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

Good morning, everybody. My name is Chris Horvers. I'm the broadlines and hardlines retail analyst here at JPMorgan, and let me also wish you welcome to our Seventh Annual Retail Roundup. We're sorry, it's a really small event. We used to do store tours, has now burgeoned into a full-blown conference. So we thank you for joining us. It's my pleasure to have with us the Lowe's team, including EVP and CFO, Dave Denton; and Kate Pearlman and Paul Taaffe from the Investor Relations team are in the background. This is going to be a fireside chat. I will start with questions, but we'll reserve time at the end when investors are encouraged to also ask questions. [Operator Instructions] So let's get started. Dave, thank you again for joining us. We really appreciate that. I know this is a really busy time of year for Lowe's for sure.

So maybe we can start at a macro level just to start the process here. Historical correlations going to existing home sales and home price appreciation as the biggest drivers of the business. Historically, in recent year, it seemed to be home price more than the existing home sales. How are you thinking about this cycle from those 2 perspectives? And what is -- what else is sort of potentially different as you think about this cycle itself?

Great. Well, Chris, first, thanks for hosting us today. We always enjoy being here at JPMorgan, and thanks to everybody in their interest in Lowe's. We're excited about where we are in our journey to improve the performance at Lowe's and really excited about the opportunity going forward. I do think this is a little different. I do -- we are watching some of those very factors that you just spoke about with home price appreciation, housing turnover, the aging housing stock, all of which are really constructive backdrop to the industry segment. I think what's a little bit different now is that I do believe just the importance of the home has accelerated pretty dramatically as we've gone now into COVID and coming through the COVID period because before, it was obviously an important asset to everybody; but now, it's being used for work, it's being used for school, it's being used for exercise. It's now a platform that you really need to make sure is stable, it is appropriate for all those utilization cases. At the same time, people are spending a lot more time in their homes. So I think just the maintenance, the upkeep is accelerating due to the utilization of that asset over time. So I think you're going to see this trend and this focus on the home we think it's going to be sustained over the next several years. Furthermore, I think we always expected the millennial to get into the housing market over the next 10 years. I think that COVID has probably accelerated that shift into the housing segment for that segment of the population more dramatically than we once thought.

Interesting. It's an interesting question. So if you went back to 2019, there were some signs that you're getting later into the cycle, ticket was a bigger driver of the business, traffic wasn't growing quite as much. Sort of at an industry level, obviously, you've had a great turnaround here at Lowe's. So do you think COVID has restarted the cycle? And how concerned are you in terms of what you're seeing as potential sort of pull forward of big-ticket items, appliances have been doing great, patio furniture and so forth?

Yes. Listen, I do think there was concern that the housing cycle was coming to a little bit of a pause in 2019. However, there was still a lot of really constructive backdrops to the industry despite that worry. I mean the age in the housing stock, prices in homes still were accelerating, the consumer was quite healthy. And I think that those dynamics are still in play. I do think with now a broader emphasis of a home has been a more important asset. I do think in the short term, Chris, you are seeing a little bit of migration from, I'll say, urban into rural locations across the country. I think that's going to be in play for a period of time. I don't know how sustainable that's going to be. Just -- we'll see how that plays out. But I do think over the next couple of years, that probably disproportionately leans into the Lowe's platform a bit more effectively just given our store location profile. And I do think that we're seeing, again, very strong demand. If you talk to our Pro customers, they're one very busy right now, and their backlogs are actually expanding and are fairly significant. So I think the investments are going to continue from a Pro perspective for some period of time here.

Just as a side question to that, one of the discussions that is often talked about is sort of Lowe's street-level locations relative to your competitor. You brought up sort of the non-coastal markets and sort of ex urban doing a bit better, it sounds like, over the past year. Could you compare and contrast sort of like that commonly held view about sort of a street-level disadvantage? Is that different in coastal markets versus non-coastal markets?

Listen, I think the -- where we -- where Lowe's has been kind of structurally different is, obviously, we have less -- fewer boxes in big urban dense locations compared to a Home Depot. And that's just a fact. I think we've always thought about that difference being about 1/3 of the gap of our performance versus my major competitor. We believe strongly that we can close 2/3 of that gap easily -- or not easily, but with the efforts we have in place, the line of sight to go after that. Having said that, the 1/3 doesn't mean we're going to give up on that. We think at some point in time, we'll be able to close that, work on chipping away at that gap maybe not by building stores in those geographies, but actually going to market a bit differently. I do think, though, at the moment and at least in the short term, Chris, is that the -- I guess the suburban and rural location platform of Lowe's probably serves us well at this point in time as we go through this period.

