Lowe's Companies, Inc. (NYSE:LOW) Q3 2023 Earnings Call Transcript November 21, 2023
Lowe's Companies, Inc. misses on earnings expectations. Reported EPS is $3.06 EPS, expectations were $3.1.
Operator: Good morning, everyone, and welcome to Lowe's Companies' Third Quarter 2023 Earnings Conference Call. My name is Rob, and I'll be your operator for today's call. As a reminder, this conference is being recorded. I will now turn the call over to Kate Pearlman, Vice President of Investor Relations and Treasurer.
Kate Pearlman: Thank you, and good morning. Here with me today are Marvin Ellison, Chairman and Chief Executive Officer; Bill Boltz, our Executive Vice President, Merchandising; Joe McFarland, our Executive Vice President, Stores; and Brandon Sink, our Executive Vice President and Chief Financial Officer. I would like to remind you that our notice regarding forward-looking statements is included in our press release this morning, which can be found on Lowe's Investor Relations website. During this call, we will be making comments that are forward-looking, including our expectations for fiscal 2023. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the Risk Factors MD&A and other sections of our Annual Report on Form 10-K and our other SEC filings.
Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found on the Quarterly Earnings section of our Investor Relations website. Now, I'll turn the call over to Marvin.
Marvin Ellison: Thank you, Kate, and good morning, everyone. For the third quarter, comparable sales declined 7.4%. Our results were driven by a greater than expected pullback in DIY discretionary spending, especially in bigger ticket categories. While we've seen a more cautious consumer for some time now, this quarter, we saw some of these consumers increasingly prioritizing experiences over goods, spending on travel and entertainment. As a reminder, at Lowe's, 75% of our revenue is driven by DIY customers and 25% by Pros while the broader market mix is roughly 50% DIY and 50% Pro. As a result, whenever the DIY customer becomes cautious, it disproportionately affects us and while we faced a softer DIY demand in the third quarter, I'm pleased that at the same time, we once again delivered positive sales comp in Pro.
Now I'd like to take a moment to dig a bit deeper into our DIY performance for the third quarter. In categories like appliances, the core flooring and kitchen and bath, where we have strong DIY penetration, we saw increased pressure on sales of bigger ticket purchases like appliances, where consumers are postponing purchases, if they can. For example, customers who may have previously bought an entire kitchen suite may now just buy a refrigerator. Keep in mind that the industry-wide pullback in appliance sales has a larger impact on Lowe's since we are the market leader in appliances in the U.S. with 14% of our sales coming from this category. Later in the call, Bill will discuss some of the initiatives we're implementing in Q4 to improve DIY performance with a more targeted effort to reach value-conscious customers, including our most competitive offers on single unit appliance purchases ahead of the holiday season and the launch of our Lowe's Lowest Price Guarantee so our customers can shop with confidence knowing that they'll always find the best price at Lowe's.
Despite the pullback in DIY, Pros are still working and many of their projects are a result of increased wear and tear on aging homes, which lead to unavoidable repairs. This continues to create project backlogs for small to medium-sized Pro, who is our core customer. In our most recent survey, nearly 70% of Pros reported healthy project backlogs. But given the uncertain macroenvironment, they're feeling a little less confident. Although Pros may be a bit cautious in this environment, our ability to deliver a positive Pro sales comp in the third quarter is a reflection that our strategy is working. We're making progress with the investments we've made over the last several years to improve our service offering, including increasing loyalty through our MVP Pro Rewards, developing a world-class CRM platform, improving job site delivery, enhancing service levels in our stores, creating a more seamless online experience and a number of merchandising initiatives that Bill will discuss later in the call.
Overall, we've built a competitive Pro sales and service model, which is creating a flywheel effect that will enable us to grow Pro sales at 2 times the pace of the market. Let's now turn to online sales, which declined 4% in the quarter as the same pressures in DIY bigger ticket categories impacted digital sales. Now let's talk about what we're doing to manage this unique environment. In store operations, we've made foundational improvements to associate productivity that enable us to effectively align labor to demand, while continuing to serve our customers. During the quarter, we leveraged these new capabilities to reduce operating expenses, while enhancing the customer experience for both Pro and DIY customers at the same time. Joe will provide more detail on these initiatives and our improved customer service scores later in the call.
