Double-digit return on capital

Lowe’s companies (DOWN), a Fortune 50 constituent, is the second largest home improvement retailer in the world, just behind Home Depot (HD). The company manages nearly 2,000 home improvement and hardware locations, comprising 208 million square feet of retail space.

Lowe’s has always been valued among income-oriented investors for its Dividend King status. This unofficial term is often used by investors to describe those companies that have increased their dividends annually for more than 50 consecutive years.

Lowe’s now has 60 years of consecutive dividend increases after the last dividend hike in late May. Along with the rise reflecting the strength and consistency of Lowe’s cash flow and management’s continued commitment to returning capital to shareholders, dividend growth has accelerated quite impressively over the past two years.

Note that shares of Lowe’s are currently trading around 30% below their 52-week high of $263.31. In addition to the overall market selloff dragging the stock down, investors are likely worried about the risks of a company in the consumer discretionary sector.

As macroeconomic turmoil persists, including sky-high inflation levels and high energy costs, the market likely fears a decline in consumer purchasing power. Additionally, there could be a reduction in Lowe’s margins (for example, due to higher shipping costs) which could have a significant impact on the retail giant’s profits.

Again, leading economic indicators regarding the health of the economy remain strong, particularly regarding unemployment levels and ongoing consumer spending.

Nonetheless, with Lowe’s valuation having corrected in particular following the pending sale and the acceleration of the company’s capital returns, the stock’s investment case may attract dividend growth investors to long term. Nevertheless, due to the underlying risks that persist these days, I am neutral on the stock.

Recent performances

Lowe’s Q1-2022 results were quite strong, despite slightly weaker top numbers. Total sales were $23.7 billion compared to $24.4 billion in the same period a year earlier, as comparable sales decreased 4.0%. Specifically, comparable sales in the US home improvement segment fell 3.8% year-over-year.

However, there are two factors to note here. First, last year’s sales were still benefiting from the momentum of the increased DIY home improvement trend due to the shift to working from home in the economy. Therefore, the comparison with last year’s sales is a bit difficult. Second, Lowe’s experienced a delayed spring selling season due to prolonged inclement weather late in the first quarter that negatively affected spring-related categories.

As management mentioned in the company’s first quarter earnings call, the adverse weather conditions lasted until last April, which was the coldest and wettest in more than 20 years. Thus, home improvement sales were pushed back. With the weather finally normalizing, it’s likely that Lowe’s will see these “delayed” sales occur in the second and third quarters, normalizing the company’s performance from a year-to-year perspective.

Despite slightly compressed sales, Lowe’s managed to improve its operating margin by 65 basis points, resulting in diluted earnings per share of $3.51. This implies an increase of only 9.3% compared to last year. This reflects strong cost discipline and strong pricing capabilities, which are critical in today’s environment and highlight the resilience of the business.

For fiscal 2022, management expects diluted EPS to be between $13.10 and $13.60, the midpoint of which suggests growth of 10.8% from fiscal 2021.

Double-digit return on capital

As mentioned, Lowe’s has an exceptional history of dividend increases that spans more than six decades. However, dividend growth has accelerated recently. Following Lowe’s 33.3% increase in dividend per share in May 2021, another substantial dividend increase of 31.3% took place last May. These are the largest increases in 15 years, with management likely aiming to maintain a strong income-oriented shareholder base in the current inflationary environment.

Despite the two huge sequential increases, Lowe’s payout ratio stands at just 31.4%, based on the midpoint of management guidance.

Lowe’s share buybacks further contribute to the company’s total capital return. The company repurchased 19 million shares in the first quarter for $4.1 billion. It also expects its total share buybacks to be $12 billion in fiscal 2022. This implies a “buyback yield” of 10.2%, which, combined with the dividend yield of 2 .4%, corresponds to a mixed return for investors of approximately 12.6%. Few companies currently pay out so much money to shareholders, and even fewer can claim the qualities of Lowe’s.

The Taking of Wall Street

On Wall Street, Lowe’s has a Strong Buy Consensus Rating based on 15 Buys and Five Takes assigned over the past three months. At $232.78, Lowe’s average price target suggests 26.4% upside potential.

Evaluation and takeaways

Lowe’s stock is currently under pressure amid the overall market selloff, and risks are attached to consumer discretionary due to the current environment. Still, the company’s results remain relatively strong, management’s outlook is optimistic, and capital returns have accelerated.

The shares are currently trading at a P/E (forward) of 13.2 over the next twelve months, which, in addition to being rather modest on its own, is also near the bottom of the P/E range. term average of the share over 20 years. Therefore, long-term dividend growth investors are likely to find Lowe’s investment case quite successful at the stock’s current price levels.

Disclosure

About Catherine Wilson

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