That's a good segue maybe on a common question that's asked out there, sort of geographic performance, especially in light of COVID. So can you maybe talk about what you saw in '20 in terms of the relative performance of those different markets? And then more specific to this year as we've gotten further in the spring, people can get outside, people can go to restaurants and further into vaccination, how has that sort of geographic spread changed? And are you seeing any differences in markets like a Florida or a Texas?

Yes. It's a really interesting question. And -- but if you look through 2020, you look at our -- kind of almost across the country, we see very consistent performance from a geographic perspective. We've not seen -- you can't point to here 2 or 3 markets that are elevating performance versus others lagging. They're all in a very tight band of performance. And so we've seen really strong and healthy demand across all geographies in most categories. As we -- as we've opened up a little bit, I think you could argue that some states might have never really been locked down too much like Florida as an example. We've seen very strong demands hold pace in those markets as well. So we've not really seen an inflection from that perspective. I will say Texas might be a little different only because the winter storm that Texas experienced earlier this year is -- obviously, there's a lot of recovery spend that has happened at this point in time. So if anything, demand in that market has probably elevated a bit as people have come out of that storm and getting their house back in order.

Do you see that -- also as an aside, do you see that Texas lift is sort of like a hurricane kind of equivalent lift? I think also given the strength of the business right now, but...

Yes. I think it is, but maybe just in a little bit different categories, if you will. Those hurricane lifts sometimes are a lot of roofing and siding window kind of issues versus this is largely an internal plumbing and things of that nature.

Wow.

Yes.

That's it. Those were big projects.

They're big projects. And if you've been -- if you've talked to people in those markets, there's a fairly significant damage in those markets.

Yes. So on the stimulus, you've been essential since the start of COVID. So you have a cleaner view of what the customer behavior has looked like relative to some of the nonessential retailers a year ago. So you had April last year, you had January, and then you have now. How are you seeing sort of the impact of stimulus from like sort of elasticity perspective, so to speak? And are you seeing any sort of category changes even January to now in terms of what stimulus drives from a business perspective?

Yes. I would say that -- listen, even prior to stimulus, demand in our platform was accelerating and was elevated. That elevation continued. I think stimulus accelerated it a bit more. So I always call it, it was kind of like the icing on the cake. And I think what you've seen when stimulus hits those consumers' bank accounts, you do see an uptick in demand in our stores and online somewhat at the, I'll say, the mid to higher price points. So if you might have been waiting, if you will, to upgrade your refrigerator or upgrade your stove, you likely lean into that. That may be different from maybe a dishwasher or something that's broken that you have to just do right away. So I think you do see it disproportionately move a little bit to the higher price points. But it hasn't dramatically changed. It's been pretty consistent over time.

And then in terms of like sort of the sensitivity of the business to stimulus, I guess, to the extent that has that changed over time? Or is it simply more a function of just the amount of dollars that are being floated out there?

I think it's been pretty consistent. I think we haven't seen -- each round of stimulus, I think we've seen more or less the same type of behavior happen in the marketplace. And again, it has helped our business, but it's not what's driving our business. I mean our -- the demand profile in our business is really strong. Our -- the demand profile goes up a tick when stimulus comes about.

Got it.

Yes.

As you think about -- you mentioned the uptick in usage of things like appliances and patio furniture. Dovetailing on what you said earlier, I mean to the extent that how do you think about not just those categories, just as you think about pull forward of demand in big-ticket durables, obviously, and a major appliance should last 10 years, you've had an accelerated pace of adoption here over the past year. How are you thinking about pull forward? And are you seeing any signs of pull forward?

We're not -- we're absolutely not seeing any signs of pull forward. I think the demand continues to maintain at a very robust level, as we said on our call recently. I think at the same time, in many of those categories, again, the utilization of these appliances and the home in general has accelerated because everybody is spending a lot of time in the home. So the repair and maintenance activities also elevated as well. So I think there's just a constant demand that's occurring within the segment.