I'm pleased that our disciplined focus on expense management across the organization contributed to a 46 basis point increase in operating margin rate compared to adjusted operating margin in the prior year, despite the sales decline which led to diluted earnings per share of $3.06. As we explore ways to drive improved sales with our DIY customers, I'd like to provide you with an update on two initiatives. Our new Lowe's Outlet stores and our rural strategy. Let me start with our Lowe's Outlet stores. We opened our 15 Lowe's Outlet location in Q3. With these smaller format stores, we can leverage the lower cost real estate in trade areas closest to our core customer without cannibalizing a nearby Lowe's store. In an environment where DIY consumers are seeking value, we're pleased with the customer response and the overall performance of our outlet locations.
These stores complement our market delivery network, allowing us to offer savings between 25% to 70% off on big and bulky, scratch and dent items like appliances, patio furniture grills, all while maximizing profitability and offering our customers' enhanced value. We look forward to discussing the potential growth opportunities of this strategy on an upcoming call. Turning to our rural strategy. This one stop shop concept is designed to give customers located in rural areas across the country everything they need for their home and farm, including a wide offering of farm, ranch and outdoor products. During the summer, we launched this rural assortment to over 300 stores where we're selling products like livestock feed, pet food, utility vehicles and apparel from brands like Carhart and Wrangler.
These programs include a Petco store within a store, which enhances the total home solution we offer by bringing together home improvement and pet care services, products and expertise under one roof. We're pleased to see this new initiative already gaining traction with strong performance in pet, apparel and automotive. In fact, these rural customers are our best performing DIY segment and these stores are performing significantly above the company average. Given this initial success, we're now exploring expanding this rural assortment beyond the original 300 designated rural stores. In addition, we are planning to add incremental merchandising initiatives within these original 300 stores because the customer is responding favorably to these new assortments and product lines.
Looking ahead, we remain focused on our merchandising and marketing efforts that highlight the everyday value at Lowe's for our price-sensitive customers. And we'll continue to invest in our strategic growth initiatives within our Total Home strategy as we strive to become a world class omnichannel retailer. And as I wrap up, let me say that we remain bullish on the medium to long term outlook for the home improvement industry, supported by favorable housing and demographic trends. We expect home prices to be supported by persistent supply demand imbalance of housing, while at the same time, 250,000 millennial household formations are expected per year through 2025 and their parents and grandparents, the baby boomers, increasingly prefer to age in place in their own homes.
And we cannot overlook the fact that we now have the oldest housing stock in U.S. history with the medium age of homes now 41 years old, which will need ongoing investments in repair and remodel projects. These factors continue to reinforce our optimism about the mid to long term outlook for our industry. In closing, I'd like to thank our frontline associates for their continued hard work and dedication to serving customers and our communities. And with that, I'll turn the call over to Bill.
William Boltz: Thanks, Marvin and good morning, everyone. Despite a pullback in DIY discretionary demand, we are pleased that we delivered positive Pro comps this quarter as our enhanced product and brand offerings continue to resonate with the Pro. Over the past several years, we've added the brands that Pros want and we have invested in the inventory quantities Pros need. And we continue to tailor our product assortments to local building codes and preferences. These investments continue to pay off even in a more challenging macroenvironment where we remain laser focused on highlighting everyday value and convenience, both in our stores and online to a price conscious consumer. Turning to our results in building products. We continue to serve our resilient Pro customer who remains active, especially on repair and maintenance projects.
We delivered positive comps in building materials, partly driven by strong performance in Pro heavy categories like roofing and drywall. We also delivered comps above the company average in rough plumbing, largely driven by positive comps in water heaters, demonstrating that Lowe's is the go-to solution for critical repair needs. This quarter, Klein Tools returned home to Lowe's. This trusted brand is the number one tool brand for electrical and HVAC professionals and we're thrilled to now offer the largest assortment of Klein Tools in the home improvement retail channel. Our Pro customers' response to our re-launch of Klein Tools has exceeded our expectations and we're excited about our plans to expand this iconic brand to support the unique needs of these trade professionals.
