Lowe's Companies, Inc. (LOW) Earnings Call Transcript & Summary

Good morning, everyone. It's Greg Melich. I cover the retailers, broadlines and hardlines at Evercore ISI. And it's our great pleasure today with, I think, almost ideal timing to have David Denton, Lowe's' Executive Vice President and Chief Financial Officer. Lowe's has been in the middle of a huge transformation. And at the same time, getting that done, while we're seeing a huge transformation in the U.S. consumer. We've got 45 minutes this morning of David's time. So we'd love to be doing this in person and in a typical trip down to Mooresville. Unfortunately, we can't this year. But David, thanks for your time. And before we jump into questions, I did think to help set the stage, we found [ to start summer ] quite useful. We have 1 slide about our MEND framework. This is what we're using at Evercore ISI to think about changes in consumer behavior. We think there are 4 key things to track. One is multichannel and e-commerce, which we think now could double in terms of penetration in U.S. retail sales over the next 5 years. We used to think it was 8 years. Second -- or really third then is nesting, which we saw after 9/11, but certainly, and we'll get into that with David, what we're seeing now and everything related to home, place of safety and refuge. There are some other categories helped back then as well. And then last but not least, de-densification. I think there's an early sort of run to the suburbs or the hills, so to speak, but we're going to watch to see whether it's really more about building out rather than up, and we'll be tracking that closely and the retailers that could win from that. So back to the topic of the day, which is our fireside chat with David Denton. David, thanks again for joining.

My pleasure. Thank you.

We -- I sort of had 6 buckets of questions. So I guess I would start right with the top line and the current environment in that our MEND framework, what are -- changes are you seeing in the consumer environment that you think will be most sticky?

Well, first and foremost, Greg, thank you for inviting us to participate. We were honored to be here. Secondly, I hope everybody on the lines, both themselves and their families and colleagues, both safe and healthy. And you need to let either cater, I know, if there's anything that Lowe's can do to help you, your families, your colleagues in this very trying time. And I think the kind of as Greg, as you kicked off with your framework, that's pretty consistent with what we're seeing right now. First and foremost, we're seeing consumers be ever so focused on making their investments in their home to make sure that, as you said, nesting in place and making sure the home is safe, secure and a destination which now not only people are living, but actually working and actually supporting the children from a school perspective. So home is becoming a very big center of investment for the consumer. Secondly, we are seeing demand shift from a channel perspective and actually accelerate both on online and in the mobile environment. And then third, probably something you didn't touch on specifically, because I do believe there is this notion of consolidation of shopping trips. And I think instead of, historically, maybe a consumer might hit 3 or 4 or 5 different specialty shops, I think they're making the most out of their single trip and consolidating those trips into big boxes. And I think you're seeing big boxes who have large breadth of assortment benefit from that environment. And then finally, as you said, there is this notion that over time, there might be a move to the suburbs. That's clearly top of mind right now. I think it's probably too early to tell whether that's a long-term trend or not. But clearly, in the near term, that's certainly something that is top of mind to consumers that we engage with.

Got it. Could you maybe dig a little deeper into that as to the type of activity you're seeing in the second wave state? So I think in the last few weeks, we've had a surge in cases and even deaths start to creep up a little bit, still staying fortunately subdued. Are you seeing differences in those areas? Or what can you tell us there?

It's probably a little too early to kind of draw any conclusions to that. But I think just near term, not seeing much difference at this point in time between the different states. I will say that we run a command center that meets multiple times per day. And we're -- and we get the feedback from people on the ground and really with our focus on, one, making sure that both our colleagues and our consumers are both safe in our environment, that we're in stock and that we're providing the best level of service. And we're continuing to march against those 3 different metrics. And I think our demand is pretty robust around the country. The only caveat to that is in the north, spring is really now in full bloom, if you will. And so obviously, as typical at this time of year, demand in the northeast is picking up. But again, that's pretty consistent with this time of year as typically the north lags the south just from weather pattern perspective.

Interesting. Is there -- how have those changes shown up in terms of category mix? Yes, because we saw some of those trends in the first quarter, those generally continued?