Yes. Our dishwasher -- personal experience, our dishwasher went down, and I think we were -- it's like a 4-week wait, which is not fun. More specific to Lowe's, you're expecting about 300 to 400 basis points of market share in '21 in terms of outgrowing the market. Where are you expecting to see those shares the best? And how does that inform your view of DIY versus Pro versus e-commerce?

Yes. Well, clearly, I think people get a little confused around the fact that this is a 2-person game. This is a very fragmented market. Between us and my major competitor, we might have a 25% share. So there's a lot of fragmentation around the country. So I -- we do believe it's not either or. We can win in this market. We can both win in this market going forward. And I think we're seeing disproportionately share coming from, I'll say, local and regional players around the nation. And I do expect that we can continue to outpace the market at that rate of 300 to 400 basis points based on all the improvements that we made around improving our in-stock in general across the business, leaning into job lot quantities to support the Pro. Just giving a better service environment and structure for the Pro customer is going to disproportionately allow us to win a greater share of wallet. I do think over the next several years, I think you'll see Pro -- the Pro segment outpace DIY over time just given the fact that the Pro one is very busy now and the backlog is pretty substantial. So I think that the amount of projects that are happening from a Pro perspective is still pretty large. And I expect that the lag, the latency in that segment is a little larger than in the DIY space. So I do think you'll see Pro outpace over time. That may not be every period in every quarter, but I do think that's the longer-term trend over the next couple of years.

So as a segue, how -- where -- can you describe where you are in terms of the Pro effort? And what's to be done as you look over the next couple of years?

Yes. Listen, we're really excited about what we've done and what we have on our plate and from a Pro perspective. I feel like we've made really nice progress on what I call the service model around the Pro. One, we made sure that we have the right level and depth of job lot quantities. We're leaning into certain brands and categories to be -- to support that Pro segment. We've recently just largely completed -- we have still a few stores left to do, but completed a realignment of our store environment to better service the Pro to make sure that the adjacencies across all of our categories are more appropriate for a very efficient shop for the Pro customer. We've also just put the labor model -- readjusted the labor model on the Pro side of the business pretty dramatically over the last couple of years, putting in loaders to support the Pro shop, to put in supervisors from the Pro business, made a better and a more efficient checkout, put in Pro parking. So we've really elevated the service model. Secondly, we've now just launched both a loyalty program as well as a CRM tool to allow us to engage with that Pro customer more completely and really reward them for shopping at Lowe's. And we're probably in the -- while we've built the infrastructure, now the opportunity is to fill up that database and use that database to really drive engagement with that Pro customer and really support the needs of that Pro customer. So I feel like we're on the early stages of that just because we've got it built, now it's harvesting what we've built to really drive performance going forward. So I think that's really the big unlock for '21, is to get that working effectively for us.

And to what extent is your focus on Pro at this point in terms of gaining share different in like a small and medium-sized Pro versus a large Pro customer?

Yes. I think, listen, we're trying to -- first and foremost, we think the opportunity really for us is in the small to medium-sized Pro. And so we're really trying to lean into that segment. I wouldn't say we're ignoring the large Pro, but the opportunity we have to really gain some market share and really drive performance for us is that small and medium contractor.

Understood. A question came in that I also had on my list. So what are you seeing from a product cost perspective? What are you seeing from a product flow perspective? A lot of discussions around congestion at the ports from Asia. And to what extent are you able to pass through price inflation?

Yes. So I think from a product -- let's take product flow first. We -- the good news is we actually ordered and pushed to our stores into our distribution centers our spring product a little earlier this year than typical. So we're in really nice shape from a product perspective as it relates to flowing that product into our store. Obviously, there's been some congestion at the port. We're managing through that. So I don't feel like that's a material impact to us, but we're managing it. We are beginning to see product inflation and cost inflation. We've built an ecosystem within Lowe's to really manage that effectively and to work with our vendors to offset that. And we've also built an ecosystem from a pricing perspective to be able to adjust pricing in areas that we have some elasticity to make some changes to harvest margin to offset those price increases. I do think on the commodity side of the house, pretty typical. We've seen a lot of inflation in lumber that largely gets passed on pretty much real time into the marketplace. And that's -- you're seeing that across the industry.

Yes. That lumber pricing chart is an amazing chart.

