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

Okay. Good morning, everyone, and welcome to the next session here at Baird's Global Consumer Technology and Services Conference. I'm Peter Benedict, Senior Retail and Consumer Products and Services Analyst here at Baird, and I'm very pleased to welcome Lowe's back to the conference. The company really needs no introduction, but I think it's safe to say that the transformation of Lowe's under the leadership of CEO, Marvin Ellison; and CFO, Dave Denton, is really shaping up to be one of the real retail success stories over the last 10 years. And we believe there's plenty of opportunity that still remains. This morning, we're fortunate to have both of these gentlemen with us along with a couple of representatives from Investor Relations, Kate Pearlman and Chad Arnold.

There's no slides or anything of that sort here. So we're just going to jump right into the Q&A. If you do have a question, please enter it into the portal, and I'll do my best to work it into the conversation. But with that, let's get started. And again, welcome, everybody. Thank you so much for joining us. The first question, we're asking a lot of our companies a similar stream of questions to kick off these presentations. And the first is really just around consumer behavior. Now that we're kind of coming out of the pandemic and the lockdown. And I'm sure things are changing by the day and by the week. But I just want to give you an opportunity to maybe speak to the state of the consumer here as you guys see it. So that will be my first question.

Sure. So look, I'll kick it off, and I'll let Dave add any additional comments. First, it's great to be with Peter. So it's always a pleasure to be at this conference. As we mentioned in the most recent earnings call, I mean, we've been very pleased with how broad-based the consumer demand has been all 15 geographic regions in the last quarter, delivered sales comps north of 18%. And minus weather impacts, we've been very pleased with the consumers' response to the business. And even as mobility begins to improve, which we're happy that things are getting back to normal in a lot of markets, we're not seeing any pullback in our business in any material way. So we feel really good about what we're seeing and the trend remains pretty consistent with what we talked about coming out of our Q1 earnings call. Dave, on that you...

Yes. The only other thing I would say is a couple of things. We're also seeing the consumer, their balance sheet is pretty healthy based on the economic climate at the moment. So that's really a nice backdrop for the home improvement sector. And then secondly, there's kind of 2 pretty broad consumer trends that we see -- we think are here to last a little bit. As you're seeing consumers consolidate trips a bit into big boxes. And I think that's going to lend well for retailers such as Lowe's. And then secondly, we are seeing consumers begin to engage companies in different ways. So the e-com platform is really important. So we've really -- we'll talk about this later. We've invested in our digital platform, and I think the omnichannel I guess, business direction that we're heading in is really enabling us to bolster up our performance as well, which again, another long-term trend.

And look, the only thing I'll add, and Dave has talked about this in past discussions is retailers that are in the best position of capital allocation are winning, they will win in the future because one thing that we're going to see that will continue post COVID is the customers are going to shop in the manner in which is highly preferred by them. In other words, retailers are not going to be able to dictate to customers the most effective way for them to transact with the retailers. It's going to be about agility, flexibility in an omnichannel environment. And we're fortunate that we have a great balance sheet and over the last 2.5 years, we've made significant investments in our information technology platform and our digital platform. And because of that, we're able to meet this really spike demand that we've all seen for the last 16 months in this sector. And for companies that didn't have the ability to create seamless curbside pickup, buy online, pick up in-store lockers. A digital platform that had flexibility and agility, it's really difficult to really serve customers in a way that they require to be served. And so we feel like that, that is going to continue, and we're in a good position to continue to build on that.

No, that's terrific. Yes. And that makes a lot of sense, and we would agree. I think another dynamic that's been consistent across both parts of retail is the lower promotion and clearance activity that's gone along with the surge in consumer demand. So just kind of curious how you guys are thinking about kind of promotions and clearance activity, how you're going to approach it over the balance of the year? And where do you think maybe we land post pandemic? Are we going to find a new normal? Or do you think we'd just go back to what we were doing 18 months ago?

Yes. Listen, Peter, we're going to find a new normal here. We were on a path here at Lowe's to get to more of an EDLP-type program. I would say the pandemic environment has allowed us to accelerate that program into 2020. And now we're running that play into '21. So I don't anticipate that we'll go back to this high-low environment at all here at Lowe's for certain. I think what we've been doing is just very focused. Again, we're on this march to do 2 things this year. One, you gain some market share at the same time, improve our operating income kind of flow through here at Lowe's. And I think we're really pleased with how we did in Q1, and we continue to focus on that. And part of that is really actively managing strategically our promotional cadence and depth and profile here. So we're not going back to this high level. We think this is here to stay.

