The future of Lowe's (NYSE: LOW) is a bit in flux right now. There's only one thing I can say about it with the utmost confidence: Lowe's will have a new CEO.
The company announced a succession plan for current CEO Robert Niblock, who will remain CEO until the board finds a suitable replacement. After years of underperforming its potential, as indicated by the rampant success of The Home Depot (NYSE: HD), Lowe's under a new CEO will have a big task at hand to ramp up sales and profit margin.
Niblock is leaving after putting a plan in place to invest for long-term growth during 2018, taking advantage of recent tax reform. That should put near-term pressure on profit margins, but it could set up Lowe's for a much better path forward to compete with Home Depot for more traffic and sales.
2018 -- a year of investment
During Lowe's fourth-quarter earnings call, management outlined six key areas of investment for the company in 2018.
- Collecting more information about customers' plans and needs through increased data collection, analytics, and partnering with third-party data furnishers.
- Upgrading technology to deliver more personalized marketing messaging as well as enabling better in-store service. (Lowe's new digital marketing platform already went live in the fourth quarter.)
- Improving online delivery and pickup in store infrastructure. It plans to open a new direct-fulfillment center in the third quarter this year.
- Differentiate product selection through strategic brand partnerships (like Craftsman and Sherwin-Williams).
- Increase penetration among professionals with improved jobsite delivery and a new workforce development initiative for store employees to become professional contractors.
- Growing its do-it-for-me business with installations, in-home sales, and project specialists.
Management also pointed out multiple areas for potential improvement, including sales conversion, gross margin, and inventory management.
As a result of the step up in investments, CFO Marshall Croom guided for a 30 basis point contraction in operating margin to about 9.3%. By comparison, Home Depot expects an operating margin of 14.5% for 2018 and reaffirmed its long-term target of 14.4% to 15%.
If Lowe's can make progress in its six investment areas, it should enable meaningful operating margin expansion over the following four-plus years.
At Lowe's investor day in December 2016, then-CFO Bob Hull guided for an operating margin of 11.2% in 2019. That number seems very much out of reach now considering its plan to ramp up investments in 2018 and continue investing for the foreseeable future. That said, Croom expects operating margin to start expanding again after this year.
Following the setback, Lowe's could realistically expand its operating margin at a similar pace to last year, when it increased 60 basis points, as it continues to invest. But it's basically putting itself about two years behind where it expected to be in 2019.
Croom expects average annual sales increases of at least 4% going forward. That still lags The Home Depot's 4.5% to 6% annual sales growth target through 2020. Growing sales is the key to exercising operating leverage and improving operating margin.
Fortunately, Lowe's has several opportunities to grow sales faster than that 4% target. After all, that's what those investments are supposed to capitalize on.
Lowe's could increase appliance sales as Sears continually closes down stores. At the very least, it should be able to drive store traffic. By its own admission, Lowe's can do a better job converting store traffic into sales, too.
Lowe's has also done a poor job attracting professional customers, which can be extremely valuable. As management mentioned in its earnings call, the do-it-for-me market is growing faster than people who want to DIY. That results in a larger share of purchases coming from professionals. Lowe's is taking initiatives to attract more professional customers to overcome Home Depot's advantage.
Finally, Lowe's can improve its online sales, an area in which Home Depot has excelled. Online sales are largely protected from other major online merchants due to the bulk and speciality of most of Lowe's products.
The Home Depot is already executing on all of those fronts, but the strong housing market with aging houses should provide room for both to grow.
Finding a CEO up to the task
The key to this bullish outlook on Lowe's is that the company needs to find a new CEO that's able to execute and remain focused on its plans -- something Niblock had trouble with (like when he acquired Rona). The Home Depot remains a formidable competitor, but there's a significant number of opportunities for Lowe's if it can execute.
Things are already set up for a new CEO, as Lowe's laid out what looks to be a good plan for long-term growth. The sales growth outlook from Croom seems conservative enough that it should be able to meet those numbers despite the upcoming CEO transition.
Investors will have to wait until December, when Lowe's will hold its next investors' day, to get a clearer picture of where management thinks the company will be in the next few years. For now, things look like they'll start picking up again next year as the company takes a year off to invest.
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Adam Levy owns shares of Lowe's. The Motley Fool has the following options: short May 2018 $175 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Home Depot, Lowe's, and Sherwin-Williams. The Motley Fool has a disclosure policy.