value is a result of LOW’s strong buyback activity. Along with their commitment to consistently grow their dividends, we believe LOW will continue to provide value for shareholders. With that in mind, we anticipate a quality alpha of 4.95% for Lowe’s in 2015.
Our model suggests that Lowe’s is fairly valued right now with a value alpha of 0.30%. Although they underperform their group in nearly every value metric, they are fairly in line with the market medians except for their weak price to book ratio and strong sales yield (revenue divided by market cap).
LOW’s short interest ratio is also significantly below the group and market medians, indicating the low level of confidence in short sellers betting against LOW. Although change in insider ownership has been highly negative, insiders represent a very small percentage of traded shares while change in institutional ownership has been very small at +0.2%.
Given the improving conditions in the U.S. economy, a pick-up in consumer confidence from 94.6 in May to 101.4 in June (according to The Conference Board), increase in homebuilders sentiment from 54 in May to 59 in June (according to NAHB/Wells Fargo Housing Market Index) and unemployment at a 7 year low of 5.3%, we believe earnings in the specialty retailer group will exceed expectation in the second half of 2015. With a business that should benefit from the current economy and fundamentals that are fairly strong, our model ranks LOW number 8 out of 95 other specialty retail stocks. The 7 stocks our model predicts will perform even better are found below.