Value Line Publishing, October 2002: Lowe’s Financial Performance

Part A: Assumptions

In 2002, Value Line Publishing published a report on Home Depot and Lowe’s. Among the considerations in the report, there is the valuation of the two companies based on historical data. Through its analyst Carrie Galeotafiore, Value Line Published asserted that the value of Lowe’s at $37 MPS was correct, and it reflected better performance than the competitor Home Depot valued at an MPS of $25 (Schill, Bruner & Eades, 2013). However, other analysts did not share Carrie Galeotafiore’s enthusiasm on the performance and valuation of the two companies, and this was evidenced by the downgrading of Lowe’s by an analyst from Jefferies, Mr. Donald Trott, who downgraded Lowe’s stock. Based on the observations of the analysts, this report seeks to clear the air by building on the valuations that Carrie Galeotafiore had compiled on Home Depot through the development of the forecast for Lowe’s.

The report was prepared based on several assumptions. The growth in sales revenue was projected based on the company’s expectation of growing the sales by between 18% and 19% as presented by the CEO. It was supported by the plan of the company to grow sales in the existing stores and acquiring new stores (Schill, Bruner & Eades, 2013). The gross margin was expressed as a percentage of the sales and the historical growth rate used to predict the percentage growth over the period in focus. On the cash and short-term investments on a ration of sales, Lowe’s maintained a stable growth rate after every two years. It explains why the ratio was found to be changing biennially over the period in focus. The same was also evident in the forecast made on Home Depot.

In the forecast, there were items that are expected to remain constant over the chosen period. These include the depreciation rates and the tax rate. The receivables turnover was expected to follow the trend experienced in the previous years while the inventory turnover was expected to be higher as the company pursues lower inventory targets. Lastly, the P&E turnover was predicted to move against the general trend considering the company’s continuous investment in new stores. Assumptions on the stability of the COGS and the cost of financing are in terms of the expectations of low-interest rates and the low rate of inflation over the period in focus. The growth in sales is also projected based on the expectation of a stronger housing market.

Following these assumptions, part 2 of this paper presents the financial performance forecasts of Lowe’s. The company’s forecast is presented in both at expected absolute values and in ratio analysis. It is to allow for comparison between the company’s performance over time and between the company and its competitor.

Part B: Ratio Analysis and Analysis of the Forecast

To start with, Lowe’s is expected to grow its stores and outlets to at least 1,437 by the end of 2006. It is from the current stores that stood at 744 in 2001. The growth represents a near 100% growth in outlets considering that the company has been focused on the acquisition of new outlets in its expansion strategy. The growth in the number of stores will result in commendable growth in the level of sales revenue. In 2001, the company’s sales revenue stood at 22.1 billion. This value is expected to grow to a level of 50.9 billion by 2006. It represents an overall growth of more than 100% (Schill, Bruner & Eades, 2013). Then, the projections indicate that the company’s outlets will be contributing highly to the growth in the sales. Additionally, the sales also indicate that as opposed to the expectation of some analysts, the company’s financial position is set to improve in the coming years.

On the EBIT, Lowe’s expects that it will grow its value from the current 1.798 billion in 2001 to a value of more than 5.14 billion by the end of 2006. This growth will lead to a subsequent growth in NOPAT from the current 1.133 in 2001 to more than 3.212 billion in 2006 (Schill, Bruner & Eades, 2013). Mr. Donald Trott from Jefferies had projected that the industry in which Lowe’s does business will be slowing down in the coming years. If the sales, the EBIT, and the NOPAT projected herein possess a value, it is evident that the performance of the industry will be improving. It also means that the position of the company in the industry will be improving, and the company is likely to gain more market share over the same period hence resulting in more sales revenue and better overall performance.

Over the period in focus, the value of the net property and equipment is set to improve. The P&E value stood at 8.653 billion in 2001. In 2002, the value should be expected to grow to more than 9.819 in 2002, 11.125 in 2003, and 12.201 in 2004. In 2005 and 2006, the company’s asset base (fixed assets) is expected to grow to 13.873 and 15.926 respectively. This growth is supported by the fact that the firm is set to be acquiring more stores. Additionally, the growth in the assets base indicates the firm’s commitment to continued investment in the business thereby ensuring growth.

In addition to the above mentioned facts, Lowe’s growth in sales revenue and net property and equipment is supported by solid growth in total capital. Further analysis indicates that the company maintains a stable capital structure considering the mix of debt and other sources of capital including shareholders’ equity. Particularly, there is evidence of massive reinvestment of retained earnings. It is shown in the growth of capital from 10.878 billion in 2001 to more than 21.736 billion in 2006. The comparison of this data to the MPS of $37 in 2001 indicates that the share price is indicative of the company’s true valuation. One of the key indicators of this assertion is the fact that the difference between market capitalization of 29 billion and the value of its assets at 21.7 billion is minimal (Schill, Bruner & Eades, 2013). In fact, the share price should be expected to gain more considering that all the information on growth as presented in the analysis is taken up by the market. The findings also indicate that Mr. Donald Trott’s (analyst from Jefferies) downgrading of Lowe’s stocks based on projected deflation of the stock markets was unfounded as the analysis shows that Lowe’s will continue to have sustained growth.

Lastly, there is the concern on the return on capital. The return on capital is forecasted to grow from 10.4% in 2001 to 11.5% in 2002. In 2003, the projected ROI will be 12.3% while in the years 2004, 2005, and 2006, the ROI is projected to be 13.5%, 14.1%, and 14.8% respectfully. It indicates that there will be continuous growth in the company’s profitability over the period in the forecast. The growth in the ROI is associated with the company’s expansionary and cost management strategies. Based on the growth of the ROI, the company can be said to be valued correctly at the MPS of $39 and a market capitalization of $29 billion. The MPS and the market capitalization should also be expected to grow in tandem with the ROI and the ROC as the investors rush to take advantage of the company’s improving financial position (Schill, Bruner & Eades, 2013).

In conclusion, the analysis of the financial position and future revenues of Lowe’s indicates a commendable and predictable growth rate. It is supported by the company’s robust expansion and cost management strategies. In the economic conditions of strong housing markets, low rates of interest rates, and low rates of inflation, the company expected to perform well and the best indicator of this is the projected ROC as shown in our analysis. Therefore, the finding confirms Carrie Galeotafiore’s enthusiasm on the performance and valuation of Lowe’s and the industry by asserting that the MPS of $37 and the market capitalization of $29 billion represents a fair view of the company’s and investors’ future expectation of growth.

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