Yes.

It just keeps going up.

Yes. And listen, I think at some point in time, that's going to stabilize. But right now, that continues to be pretty inflationary category, if you will, within our business.

And then are there certain categories where you are still chasing in-stocks that -- and when would you expect to catch up?

Yes. We're getting better. So we're better this year than we were last year once COVID kind of -- and the demand profile accelerated. So we're not quite as in-stock as we'd like to be from a visual presentation perspective. And some of the lead times in certain categories are a little longer than we'd like. Having said that, again, we're better than we were. I think we're probably leading the industry. We're probably best positioned in the industry at this point in time where we stand from an in-stock perspective. And I think every day, we're chipping away at that. So I don't think it's affecting us in any material fashion. We think our service model -- we think we can enhance service if we could get a little bit better there.

Yes. Understood. Can you talk a little bit about the promotional environment? Obviously, last year, you had very subdued promotions, particularly in the first half of the year. So are you seeing any changes in terms of how the promotional environment is shaping up relative to last year, especially because I mean some of your peers were actually closed during this time a year ago? And to what extent or when might you expect having to give back some of that promotional efficiency?

Yes. Listen, I don't -- it's not our expectation to give back much promotional effectiveness because our plan was always to move from more of a high-low player to more of an EDLP-type player in the marketplace. I think COVID has allowed us to pull that forward a bit from a time line perspective. I think the -- we've been very, I'll say, strategic and focused on making sure that the promotions we put in the environment add value to our consumers, add value to our vendors and importantly, add value to Lowe's. And I think we're managing through that. I think promotional environment will be -- it will not be as broad and will not be as deep. It may be longer. So if you watch just a bit, we're not leaning into a specific weekend or a handful of days. We're probably extending the promotional length of certain events to make sure that we can accommodate people in and out of our stores in an appropriate fashion without creating congestion. And again, I think this is something that -- this is -- has always been our -- on our path to do. We're very focused on being more efficient in this area. And I think that our merchants with our finance partners have done a nice job of working with vendors to drive performance and really, at the same time, improve our margin profile.

Understood. We did have a follow-up on the Pro question, so I'll just interject this now. So can you talk about, and I'm not sure if you size this, what percentage of the Pro market is a small, medium contractor versus a large Pro?

I don't know the answer to that at this point in time as far as the size of the market. I do know that at the end of the day, our focus on that Pro, that small to medium-sized market, is allowing us to get to those -- achieve those financial objectives that we set out both from a top line and, importantly, from a bottom line perspective. And this is largely about winning just a bigger share of wallet of a lot of Pros that shop us today. So we're not as deep with many of our Pro customers as I think we should be, and that's largely because we haven't had the right service model, haven't had the right depth of inventory. And I think if we can just begin to make those improvements that you'll see us garner more share of that Pro that's shopping us at the moment.

Yes. Another area of share opportunity is clearly e-commerce relative to -- it seems like you're -- based on our math, you're ahead in terms of, from an industry perspective, your mix, but you trail your biggest competitor. So can you talk about where you are in terms of the e-commerce process? And what's ahead of us in terms of improving that, the experience for the customer?

Yes. I think the good news is we've done a lot of work, had a lot -- did a lot of heavy lifting to get our e-commerce platform, I'll say, both stable and kind of up to par with the marketplace. We still have work to do. But we've actually transitioned the platform on to Google Cloud, gives us the opportunity, one, to be a lot more stable and also allows us the opportunity to almost in real time make enhancements to the site. So I think we're nicely positioned. Our penetration has gone from -- over the last 24 months from roughly 5% to 10%. Our opportunity is to continue to expand our assortment to have more of an endless aisle in certain categories, maybe even lean into some adjacent categories that may not ever be appropriate in the store but can be appropriate online to support our -- the needs of our customers. I think the other piece of work that we're affecting at the moment is to make sure that our e-commerce platform is very efficient for consumers to buy a project. Because right now, we're very good at buying a product, a specific item, but bundling something together is an area that we still have opportunities. I'll give you a good example. To curate, let's say, remodeling of a bathroom, putting all that together in a way that's easy for the consumer to pick out tile, faucet, showerhead, et cetera, in a way that's seamless for them, that is an opportunity. It's something that we're leaning into. So there's constant enhancements in those spaces to allow us to elevate our performance from an e-commerce perspective. I think the good news as well is we've also accelerated a lot of efforts around how consumers both engage on the website, but importantly, engage at the store, whether that's buy online, pick up at store, pick up at curb, pick up in locker. We've just substantially increased the rollout of our locker program. It's a big opportunity for us. And so the -- so kind of behind the scenes, as we give customers choices on how they engage with us, I think it's a real opportunity as we think about that.

