Lowe’s Business Grows as its’ Income Shrinks

The latest earnings report had good news and bad news for Lowe’s (NYSE: LOW) investors. Revenues at the home improvement store grew while income shrank over the course of third quarter 2016.

Lowe’s went into the third quarter with a net income of $2.798 billio;n that fell to $2.441 billion on Halloween day 2016. That number was also well below the income Lowes reported in October 2015 which was $2.985 billion. The company is not making as much money as it used, the net income fell by $544 million over the last year which indicates that hardware might not be as profitable as we thought it was.

Now for what is truly interesting, Lowe’s revenues are growing like weed. Lowes added $1.38 billion in revenue during third quarter 2016; and $4.09 bill over the course of the year that ended on October 31, 2016. Lowes reported revenues of $58.38 billion on Halloween day, 2015, $61.09 billion worth of revenues in July 2016, and $62.47 in revenues at the end of third quarter 2016.

Why is Lowe’s Income falling?

All of this indicates that Lowe’s home improvement business is growing like gangbusters – but it is having a hard time making money from that business.

CHICAGO, IL - JANUARY 24: Wes Bielinski (L) helps a customer shop for a sander at a Lowe's home improvement store on January 24, 2013 in Chicago, Illinois. Lowe's said they plan to hire 45,000 part-time workers this spring, the busiest time of the year for home improvement retailers. The company also expects to hire 9,000 permanent part-time employees. (Photo by Scott Olson/Getty Images)
CHICAGO, IL – JANUARY 24: Wes Bielinski (L) helps a customer shop for a sander at a Lowe’s home improvement store on January 24, 2013 in Chicago, Illinois. Lowe’s said they plan to hire 45,000 part-time workers this spring, the busiest time of the year for home improvement retailers. The company also expects to hire 9,000 permanent part-time employees. (Photo by Scott Olson/Getty Images)

My guess is that the cost of expansion, acquisitions and increased sales is eating into Lowe’s profits. After all Lowe’s has a very high overhead business that includes giant retail outlets, delivery and servicing of commercial clients all of which can get expensive fast.

Another problem Lowe’s faces is deep discounting particularly in the appliance sector. To compete with arch rival Home Depot (NYSE: HD) and big box operators like Best Buy (NYSE: BBY) Lowe’s has to keep prices for appliances and fixtures fairly low. Yet it also has to deliver and install some of those items while fending off deep discounters like Walmart Stores Inc. (NYSE: WMT).

Is Lowe’s Making Money?

Despite that Lowe’s is still making a lot of money it reported $5.507 billion in cash from operations on October 31, 2016. That number was up substantially from July when the company generated $5.24 billion in cash and from operations and October 2015 when it made $4.791 billion.

That figure gives Lowe’s a lot of float which appears in the financial records as $1.083 billion in short-term investments and cash for third quarter 2016. Lowe’s business model is still working, it’s just struggling to maintain income.

The struggle to maintain income can be seen in the free cash flow which was quite low at $311 million on October 31, 2016. Despite that Lowe’s is capable of generating significant amounts of free cash flow ($3.012 billion in April 2016) at certain times of the year.

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Lowe’s is a Value Investment

This makes Lowes a value investment because it is a somewhat quiet company that generates a lot of cash. Lowes also runs a business that is not very sexy; selling toilets and chainsaws to do it yourselfers and small contractors. Yet that business can be quite profitable the company reported a 2.41% profit on October 31, 2016.

If you’re looking for a value investment in retail Lowe’s would be a good choice. What’s interesting is that it is also a pretty income investment. Lowe’s investors were rewarded with a 33.21% return on equity n October 31.

Lowe’s is a Great Dividend Stock

They also received a 1.77% dividend yield on November 22, 2016. That yield comes from a 35¢ dividend; scheduled for payout on January 23, 2017.

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Lowe’s is a good dividend stock because the dividend amount has been growing in recent years. During 2016 the dividend jumped from 28¢ in April to 35¢ in July. That’s a seven cent a share dividend increase in just one year that sounds good to me.

During 2015 the dividend increased from 23¢ in April to 28¢ in July – a five cent increase. In 2014 the dividend rose from 18¢ in April to 23¢ in July – another five cent increase. Back in 2013 the dividend was raised from 16¢ in April to 18¢ in July a two cent increase. In 2012 the dividend was increased from 14¢ to 16¢ a share between April and July.

Lowe’s dividend has more than doubled over the course of four years. Rising by 20¢ a share which tells us that this home-improvement store is a good choice for persons looking for dividend income in retail.

Can Lowe’s Growth Continue?

Now we come to the $1 billion question; can Lowe’s growth continue? My short answer to that would be yes based on the changes in the retail landscape. There’s plenty of opportunity for growth in Lowe’s sphere and limited competition.

The epic collapse of its historic rival Sears Holdings (NASDAQ: SHLD) and Walmart’s lack of interest in large appliances provide a major opening for Lowe’s in that field. The growth of Amazon (NASDAQ: AMZN) helps Lowe’s and Home Depot by driving competitors like department stores and mom and pop hardware stores out of business.

Although Amazon creates a problem for Lowe’s by forcing it to concentrate on more expensive big-ticket items that cannot be sold online like lumber and appliances. It and other online retailers also steal some more profitable sales such as those of tools and power tools.

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That forces Lowe’s to concentrate more resources on contractors and bigger ticket items which creates more customer service expenses. Selling a load of lumber is more expensive than selling a chainsaw for Lowe’s; because the retailer will probably have to deliver the lumber. That creates the added costs of truck, truck driver and perhaps another employee to help load and unload the truck.

Despite that I expect Lowe’s growth to continue because of the lack of competition in the home-improvement sphere. Although there are some problems on the horizon including rising mortgage rates which might slow home construction and remodeling and limit demand for building materials.

The 30 year fixed mortgage interest rate jumped to 3.94% during the first week of November 2016. Whether that was panic because of the election or the start of a trend is unknown. Although a period of high mortgage rates might dampen construction and remodeling and hurt business.

Even if that occurs, I think Lowe’s is a pretty good investment because of the cash it generates and the dividends. If you need income in your portfolio and you want a retailer investigate Lowe’s.