Bill Ackman’s Most Undervalued Stock

 

Outlining the fund’s performance in his annual letter to shareholders, the Wall Street billionaire highlighted the relatively poor returns from two of his positions, Netflix and Lowe’s.

 

Indeed, these companies made a net loss of 3.9% and 4.7%, respectively, representing the worst of his bets by quite some way.

 

However, while Pershing went on to cut its Netflix stake, the company decided to stay loyal to Lowe’s.

 

That’s not surprising. In fact, Ackman describes LOW as a high-quality business with significant long-term growth potential. Moreover, he reckons the firm is cheap at its current earnings multiple, offering a 23% discount against its primary rival, Home Depot.

 

So, with a ringing endorsement from one of America’s most famous investment gurus, let’s take a closer look to see what makes Lowe’s such a special business.

 

Source: Unsplash

 

Lowe’s Companies, Inc. is an American retailer specializing in home improvement products and services. Founded in 1921, the company operates nearly 2,200 stores in the United States and Canada, serving roughly 19 million customers weekly. Lowe’s focuses on providing a comprehensive selection of goods and services at some of the most competitive prices out there.

 

Furthermore, the brand offers a wide range of product categories, including hardware, tools, building materials, and millwork, and provides services such as installation, product assembly, and pickup. It has also developed a strong online presence with its e-commerce platform, which allows customers to shop for products and services from any device.

 

Crucially, the business is well-positioned in the home improvement industry, boasting a well-established name and a loyal customer base.

 

Moreover, the company’s Total Home Strategy has allowed it to stay ahead of its competitors while capitalizing on the growing demand for home improvement products. Lowe’s has established its presence in the space and continues to post strong financial results through its focus on customer service, technology, and operations.

 

Indeed, the firm’s management team has taken a disciplined approach to capital investment and maintains a conservative balance sheet. The company has diligently utilized its cash flow to invest in strategic initiatives that drive long-term value. Demonstrating this, Lowe’s announced it had repurchased $4.0 billion worth of stock during the third quarter of 2022 and paid back $666 million in dividends to eligible shareholders.

 

Going forward, Lowe’s plans to continue to grow its market share by leveraging its omnichannel capabilities and expanding into new territories. This strategy should help Lowe’s to remain agile in a highly fragmented industry and keep up with the changes in the retail landscape.

 

Lowe’s reported a “better-than-expected” performance during its recent third-quarter earnings rundown. The company’s total sales were up slightly at $23.5 billion, with comparable sales growing 2.2%.

 

However, adjusted diluted EPS saw more substantial improvements, increasing 19.8% to $3.27 from the previous year.

 

That said, the full-year outlook is a mixed bag. While gross margins are expected to be up slightly from 2021, comparable sales will likely fall 1% – although the mid-point for adjusted diluted earnings has increased from $13.35 to $13.80.

 

The company did see strong demand from professional customers, while sales on its Lowes.com platform expanded 12% in addition to the 25% growth it registered last year. Indeed, due to its superior cost management and disciplined execution throughout the quarter, the business was able to announce a $170 million rise in permanent wage increases too.

 

The rivalry between Lowe’s and Home Depot has been longstanding, with each company competing for the same customers in the home improvement sector. This competition takes the form of both price and quality of merchandise, each offering various items at differing entry points. Examples of this include the placement of stores close to one another, the launch of joint promotions and sales events, and the availability of similar products and services.

 

While this might seem academic, the battle between Lowe’s and HD could have severe ramifications if either store slashes prices. This would have a material effect on each company’s earnings haul and could lead to a complex operating environment for both.

 

Indeed, having seen unprecedented growth in demand during the pandemic years, sales have only just begun to contract for LOW. For instance, revenue exploded by 24% in 2020 to $90 billion and increased again in 2021 to $96 billion. And it wasn’t just sales that soared; diluted earnings grew 54% in 2020 and another 36% in 2021.

 

Unfortunately, with a tougher macroeconomic outlook, it’s not unthinkable that Home Depot and Lowe’s will engage in further competitive practices. If that happens, the already challenging circumstances they are in now could only worsen.

 

Notwithstanding Bill Ackman’s positive views on Lowe’s valuation metrics, is the company really a steal a today’s price?

 

To begin with, its forward PE ratio of 15.5 is definitely better than The Home Depot’s, which lags behind at 19.4. Furthermore, LOW has share price momentum to back it up, having grown in value by 7.4% in 2023 compared to HD’s modest 0.80% increase.

 

But Lowe’s does face some headwinds. Its revenue growth is stagnant, and its return on total assets – while good at 14.2% – is not as inspiring as Home Depot’s 22.2%.

 

No matter. For investors, it’s LOW’s dividend that sets it apart. Its forward yield of 1.96% is not dissimilar to HD’s 2.35% – but beats it hands down on all other fronts. For example, Lowe’s payout rate is stellar at 28%, with a 5-year growth rate of 20%. On the other hand, HD disappoints; it has an inflated payout ratio of 46% and a compound annual growth rate of just 16% for the last half-decade.

 

On this basis, you’d do well to follow Ackman’s lead. So either hold your position if you already own – or if you’re new to Lowe’s, it’s time to buy.