Now, let's shift gears to home decor, which was most heavily impacted by lower DIY project related demand. And as you heard from Marvin, this had a greater impact in categories like appliances, flooring and kitchens and bath. Within appliances, we are seeing lower industry unit volumes as well as the reintroduction of pre-pandemic levels of vendor funded promotion, which puts pressure on average selling price. And while our results in kitchens and bath were also impacted by softer DIY demand, we are seeing our private brand products gaining traction as the consumer continues to look for value, like with our new Allen and Roth Butcher Block countertops. These are made of solid FSC certified wood and this stylish product is a cost effective way to refresh your kitchen, bar or studio.
This item has been so popular that we are now doubling our sales expectations. Turning to paint. We delivered comps above company average in the quarter, largely driven by the Pro who paints, who relies on Lowe's as a one stop shop for their project needs. We continue to look for opportunities to expand our product offering, including a recent launch of an exclusive line of Sherwin-Williams primers from HGTV HOME. These new primers designed for the Pro who paints gives them a versatile multi surface application that makes it easier to work on both interior and exterior projects. Shifting gears to hardlines. In addition to a broad based DIY pullback, we also saw a pressure in categories impacted by storm related activity such as generators, gas cans, fuel and chainsaws as we cycled Hurricane Ian from last year.
We delivered comps above company average in lawn and garden, as our customers engaged in smaller fall cleanup projects. And we also drove comps above company average in hardware led by key Pro categories like fasteners, safety equipment and cleaning products. Lastly, we continue to build out our brand portfolio like with our new strategic partnership with the Toro Company. Their exciting product lineup further complements what is now the strongest brand offering in outdoor power equipment, one that resonates with both the Pro and DIY customer who relies on Lowe's to offer the best selection. We're looking forward to launching Toro ahead of our upcoming spring season and building on our momentum as the leading retailer of outdoor power equipment.
In response to the customers' increased focus on value, I'd like to talk about how we are highlighting some of the ways that customers can save time and money during this holiday season. For starters, we recently kicked off our holiday campaign with a commitment to supporting shoppers in new ways, all season long, which includes a wave of exciting offers and new deals every week on great gift ideas including power tools from some of the best brands like DEWALT, CRAFTSMAN and Kobalt and pre-lit Christmas trees trimmed with the innovative energy saving LED lighting. Our customers can also look forward to same day delivery on key holiday and home improvement items as well as services like holiday lighting for the home through A&G. And as Marvin mentioned, we recently launched our new Lowe's Lowest Price Guarantee to remind customers that not only can they expect a great shopping experience, but they will also receive the lowest price on items for their home.
In fact, customers can now find our lowest prices of the year on select major appliances. And in an effort to simplify the offer and make it easier to understand, we're offering $100 off for every $800 a customer spends. For our Pros, we have tailored exclusive bulk saving offers on appliances as well and to drive even greater excitement and traffic on Black Friday, we will feature more than 10 major appliance door busters. We're excited to deliver what we think will be the most compelling offers in the market. In addition to these great deals. Lowe's is now offering Carhart apparel online and in select stores. This iconic workwear brand makes a perfect gift for the Pro this holiday. Before I close, I'd like to highlight just a few of the Perpetual Productivity Improvements or PPI workstreams that are underway in merchandising.
Our teams continue to make progress in our three main focus areas: product cost management, inventory productivity, and pricing and promotional strategies. We continue to partner with our suppliers to take costs out, especially now that transportation and commodity costs have come down. And we are expanding our private brand portfolio, which delivers great quality and value at a lower price to our customers, while also driving better margin rate productivity. Our teams are working hard to ensure that customers have the best value every day at Lowe's, while also delivering productivity for the organization. And as I close, I'd like to extend my appreciation once again to our vendors and our merchants for their hard work, dedication and ongoing partnership.
Thank you and I'll now turn the call over to Joe.
