Slow Pace of Lowe's Transformation Hurts Outlook
08/20/2012| 01:46pm US/Eastern
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--Transformation benefits taking longer than expected to surface
--Comparable sales slip and promotional misfires hurt margin
--Increased outlook caution results in slash to 2012 guidance
(Updates with executive comments from conference call and interview)
By Joan E. Solsman
Lowe's Cos. (>> Lowe's Companies, Inc.) said its transformation is taking longer than hoped to gain traction with customers and filter down to the bottom line, resulting in a weak fiscal second quarter and slashed full-year view Monday.
Shares fell 6.6% to $26.02 in recent trade.
The company, the No. 2 home-improvement chain by sales after Home Depot Inc. (>> The Home Depot, Inc.), has been reshaping its operations to compete more readily with its larger rival, with the ultimate goal of making online selling a seamless part of an improved customer experience.
"Frankly, the benefits are accruing at a slower rate than I expected," Chairman and Chief Executive Robert A. Niblock said Monday during a conference call to discuss the results.
He also said the changes would pay off, despite their costs in the short term. "We still longer-term think the benefits are there and are optimistic about what we'll deliver," he said.
Lowe's has been shifting to an everday-low-price strategy and is reviewing all its product lines with vendors to improve assortment and reduce unit costs. But Lowe's underestimated how long it would take for customers to respond to improvements and for gross margins to fully reflect cost reductions, executives said Monday.
In addition, the company misfired on promotions in the latest period, also hurting margin.
Lighter promotions in May made for slow Memorial Day weekend traffic, leading it to heavily promoting big-ticket items. "As a result of early adjustments, we improved sales as the quarter progressed but in hindsight, we overcorrected and added too heavily to big-ticket promotions," Chief Customer Officer Gregory M. Bridgeford said.
In the latest period, gross margin fell to 33.9% from 34.5%, and sales at Lowe's established locations dropped 0.4%, returning to a decline after three quarters of growth. It extends a streak of Lowe's same-store sales underperforming Home Depot's to more than three years.
In an interview, Mr. Niblock said Lowe's was disappointed that both same-store sales and margin were below the company's hopes, though he noted Lowe's does "a good job controlling expenses and managing inventory."
He also said homeowners were sensing a bottom of the housing cycle and more willing to move forward on projects, which meant that some of the company's promotions--such as for cabinets and counterops--were well timed.
But where Home Depot last week raised its full-year outlook, Lowe's lowered its forecast Monday. Lowe's now expects earnings of $1.64 a share, from its previous view for $1.73 to $1.83 a share. Lowe's also reined in its sales outlook, predicting flat revenue versus its prior forecast of 1% to 2% growth. The outlook implies flat same-store sales in the second half and less of a gross-margin increase than previously anticipated.
Chief Financial Officer Robert F. Hull said so far, August sales trends have continued to accelerate, with same-store sales higher than July's 0.7% growth. And gross margin is essentially flat with last year thus far, he said.
Mr. Niblock said the current phase of Lowe's transformation would take about a quarter longer to complete, pegging it would be done in the middle of next year.
The results follow Lowe's proposal to expand in Canada by taking over a rival there, Rona Inc. (RONAF, RON.T). Mr. Niblock said Monday no deal was imminent.
"We are evaluating options," he said, including "whether or not we can complete confirmatory due diligence and ensure a fair price and an adequate return on our investment."
Rona in July rejected Lowe's unsolicited takeover proposal that valued the Quebec retailer at $1.75 billion. The combination would quickly vault Lowe's to the top spot of the home-improvment market in Canada, a region that has been a source of growth. But the deal faces multiple challenges, including board and political opposition.
Overall Monday, Lowe's reported a profit of $747 million, or 64 cents a share, for the quarter ended Aug. 3, compared with $830 million, or 64 cents a share, a year earlier. The number of shares outstanding dropped 9.3%, and both periods were skewed by charges, including 4 cents in the latest period. Analysts polled by Thomson Reuters had predicted per-share earnings of 70 cents.
Net sales decreased 2% to $14.25 billion, while analysts were expecting revenue of $14.46 billion. Calendar shift accounted for $259 million, or 1.8 percentage points, of the sales decline.
Building materials, lawn and garden and millwork categories were particular sales underpeformers.
In lawn and garden, the combined effect of weather pulling forward sales in the early spring followed by extreme heat and drought slowed sales in the period and distressed live-goods inventory, which hurt margin. The company also had weak attachment item performance in nursery, a further damper on margin.
Storm repair a year earlier set up a difficult comparison for building materials. Millwork sales suffered as Lowe's struggled strike the right promotional balance.
Strong selling categories included lumber, cabinets and countertops, paint and tools and outdoor power equipment.
Write to Joan E. Solsman at joan.solsman@dowjones.com and Saabira Chaudhuri at saabira.chaudhuri@dowjones.com
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