They generally continued. I think we've seen strong demand across just about all categories in our stores. I think as we said on our first quarter conference call is that some categories that required people to be in the home from an installation perspective, those were a little softer than other categories. And I'll give you a good example, carpet. You have to go in, you have to measure, then you have to come back and install that. I would say actually, right after Q1 and leading into Q2, as we talked about on the call, is we actually saw those businesses beginning to tick up a bit as well. So I think unfortunately, we're kind of getting back to a new norm as consumers are now a bit more willing to have people in their homes.

Got it. And so that -- is it fair to say DIY continues to be very strong, but the gap between the other Pros are getting back to work? Would that be a way to summarize it in the [ 2 we're putting on ]?

I would say the Pros largely never were out of work. I'd say there were periods when this first broke in the first quarter, where there was a few weeks where there's a lot of nervousness and the Pro was maybe a little soft, and they pivoted their business mostly from interior projects to exterior projects and kind of made up the gap. I would say now, both DIY and Pro customers are doing quite well.

Got it. So a nice balance there, but it's still more exterior, but we're starting to get more interior. That would be a fair way to put it?

Yes. I think that's a fair way of putting it, yes.

Okay. Great. So then maybe transitioning a little bit. From a Lowe's standpoint, what -- of the changes that are going on now, which ones do you think will be most sticky and important to impacting your business?

Well, I think what's interesting, and we've said this a bunch of times in the past before the pandemic hit, and it really centers around a really good experience in the store to start with is, as we've always said, if you -- when spring hits in a certain region, that first trip to the store from a consumer perspective, if you do a good job, you win multiple trips throughout the year. And so it really emphasizes the importance of service at the store. So I think, clearly, if we can provide good services, we'll ultimately end up capturing additional trips. I do think the other thing that now has elevated in importance is the ability to engage with us from a digital perspective, whether that's buy online, pick up at store; buy online, pick up at curb; ship to home, all of those have become more important. And I'm really proud of our online team and our digital team is -- as you know, we don't have the best platform historically. We're on some old technology. We've bolstered that technology in the past, but we're migrating it to the Google Cloud Platform. And despite the fact that demand accelerating very dramatically, we've actually had really good service scores and being able to effectively service those customers. So I think that's also helping our business as well.

Maybe that's a nice transition. And so I want to make sure we talk not just about the current environment, but the strategy and where you are in terms of getting to those milestones of -- I think you guys have defined the home improvement market that you think is addressable, $800 billion to $900 billion. What goal would that mean for sales per foot or digital penetration when you sort of piece that together on a 3- to 5-year view to get to where you want to be?

Yes. Yes. I think that's an accurate assessment of the market. Keep in mind, this market is very fragmented. If you think about us and our major competitor, we probably have 20%, 23% of share of the market. So there's a lot of market up for grabs in regional players. And I will say that from some -- at some level, the fact that we're large and have scale and have such a broad assortment, we're able to weather the storm probably better than many others. And so I think as we come out of this pandemic, whether that's 6 months, 12 months, 18 months from now, I think we'll be in a very healthy position. We have a very specific stated goal of getting to approximately $370 per square foot and a margin target of 12%. That's very much line of sight to us, very focused against that. As you know, our digital penetration is pretty modest at about 5%. We think that has a substantial runway to grow over the next several years, and we're seeing that accelerate as we speak now. We haven't really set a target for that, but I do think there's a big opportunity. And if anything, as you indicated earlier in your comments, the transformation, the shift into the digital channel has probably been accelerated due to COVID.

So on that point, I know Google was rebuilding your website. And I think last year, that was one of the -- that raised challenges. But now it sounds like -- are you where you want to be on that? What can you do now that you couldn't do a year ago? Is it -- can you add SKUs? Can you get pricing right? I mean how do we see that?

Yes. So we've been on this path to migrate to the Google Cloud. We have the front end of the platform migrated last year. The back end of the platform will be migrated by the end of the second quarter here. So we're very much on plan or probably a little bit ahead of plan. And it's important because, one, it further enhances our stability on the site, which actually has been quite good through year-to-date. Even though we're on an older platform, it's actually been quite solid from a stability standpoint. But what it does allow us to do is make rapid changes and enhancements to the platform that's more visible to the consumer, making a more seamless transaction in an easier way to either over time, be able to track shipments; decouple our freight from product cost; further enhance curbside pickup, which today works fine, but it's a little clunky because we put it in literally over a weekend. And so there's just a lot of things that the platform will now allow us to be much more agile and adapt to the needs that the consumer has. So we're excited about it. I think that the back half of the year, you'll see visibly as a consumer, more enhancements to the site into the mobile platform.