You just did a pretty big planogram reset over the past couple of quarters, and we were reading an article, I think it was in the Charlotte Business Journal, and had some great photos of what you've done in the front of the store around the Pro. So how have you -- as you've grown Pro last year, how have you improved the ability to attach those adjacent categories, cleaning and so forth, where you enrich margin rate of the transaction?

Yes. I think importantly, Chris, what we did is just made it so much easier for the Pro customer to shop our store. If you talk to a Pro customer who is doing, let's say, plumbing in a bathroom, they would have to literally go through 3 or 4 aisles to complete the purchase to support that. We now put that all together. They can do it in 1 aisle. It's very efficient. So because at -- time is money for them. So in and out is really important. So we made it very difficult for that Pro customer to shop our store. So now what we've done is fix those adjacencies, made some laydown areas for really interesting product assortments for the Pro that is high on their demand list, again, allowing us to capture more share of wallet. And we've largely got that complete and rolled out throughout the infrastructure at Lowe's absent a few stores. And so I think this is a place in which we're going to constantly gain a little bit of share over time. It's not like we turn on a light switch. This is something that's going to -- as we build trust and deliver on our service promise with these customers, we're going to gain more share of wallet here.

Understood. Maybe delving into the -- on the margin front. You guided to flat gross margin in 2021. There's a lot of puts and takes, promotion, shrink, supply chain. So can you talk about those puts and takes and how you're thinking about getting to that flattish? And any commentary around the cadence of the year?

Yes. Listen, I do -- we have line of sight for flattish is what we thought about. Keep in mind that some of the headwinds that you just articulated are headwinds that we began to -- the industry began to experience in the back half of 2020. So if you think about costs from a transportation perspective or an import perspective or a supply chain perspective, those things were happening in 2020, and so they're baked in our outlook for '21. At the same time, we've built up a pretty sizable cost management platform and a pricing ecosystem to allow us to manage both cost and price in a very dynamic and efficient manner. At the same time, we've enhanced our promotional effectiveness program to really allow us to manage those promotions in a way that drives improvements from a gross margin perspective. So we're constantly working to kind of manage that flattish gross margin level. So there are puts and takes. I do think it will be -- it might be a little lumpy at periods of time because at the moment, like as we said, as inflation in lumber increases that while it's passed on to the consumer, it sometimes pressures gross margin as deflation occurs as well. So -- but we're managing through that, and we feel like we have a really good line of sight to be effective there.

Understood. And then -- and if you think about the journey to the 13% operating margin target, there's sort of a pricing promotion and localization seem to be the big drivers with about 150 basis points of benefit around those. So can you talk about that a bit more in terms of where you are in that pricing and localization journey? And any view in terms of what's -- which aspects of those are bigger drivers to that 150 basis points?

Yes. I would say probably pricing is probably the biggest unlock there just from a mathematical perspective and a dollars perspective. I would say we've built a really nice foundation, and we have -- we're probably, I would say, 1/3 of the way through that journey, if you will. We -- part of this is a technology play and part of this is us staying at the right organization to focus on these areas. I do think that the localization will also play an important role, but we -- the project, the adjacency project that we just went through was a good really large first step in that localization effort. So I feel like we've made nice progress there. That's probably 70% the way to that effort. Now we have to do the last 30%. And we're focused against both of those. And it's our expectation that really by the end of '21 is to have our pricing ecosystem largely in, I would say, world-class levels at this point in time.

You're investing a lot around the supply chain, moving distribution upstream around big and bulky. Can you maybe talk about where you are in that process? What the long-term plan is around moving distribution up, but also e-commerce distribution and where you are on that journey as well?