Joseph McFarland: Thank you, Bill and good morning, everyone. I'd like to begin by thanking our frontline associates for their ongoing efforts to deliver excellent customer service. As Marvin mentioned, we were able to reduce operating expenses this quarter while, at the same time, delivering a 200 basis point improvement in DIY customer satisfaction scores and a 300 basis point improvement for the Pro. This represents the ongoing benefit of our foundational technology investments designed to modernize our stores' operational process and simplify our associates' jobs, while also creating a great shopping environment for our customers. Let me highlight just a few of these changes. For starters, we created an industry-leading customer centric scheduling system, which allows us to predict customer demand and align staffing around peak customer traffic for each store and each department.
This system creates enhanced operational agility so we can rapidly adjust as demand pattern shift. Second, we've enabled greater productivity by putting mobile smart devices in all of our associates' hands to make them more efficient, reducing manual tasking and enabling faster customer service. For example, by integrating smart devices with our new Store Inventory Management System or SIMS, our associates can find products 40% faster. And through Project Simple, we've eliminated duplicative tasks and reduced non-productive hours, so we could repurpose associate time from tasking to selling and service. A third foundational improvement is the expansion of our Merchandising Services Team or MST. This team keeps our shelves stocked and they recently assumed responsibilities for price changes across the store and watering in the garden center.
MST is now leveraging a new app that directs them to serve a specific base based on the rate of sales, making their hard work even more productive and freeing up more time for our Red Vest associates to spend with customers. Another important aspect of delivering excellent customer experience is convenience. That's why we're making a number of enhancements to create a more convenient shopping experience ahead of the holiday season. For example, we're extending our same day delivery to in-store purchases through our gig network to both Pro and DIY customers. And in certain locations, we'll even be delivering live Christmas trees to our customers' doors, saving them the hassle of getting it home themselves. This new gig delivery capability, which we first rolled out on lowes.com enables us to tap into the OneRail network of 12 million drivers to deliver directly to Pro job sites and customer homes in just a matter of hours.
Our store operations team is also focused on unlocking even more productivity through our perpetual productivity improvement initiatives or PPI. This past quarter, we've fully retired the old self-checkout systems and have shifted to the proprietary self-checkout systems that we've built for the home improvement shopper. We've seen greater customer adoption of these new systems since they're so much easier to use. In fact, our front-end transformation is well underway with approximately 450 stores planned by the end of this year. Over a three-year timeline, we're revamping the checkout experience across all of our stores and increasing the selling space at the front. We're adding more merchandise right at checkout with a new design that makes it easy to showcase grab-and-go items.
And with this front-end transformation, we're shifting to an easy-to-use assisted self-checkout with cashiers, who'd be right there to answer questions and help customers when they need it. Finally, we're tripling the staging area for buy-online pickup-in-store orders to support increased online sales and create a much faster, easier, customer experience, building on our momentum when it comes to driving improved customer service scores for these orders. At the same time, we're excited to launch omni-selling in our stores, a critical milestone in our journey to become a world class omnichannel retailer. Enabled by our new store operating system, we can now easily sell our endless aisle on lowes.com within the aisles of our stores. For example, let's say a customer is shopping for new faucets and browsing our selection of the most popular finishes in the store.
While talking with an associate, they decide to go with the unique finish from lowes.com that the associate highlights on their mobile device. The associate then saves the faucet in the customer's digital card with their phone number and the customer can continue shopping in the store. When the customer is ready to checkout, all the cashier needs to do to combine the digital and physical purchases is pull up the digital card using the customer's phone number. We're still in the early innings here, but we know this is a great opportunity to drive our omni sales and make sure our customers get everything they need to complete their project in one shopping trip. As I close, I would like to thank all of our store leaders and associates once again for their hard work serving customers and delivering results each and every day.
Thank you, and now I will turn it over to Brandon.
Brandon Sink: Thank you, Joe, and good morning, everyone. Starting with our Q3 results. We generated diluted earnings per share of $3.06. Please note, in the prior year, we recorded an asset impairment charge of $2.1 billion associated with our Canadian retail business. Now, my comments from this point we'll reference comparisons to certain non-GAAP measures from last year where applicable. Q3 sales were $20.5 billion. For reference, prior year sales included $1.2 billion generated in our Canadian retail business. Additionally, Q3 results include a $115 million sales headwind due to the shift in our fiscal calendar as we cycle over a 53-week year. Comp sales were down 7.4% as the slowdown in DIY bigger ticket spending offset growth in Pro.