Got it. And from the back end, it -- will it allow you to be more profitable or add SKUs more quickly? I mean is there -- how else should we think about it? Like you normally have, I don't know, 500,000 SKUs. Can you now have 1 million or change them over more frequently?

It certainly will. But just moving to the Google platform doesn't 100% solve for that because, ultimately, you got to tie that back into the store system. So there's more work before we can just, I'll say, take a catalog of 100,000 items and within a weekend or within a week, add that to the website. That's going to take a little bit more time. It does give us the ability to more quickly add SKUs, but it's not to the level we'd like it to be. That's still work to come. But it does -- it will enable that. It will make our curbside and buy online, pick up at store process more efficient for us and probably enhance the consumer experience a tad, even though I think we're getting pretty good scores right now as we use that service today.

Got it. So maybe next stage on that would be supply chain. A key part of that longer-term strategy was a supply chain transformation. Where are we on that path? Number of facilities, the benefits to the margin or inventory, et cetera?

Yes. So think about this, at least in my mind, simplistically as a big and bulky play for the most part, is how do we make sure that we get big and bulky to the home or to the job site in a way that: one, is efficient for us; and two, importantly, is very consumer-friendly and customer-friendly to the consumers who engage with us. And so it's both an infrastructure play from a number of cross-dock facilities, but also a technology play as we integrate that to have visibility from an inventory flow perspective, so the consumer can track their deliveries. I would say we have it up and running in, I guess, 3 regions at this point in time in pilot. We're still working out some of the kinks -- the trajectory and the performance is positive. We obviously continue to modify, enhance mostly on the technology side, and then we'll look to rapidly deploy that through the balance of probably the next 18, 24 months kind of across the nation. So we're on track. We feel good about it. We're still working through it. Obviously, the COVID situation has made it a little bit more difficult for us to be out in the market looking for sites and building the infrastructure. But that's -- but probably the technology piece is, quite honestly, a little bit more important than putting up a cross-dock. That's a pretty simple build-out.

And maybe also on a strategy as we think about Pro, we talked a little bit about DIY and what people are getting for here and now. So I'd love to talk about, if you will, both for customer bases. So let's start with DIY. What can you do now? I mean we got the Census Bureau numbers yesterday of up 17% for the category. You guys seem to be winning share, at least more than holding your own. What can you do to make sure that the customers you're winning today and the traffic and the basket that you're able to keep it on the DIY side?

Well, I think the biggest thing is making sure that we have a really good service program. I think the good news is we invested pretty aggressively last year and into early this year on programs, one that freed up our associates in the stores, allowing them more time on the sales floor to help customers as opposed to doing tasks that are not customer-facing. So I think we've leaned into that. From a soft sales perspective, we spent a lot of time in training our associates to be more sales and customer service focused. I think that's beginning to pay off. We're in the process of rolling out new technologies in the front of our stores that will allow us a more enhanced checkout process. That's probably back half of this year for the most part. And I think just making sure that we -- as we leaned in to fix the chronic out-of-stock issues that this company had historically, I think that's allowed us to meet those service objectives. And then just -- also just step back and think about this. Back to my earlier comments about now people from a consumer perspective are consolidating trips. So instead of going to multiple specialty stores, they're going to 1 store. And I'll use the example of there are many specialty retailers that I historically would not have thought of as competitors, but they have categories that are within our store. Think about that as home organizations, small appliances, some of the core categories. Today, those consumers, instead of going to that specialty retail outlet are coming and shopping our outlet. Let's say, if you want to do home organization, you're not going to The Container Store today because they're closed or were closed. You're going to Lowe's or Home Depot or one of our competitors who are open. We have to make sure that our assortment is appropriate to service that customer both in the store and online. And so we're going back and just making sure that we're sorted correctly, we have the depth of inventory in the right categories to meet those changing needs.

Interesting. Is there any way to put a -- we're analysts, so analysts here. So can you put numbers? Are there like 4,000 additional SKUs that you've added to the store assortment? Or some way to think about that?

There probably will be over time, and a lot of this will be an online play more than in-store play. So making sure you get the core SKUs correct in each of these categories in the store. But importantly, making sure that you enhance that assortment online, and you enable the store associate as they're serving that customer to fill out the basket, if it's not in-store with an online order and supplement of that in-store transaction.

