Pershing Square Capital founder Bill Ackman has gained notoriety as an icon of the investment world over the last 15 years. Today, the billionaire’s portfolio is quite concentrated, with a single stock making up 23.5 percent of Pershing Square’s holdings. This stock is home improvement giant Lowe’s (NYSE:LOW).
Why has he bet so heavily on it?
Revenue Growth Is Not The Reason
While Lowe’s has not yet released full-year results for 2022, its earnings report for Q3 detailed comparable sales growth of 2.2 percent year-over-year. Pro sales growth, however, was much higher at 19 percent. 2022 was also a good year for Lowe’s online sales growth, which advanced 12 percent over 2021.
Diluted EPS, however, was much lower than the previous year. Each share earned just $0.25, compared to $2.73 in Q3 2021.
Like many businesses, Lowe’s has been pressured by inflation and rising labor prices. This year, Lowe’s will likely experience very anemic earnings growth.
Current projections suggest that EPS will rise by less than 1 percent over the next 12 months. Over the next 3-5 years, however, analysts expect Lowe’s to return to its growth streak and achieve compounded EPS growth of nearly 11 percent.
The management team at Lowe’s has also laid out its long-term plan to drive further growth. Internally referred to as Lowe’s Total Home, the strategy involves making Lowe’s a complete one-stop shopping experience for both professional and DIY home improvement projects.
Lowe’s is likely in a unique position to achieve this status within the industry, given its deep market proliferation and well-known brand recognition among consumers.
But Lowe’s Has Significant Upside
For a large, established business, Lowe’s could carry a considerable amount of upside in 2023. Analysts project LOW fair value of $235, up 16.6 percent from the most recent price of $201.50. Of the 36 analysts covering Lowe’s, 34 rate the stock as a hold, outperform or buy.
At today’s prices, Lowe’s seems to be slightly undervalued. The home improvement giant trades at under 15 times earnings and just 1.6 times sales, while its price-to-cash-flow ratio is just over 13.
Given that Lowe’s is a dominant company in its industry and has reasonably strong growth prospects over the next few years, the stock’s current price makes it a fairly attractive value.
Lowe’s currently has a reserve of cash and equivalents of nearly $3.2 billion. While significant, this reserve is far below the company’s long-term debt load of over $32 billion. As such, debt could be a detractor from the value argument for Lowe’s. Given the company’s management team and long history, though, it’s difficult to imagine Lowe’s failing to manage these debts responsibly.
The company is a surprisingly strong performer on the dividends front. It currently pays $4.20 per share, yielding 2.08 percent. At 49 years of consecutive increases, Lowe’s is just shy of being considered a dividend king.
Over the last three years, management has raised this payout at an aggressive compounded rate of over 22 percent. Given that the payout ratio is still only 41 percent, though, this dividend growth seems to have plenty of room left to run.
Will Consumer Spending Hurt Lowe’s?
In the short term, Lowe’s biggest risk factor is likely reduced consumer spending as inflation, a slowdown in the real estate market and a possible recession reduce non-essential home improvement projects.
In 2023, consumers are expected to massively reduce their spending on home renovations. As a premier source for materials and tools, Lowe’s will almost certainly feel the effects of this lower spending until consumers begin tackling larger projects again.
Lowe’s is also relying on online sales to drive its future growth. While the company has performed quite well in building its brick-and-mortar business over the years, it has historically struggled to transition to more modern eCommerce. If the company cannot execute its digital transformation plans effectively, it could see slower-than-expected sales growth in the coming years.
Finally, Lowe’s faces close competition from Home Depot. Both companies enjoy a strong presence in the mind of consumers, and both offer exclusive brands. As they are active in the same markets and competing for the same basic group of consumers, these two companies constitute an effective duopoly.
Why Did Bill Ackman Buy Lowe’s?
Lowe’s has several points in its favor as a potential buy. In addition to its economic moat and growing pro sales, the company is seeing early signs that its eCommerce strategy is beginning to pay off. While it will need continued growth in this area to reach its long-term goals, 2022’s results do show online sales moving in a positive direction.
Between its relatively conservative ratios and its focus on rewarding shareholders with dividends, Lowe’s also appears to be a decent value buy. Although the company isn’t massively undervalued, it appears that investors who buy at today’s prices likely won’t overpay for the stock.
The company’s risks in the short term are considerable, given how much consumer spending on home improvement is expected to drop. If inflation drops off and consumers begin investing discretionary income into their homes again, though, Lowe’s could still have plenty of room for long-term growth.
Those watching Ackman’s portfolio should also notice that the billionaire investor acquired his stake at prices far lower than today’s. Ackman’s average cost basis was $99.39 per share, less than half the current trading price of the stock. As such, the value argument that likely drove Ackman’s purchase is much weaker in today’s context.
While this certainly doesn’t rule Lowe’s out today, it’s important to understand that the stock has likely moved much closer to its intrinsic value while Ackman has held it.
Overall, Lowe’s appears to be exactly the kind of dominant business with long-term growth potential that attracts Bill Ackman’s investment team. For retail investors, the stock could be a decent choice as a conservative growth or dividend income asset. Although Lowe’s is unlikely to produce enormous annual gains given its current size, the company could see moderate, reliable growth over the next several years.
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