Q3 comps were negatively impacted by approximately 50 basis points due to lumber deflation. As a reminder, the calendar shift impacted total sales growth, but had no impact on comparable sales as comps were calculated based on weeks 28 through 40 in fiscal 2022. Comparable average ticket was down 0.5%, driven by lumber deflation, more normalized appliance promotions and a decline in big-ticket DIY transactions. However, average ticket still increased in the majority of our merchandise categories. Comp transactions declined 6.9%, driven by softer demand in DIY discretionary projects, partly offset by positive comp transactions in Pro. Our monthly comps were down 6.3% in August, 8.3% in September, and 7.3% in October as DIY traffic slowed as we exited our peak seasonal weeks.
Gross margin was 33.7% of sales in the third quarter, up 36 basis points from last year. Gross margin benefited from our ongoing merchandising PPI initiatives as well as favorable product mix and lower transportation costs. This was partially offset by costs associated with the expansion of our supply chain network. And consistent with our year-to-date performance, shrink was in line with prior year. SG&A of 18.4% levered 30 basis points versus prior year adjusted SG&A, demonstrating our enterprise-wide agility to manage expenses and drive productivity in a lower sales environment. These results would not have been possible without the exceptional efforts of our store leadership teams to rapidly respond to the sales pressure as well as the ongoing benefits that we are harvesting from our technology-led PPI initiatives.
Operating margin rate of 13.2% improved by 46 basis points versus prior year adjusted operating margin. The effective tax rate was 24.6%, in line with prior year adjusted effective tax rate. Inventory ended the quarter at $17.5 billion, down $2.3 billion compared to Q3 of last year. U.S. inventory dollars and units were both down compared to last year as we aligned inventory purchases with sales. Turning now to our capital allocation. During the quarter, we generated $485 million in free cash flow. We repurchased 7.3 million shares for $1.6 billion and paid $642 million in dividends at a $1.10 per share, returning $2.2 billion to our shareholders. Capital expenditures totaled $579 million as we continue to invest in our strategic priorities within our Total Home strategy.
Adjusted debt-to-EBITDAR finished the quarter at 2.72 times, in line with our stated 2.75 times leverage target. Finally, we delivered return on invested capital of 35%, inclusive of an unfavorable 125 basis point impact related to transaction costs associated with the sale of our Canadian retail business and the gain we reported in Q1. Now turning to our 2023 financial outlook. Given the recent pullback in DIY bigger ticket discretionary spending and the uncertainty surrounding the macro factors that impact our business, we are updating our full year 2023 financial outlook. With this in mind, we are now forecasting Q4 comp sales to be fairly consistent with Q3 results. Also, the fourth quarter of 2022 included approximately $1.4 billion in sales from the additional 53 week.
We are now expecting 2023 sales of approximately $86 billion with a comparable sales decline of approximately 5%. We also now expect adjusted operating margin of approximately 13.3% as our ongoing PPI initiatives and disciplined expense management help to offset volume deleverage pressure from lower sales. Additionally, we expect full year interest expense of approximately $1.4 billion, capital expenditures of up to $2 billion and an adjusted effective income tax rate of approximately 25%. This results in an updated outlook for adjusted diluted earnings per share of approximately $13. Please note that our outlook for operating margin, and diluted earnings per share are adjusted to exclude the gain associated with the sale of our Canadian business that we recorded in Q1.
Finally, we are reconfirming our capital allocation priorities. We will continue to invest in the business to take market share, target a 35% dividend payout ratio and then return excess cash to shareholders through share repurchases, which will be funded in the near term through free cash flow. And in closing, I'm confident that our continued investments in our Total Home strategy, our strong balance sheet and our ability to effectively manage our business in any environment will allow us to navigate the near term challenges while continuing to deliver sustainable shareholder value. And with that, we will open it up for questions.
To continue reading the Q&A session, please click here.