Got it. And maybe in a couple of areas, do you feel that you're now fully positioned with the CRAFTSMAN rollout? And I'm thinking the other one that might matter to DIY would be in paint with Sherwin-Williams and them. Is that all where you want it to be?

Yes. We feel good about both of those programs. And I think even before COVID, both of those programs are doing quite well. And obviously, as COVID hit, making sure that we have the right assortment was really important, and we've seen strong performance in those. But yes, we're where we need to be.

Great. And then on the -- turning on the Pro side, right? So you've got LowesForPros, plenty of initiatives. I can't remember where I heard it from you guys, but I think you had signed up something like 50,000 Pros to the B2B site. Any other updates in terms of how those initiatives are going, how some of the key new products that you brought in and job lot quantities are rolling out?

Yes. I think about this in 2 buckets. One is think about 2019 is the year in which we fixed the service model from a Pro customer perspective. We've leaned in the job lot quantities. We've put in dedicated Pro department supervisors and staffed the Pro department with the appropriate level of service, both in the store and from a loading perspective. We put in designated parking lots or parking spaces for the Pro, opened up the canopy for them, made sure that we had the right assortment in the right areas as best we could. We have some more work to do on that. So really fixing the service model. Now what we've done is rolled out Pro Loyalty, where we put in a CRM tool that's Salesforce.com supported. And now as Pro customers are beginning to use and shop our platform and our store more completely, we're able to identify them, capture their information, make sure they understand the offers and the value that's available to them to shop at Lowe's. And also has given us now a platform that we can actively engage with them in a manner that they see fit. Keep in mind, we have -- think about our Pro business and how we go to market really in 2 buckets. One is we do in the store how we engage them in a store, but we also have a very active outside sales force that calls on Pros either in their offices or at their job sites and really helps work with them as they are looking forward into new projects. And it actually helps them assimilate bids, helps them understand the different products and service offerings that are available to support their projects kind of on the ground, and that's beginning to gain traction as well.

Great. And then if I remember, I think at the summit last year, the external sales force is several thousand people, and that came through some of the MRO acquisitions. Does that...

Yes. It's probably not quite that big. It's probably -- in probably, I don't know, 400, 500 is probably my best guess. I don't have that number off the top of my head, but it's in that ballpark.

Got it. Great. So look at then, we've taken -- I could go, go on for sales and strategy forever, but we are the CFO, so we now got to get to the numbers on the margins and cash flow. So that goal that you've put out of 12%, and if I remember correctly, it was re-baselined at just over 9% at the time. I think consensus this year is already up to around 10%. Is 12% still a reasonable goal? I know there's been a lot of incremental COVID costs. Could you sort of walk us through the incremental cost, but then obviously, what your variable margin would be if sales are stronger to help understand some progress to that goal?

Yes. Listen, I think that the 12% -- the path to 12%, I think, is a very reasonable target. We feel very strongly and see good line of sight to that. Keep in mind that we always thought this was a platform in which, one, we're going to accelerate our performance from a top line perspective. We're going to largely hold gross margin stable, even though we kind of had a downdraft in 2019 and then get a lot of leverage from an SG&A perspective as we put in actions to improve productivity, but also just leverage some of the fixed costs. And I think what we're doing is we're continuing to push on that. We feel we have line of sight to progression against that. Obviously, there's kind of puts and takes to what's happening now. At this point in time, we've had a step-up. As you well know, through Q1, from a top line perspective, margin has done well. We are experiencing incremental costs, both as we probably use more overtime labor as some of our associates have needed to be at home to take care of maybe their children if they weren't in school, et cetera. So we're probably running higher cost per hour than typical. And also, we've leaned in to make sure that we've dedicated enough resources, both from a safety and cleaning perspective to ensure that our stores are appropriate from that perspective. And so there's puts and takes, but I think the net effect of this is we feel very strongly that the 12% operating margins are certainly within our graphs over a period of time.

And maybe to help a little -- understand a little bit more. In the first quarter, I think it was, what, $300 million of COVID-related costs that you called out, give or take?

Yes.

And was that because of the timing of when COVID hit, it was sort of only 2/3 of the quarter? Can we just sort of use that as a baseline and then sort of gross it up because this was going on for longer? Or how should we think of that as recurring versus not?