Changes Under Way at Lowe's, Market Applauds
New CEO Marvin Ellison is altering the wide-moat business by winding down the Orchard Supply brand and introducing an inventory rationalization plan.
With Marvin Ellison taking the helm at the beginning of July and a massive overhaul of the C-suite, we aren’t surprised that changes are underway at Lowe's (LOW). Taking his first step to alter the business, CEO Ellison announced the wind-down of the Orchard Supply brand, which was acquired in 2013 and has troubled the wide-moat company, generating a $76 million impairment in 2016. He also announced an inventory rationalization plan; both are set for execution over the remainder of the year. Given that Lowe’s inventory days (92) were around 30% higher than Home Depot’s (70) at the end of 2017, there should be ample opportunity to improve working capital efficiency, and with an executive team with extensive retail experience at topnotch category leaders, execution should be seamless.
Expenses of $230 million from the wind-down cost Lowe’s $0.21 per share in the second quarter, and another $390 million-$475 million is expected in the second half of 2018, leading to one-time charges around $0.60-$0.65 per share for the full year, by our estimate. The remainder of Lowe’s GAAP earnings guidance downgrade (to $4.50-$4.60 per share from $5.40-$5.50) comes from inventory management initiatives. These two efforts should better streamline the business and lead to improved operating metrics over time as a focus on faster inventory and cash conversion metrics could generate meaningfully better cash flow. We expect Lowe's will lay out a more detailed road map of changes ahead and the potential benefit these efforts could have on the longer-term operating margin profile at the company's investor day later this year.
We don’t plan any immediate change to our five-year outlook, which calls for comparable-store sales growth that averages 3%, a top line that rises slightly faster than comps, and low-double-digit operating margins. As a result, we don’t plan to materially alter our $94 fair value estimate and view the shares as modestly overvalued.
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Jaime M. Katz does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.