Lowe's Stumbles at the Start of the Spring Selling Season

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Investors were optimistic heading into Lowe's (NYSE: LOW) first-quarter earnings report. CEO Marvin Ellison and his team had said in late February that business momentum was improving following weak results earlier in 2018. This raised the potential that the home-improvement giant might finally start closing the performance gap with bigger rival Home Depot (NYSE: HD).

Like its peer did a day earlier, Lowe's on Wednesday announced sales growth results that kept it on pace to meet its full-year objectives. However, significant pricing challenges forced the chain to lower its earnings and profitability targets for 2019.

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More on that profit outlook in a moment. First, here's how the first-quarter numbers compare with the prior-year period:

What happened with Lowe's this quarter?

Sales growth accelerated for the second straight quarter, just as management had predicted. The retailer even edged past Home Depot on the key comparable-store sales metric. Yet Lowe's gave up significant profitability.

The key highlights of the quarter:

  • Sales at existing locations jumped 3.5%. That result marked a solid acceleration over the less-than-2% rate the retailer had achieved in each of the last two quarters. It suggests a firmer market position, too, given that Home Depot's growth slowed to 2.5% over the same period.
  • Gross profit margin took a surprising dive, falling to $5.6 billion, or 31.5% of sales, from $5.7 billion, or 33% of sales a year earlier. Home Depot's comparable figure held steady at 34% of sales, year over year.
  • Lowe's operating profitability declined to below 8% of sales compared to Home Depot's 14%.
  • Lowe's booked a one-time benefit from the sale of its Mexico business. After adjusting for that windfall, earnings rose by 3% this quarter.

What management had to say

Ellison said the retailer's faster growth confirms that management's rebound strategies are working. "Our first quarter comparable sales performance is a clear indication that the consumer is healthy and our focus on retail fundamentals is gaining traction," he said in a press release. "Our commitment to improving [inventory levels] and customer service coupled with our focus on winning with the pro customer were integral to driving improved sales."

Nevertheless, Ellison detailed a few pricing and cost stumbles that suggest the chain hasn't yet fixed the core retailing issues that drove down profits last year. "Cost pressure" and "ineffective legacy pricing tools," he said, combined to reduce gross profit margin in the first quarter.

Looking forward

Lowe's reduced its profit outlook for 2019 to reflect those lingering challenges. The retailer now sees operating margin holding steady at about 8% of sales rather than rising by almost a full percentage point. Earnings are expected to range from $5.54 to $5.74 per share, down from the prior forecast of between $6 and $6.10 per share.

Consistent with Home Depot's recent comments, the chain still sees industry trends supporting another year of sales growth, and Lowe's comps are still on track to rise by 3% compared to Home Depot's projection of 5% gains.

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Demitrios Kalogeropoulos owns shares of Home Depot. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.