Why were Lowe's comparable store sales flat in 2006 if the company still grew sales 8.5%?

Total sales growth came from new store openings, which added about 12% more retail square footage. Comparable store sales, which only count stores open more than 13 months, were flat because of a slowing housing market, weaker home improvement demand in previously strong markets, tough comparisons against 2005 hurricane rebuilding demand, and roughly 15% deflation in lumber and plywood prices.

Is Lowe's margin and earnings growth sustainable given the slowdown in comparable sales?

Margin gains in 2006 came partly from favorable product mix, a higher share of imported goods (about 11% versus 9.5%), and lower bonus and retirement expense that scales with performance. Some of these benefits may not repeat. Management guided to a 70 to 80 basis point decline in operating margin for 2007, reflecting higher depreciation and store investment, so earnings growth will likely slow.

How is Lowe's funding its growth and shareholder returns?

Operating cash flow of $4.5 billion covered most of the $3.9 billion in capital expenditures, with the remainder financed partly by a $1 billion senior notes issuance in October 2006 and by stock option exercises. The company still returned about $2.0 billion to shareholders through buybacks and dividends. Management says it expects operating cash flow and financing to be adequate for the next 12 months, but a rating downgrade could make debt markets more costly.

What are the main risks investors should monitor?

Key risks include dependence on housing turnover and consumer confidence, unseasonable weather, the ability to open and staff about 150 to 160 new stores a year (including new Canadian and Mexican markets), competition from other home improvement and online retailers, product liability claims in which the company self-insures, and disruption to its supply chain, particularly for imported goods. The company disclosed no material pending legal proceedings.

What does Lowe's 2007 outlook imply for investors?

Management expects sales growth of roughly 10%, flat to modestly positive comparable sales, and diluted EPS of $2.02 to $2.09, which would be about 2% to 5% above 2006 EPS of $1.99. Results will depend on whether the housing slowdown stabilizes, whether lapping hurricane-related sales eases in the second half of 2007, and whether store productivity and new store returns hold up as the company expands into more markets.

LOW 10-K FY2007 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed April 3, 2007. Cited figures are marked; the original filing is the authoritative source.

Lowe's (LOW) reported fiscal 2006 (year ended February 2, 2007) net sales of $46.9 billion^a, up 8.5% year over year, driven almost entirely by store expansion: 155 stores opened, bringing the chain to 1,385 stores in 49 states.

Comparable store sales were flat, versus a 6.1% gain in 2005, reflecting a slowing housing market, difficult hurricane-related comparisons, and roughly 15% deflation in lumber and plywood. Despite the flat comp, profitability improved: gross margin rose 32 basis points to 34.52%, SG&A leveraged 9 basis points (largely from lower bonus and retirement expense), and net earnings grew 12% to $3.1 billion^b, with diluted EPS of $1.99 (post 2-for-1 split) versus $1.73. Lowe's also reported that Lowe's gained 110 basis points of unit market share across its 20 product categories, a sign that share gains continued even as the core market weakened.

Balance sheet and cash flow remained strong. Operating cash flow rose to $4.5 billion^c, while capital expenditures were $3.9 billion, leaving the company with capacity to return cash to shareholders. Lowe's repurchased $1.7 billion of stock in 2006, raised its quarterly dividend to $0.05, and retained $1.5 billion of remaining buyback authorization.

Long-term debt rose to $4.3 billion^d after a $1 billion senior notes issuance in October 2006, and the debt-to-capital ratio rose to 22.0% from 19.8%, though debt ratings remain at A+/A1/A+ with stable outlooks. Management guided for 2007 comparable sales of roughly flat to up 2%, total sales growth near 10%, and diluted EPS of $2.02 to $2.09, while expanding into Canada (Toronto, second half of 2007) and planning Mexico entry in 2009. Key risks disclosed include housing turnover, weather, competition, supply chain disruption from imports, and the execution of an aggressive store-opening program.

02—Key points

Key Highlights

Net sales rose 8.5% to $46.9 billion, driven by 155 new and relocated stores; the chain ended the year with 1,385 stores in 49 states.
Comparable store sales were flat in 2006, down sharply from a 6.1% increase in 2005, reflecting a weaker housing market and deflation in lumber and plywood.
Net earnings grew 12% to $3.1 billion; diluted EPS was $1.99 versus $1.73 in 2005, supported by a 32-basis-point gross margin expansion and lower SG&A as a percentage of sales.
Operating cash flow increased to $4.5 billion, and capital expenditures of $3.9 billion were funded internally, leaving free cash flow of about $0.6 billion before shareholder returns.
The company repurchased $1.7 billion of stock (56.8 million shares) and raised its quarterly dividend to $0.05; $1.5 billion of buyback authorization remains.
Long-term debt increased to $4.3 billion after a $1 billion senior notes issuance; the debt-to-capital ratio rose to 22.0%, but credit ratings remain strong (A+/A1/A+, stable).
2007 guidance calls for total sales growth of about 10%, comparable sales flat to up 2%, and diluted EPS of $2.02 to $2.09, with 150 to 160 new stores planned, including the first Canadian stores.

03—Questions

Frequently Asked Questions

Why were Lowe's comparable store sales flat in 2006 if the company still grew sales 8.5%?
Total sales growth came from new store openings, which added about 12% more retail square footage. Comparable store sales, which only count stores open more than 13 months, were flat because of a slowing housing market, weaker home improvement demand in previously strong markets, tough comparisons against 2005 hurricane rebuilding demand, and roughly 15% deflation in lumber and plywood prices.
Is Lowe's margin and earnings growth sustainable given the slowdown in comparable sales?
Margin gains in 2006 came partly from favorable product mix, a higher share of imported goods (about 11% versus 9.5%), and lower bonus and retirement expense that scales with performance. Some of these benefits may not repeat. Management guided to a 70 to 80 basis point decline in operating margin for 2007, reflecting higher depreciation and store investment, so earnings growth will likely slow.
How is Lowe's funding its growth and shareholder returns?
Operating cash flow of $4.5 billion covered most of the $3.9 billion in capital expenditures, with the remainder financed partly by a $1 billion senior notes issuance in October 2006 and by stock option exercises. The company still returned about $2.0 billion to shareholders through buybacks and dividends. Management says it expects operating cash flow and financing to be adequate for the next 12 months, but a rating downgrade could make debt markets more costly.
What are the main risks investors should monitor?
Key risks include dependence on housing turnover and consumer confidence, unseasonable weather, the ability to open and staff about 150 to 160 new stores a year (including new Canadian and Mexican markets), competition from other home improvement and online retailers, product liability claims in which the company self-insures, and disruption to its supply chain, particularly for imported goods. The company disclosed no material pending legal proceedings.
What does Lowe's 2007 outlook imply for investors?
Management expects sales growth of roughly 10%, flat to modestly positive comparable sales, and diluted EPS of $2.02 to $2.09, which would be about 2% to 5% above 2006 EPS of $1.99. Results will depend on whether the housing slowdown stabilizes, whether lapping hurricane-related sales eases in the second half of 2007, and whether store productivity and new store returns hold up as the company expands into more markets.

04—Continue

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