Yes. So just -- let me just remind you what we're doing. Today, if you look at our mostly big and bulky, let's use appliances as an example, most of that delivery comes out of each of our stores. And so think about each of our stores as almost a distribution center. It -- and with that, they're carrying a full assortment of appliances in the back of the store. So what we're trying to do is build out market delivery cross docks, if you will, to support multiple stores. So taking out appliances in the back of the store, pushing it up one node in the supply chain, now we can be much more efficient as we think about delivery to the home and creating the right and more efficient routing of that delivery and also really making the inventory much more productive because we don't have to carry all that assortment in each location. At the same time, when we do that, we reduce the images because we're not touching that appliances frequently. At the same time, we can reduce labor in the stores because we're not spending a lot of labor moving these appliances around and delivering to the home. So we're building these things out. We have that in one market in totality. We're working -- from a pilot perspective, it's working well. We're still working out some of the finer process enhancements to make it even more effective. Once it's fully effective, we're going to roll this out throughout the nation. And I would expect that's an 18- to 24-month time line journey to get that done. So at the end of the day, what's going to happen here is as we push those -- that inventory and that work up into the supply chain, that's going to pressure gross margin, but it's going to relieve SG&A in the stores. The flow-through is really nice, but you're going to have that pressure and that relief on those different geographies on the P&L.

And then in terms of the e-commerce supply chain update.

Yes. So we have -- we now cover the full nation, essentially 2-day parcel. We have a fulfillment center, a large one on the East Coast or Central -- I guess really more Central and one on the West Coast. We're also filling in with smaller DFs, direct fulfillment centers, around the nation. So we'll ultimately have 5, 2 big ones and kind of 3 small ones that can kind of flex up and down. And I think that will largely complete the ecosystem that we need to support that parcel location.

Understood. And longer term, do you have a vision around same day, next day? Moving big and bulky out of the stores frees up a lot of space that used to be filled with dishwashers and refrigerators. So how are you thinking about leveraging the stores and goals around same day, next day?

Yes. Chris, that's the opportunity that Lowe's has. I think we -- one thing that's great about our business, once we get those appliances out the store, it's going to free up 10,000 to 12,000 square feet in the back of our store that now we can repurpose to the same-day, next-day delivery both for consumers and importantly, for Pros from a job like -- from a job site delivery perspective. So we think that's an unlocked opportunity that we have that we need to go after.

Understood. And then on the SG&A side, companies have explicit COVID laps from bonuses and PTO. At the same time, there's wage pressure in the environment. So as a first question, can you talk about potential wage risk given how much inflation there is in retail at this point?

Yes. Just a little history here. Over the last couple of years, we've actually probably leaned into wages in our stores with our associates. So we're probably on the higher scale -- higher end of that wage spectrum than most retailers. I think you're seeing some retailers try to catch up to us, if you will. What we're seeing in the market today as we staff up for spring is we've been very effective at being able to hire people around the nation to support our business at the wage rate that we plan. So we -- yes, there's some inflation, but the inflation is as we expected. So nothing out of the ordinary from that perspective.

Yes. And you lap through, I think, with store resets something like $1.2 billion of COVID costs last -- next year. If you look at your guidance, the 3 guidance lenses in the robust scenario, which you talked about on the fourth quarter call, feeling more confident about, there's about $700 million of operating expense productivity. Can you talk about -- 2 parts, a, where is that coming from? But at the same time, you're assuming lower sales from a top line perspective. So it seems like that $700 million is -- it could be just variable costs. So the bottom line question is, if you're taking costs out, whether that's focused in the store or what have you, could there be some potential SG&A savings above that $700 million?

Yes, there could be. But keep in mind, we also want to make sure that we're investing in service appropriately, too. So we spend time. As we create efficiencies in our network, in our stores, we have a discussion around do we invest some of that back into service or do we take that to the bottom line? And so we're constantly working on that and have that debate. But at the end of the day, we're focused really on a couple of things. One is we -- we're -- eye on the prize to take market share this year and improve our operating margin performance. And those 2 commitments are things that we're very focused against and we have very robust plans against. And we continue to just work on our projects to improve our performance day in and day out in those areas.

Understood. Well, at this point, we're, unfortunately, right at time, and it's important that we stay on schedule, especially considering the webcast. So Dave, we really appreciate your time for joining us today. Best of luck with spring, and we will talk to you soon.

Thank you. Appreciate it, Chris. As always, look forward to doing this in person, and thanks to everybody in their interest in Lowe's. Be well.

Be well.