And Peter, the good thing about this sector is that it's always been very rational from a pricing and promotional perspective with the exception of a few regional players, there's really consistent predictability in how the larger players in home improvement, go-to-market from a promotional standpoint. And to be honest with you, Lowe's was an outlier. I mean a lot of things we were doing in this whole halo overly promotional way we ran the business when Dave and I arrived back in 2018 was quickly looked upon is not sustainable. One of the first conversations Bill Boltz, who's our Chief Merchant, and I had, when he arrived in August of 2018 is that we have to quickly as we can work our way off this high-low pricing environment because it, number one, is not sustainable, it puts pressure on gross margin. But second, it trains the customer to only shop you when you're shouting a deal, and that's not the foundation of how you want to run this type of a retail business. And so to be candid, the pandemic only forced us to move faster than we were moving in the first place. But today's point, we're not going back. I mean, we're going to stay rational. You're going to see us have more special buys. We want to be really focused on offering a value. We're going to lean into loyalty programs. We're going to lean into our credit offer. These are the things that we're going to do to create differentiation, but the high-low environment is behind us, and we don't plan to get back into that business.

Yes. I recall those conversations, you hosted a breakfast in New York with myself and the rest of the sell side. And so nice to see you get follow through on that, and it really bearing fruit. So that makes sense. Last kind of general question just around kind of the inflationary environment, rising input costs, products, labor, freight. Just maybe give us your latest sense in terms of how those dynamics are affecting your business and what you're doing to mitigate them.

Yes. Certainly, we're experiencing inflation in certain categories. And then certainly within the transportation area and the supply chain area, largely as we expected, by the way. So as we thought about our plan, going into '21, we expected that we were going to see some of those input costs begin to rise. I think we're here at Lowe's, what we've done is we put in a very active cost management program that really works between the finance and merchant department to kind of push back and manage the cost complement within our products. At the same time, we've been elevating our pricing ecosystem to be able to rapidly adjust our pricing to maintain margins, either SKU for SKU or within certain product groups to hold ourselves constant and whole so we're -- this is a daily battle. We're fighting through it. I feel like we have good line of sight. We do -- we are experiencing, as we've talked about in Q1, some pretty significant cost in price inflation, particularly in the lumber category. I do think over time, that's going to become more rational, whether that happens late this year or early into next year. But I do think you're going to see that begin to mitigate a bit over time. But we're planning it. We're actively involved in it.

And Pete, the only thing I'll add is I give the merchant and the finance team a lot of credit for how effectively we manage through this kind of historic inflation specifically in the lumber category. And I'll take you back to 2019. I mean, when we were 6 months into these positions and we had a similar impact on cost-related changes in the system that we simply didn't have the infrastructure, we didn't have a price management system from the robust nature of our price management system to manage it and our results suffered as -- because of that, but we put a very dynamic team in place. We've rolled out much improved systems, we have enhanced processes. And because of that, we've been able to manage this pretty effectively. So it's just another example of the retail fundamentals that we talked about from the very beginning that we put in place just so we could manage the unforeseen a lot more effectively than we have in past years. I can just show you quite candidly, if this would have occurred 2 years ago, it would be a much different situation for us and how we're able to manage it. Doesn't mean it's easy, but it means we now at least have the tools and the visibility to allow us not to be material to the business as it would have been a couple of years back. And as Dave said, at some point, we'll get back to a normal environment. We're forecasting what that's going to look like, and we're going to be able to manage through it as effectively as any of our peers.

Yes. No, that makes -- I mean, the retooling of the business has been great and certainly going to pay dividends for you guys for a long time. I guess as you think about the demand environment and all that's going on over the last 12 to 18 months, what's your thought on kind of leading indicators that you guys are watching? As we start to come through the pandemic, we're moving to post pandemic. Is there -- is it a different set of indicators that you guys are watching to kind of inform maybe where this business is going? I mean is home improvement going to be driven by the same factors as it was pre pandemic? Or are there some differences that you would call out?

Well, look, I'll give you some internal ones. I'll let Dave talk about, kind of, external macro factors. Internally, obviously, we're looking at geographic locations and understanding, as I mentioned earlier, as mobility picks up are we seeing material impacts to the business relative to transactions, ticket and just overall performance. We're also spending a lot of time talking to our professional customers. Because those customers have line of sight to future business trends. And quite candidly, they are very excited that their book of business remains strong. They have a nice visibility to jobs and additional jobs over the course of the next couple of months and quarters, and they're very confident that they're going to stay busy, and that's good for us, good for home improvement. We also can look at our pipeline from an installation standpoint. Just to remind you, 3 years ago, our installation services business was losing money. We had massive customer service issues. So we've revamped that entire network, and now it gives us the ability to look at quotes and leads in out months and out quarters, we can get visibility to how robust the pipeline is in that area as well. And obviously, we look at transaction ticket in different price points just to understand how the customers are responding to us and responding to what we're bringing for in the business. There are other things look at like credit, et cetera. But internally, there are not dramatically different metrics. We're looking at post pandemic as we looked at pre pandemic, they're pretty much the same, but they give us really good leading indicators on the help of the business and how out months and out quarters will play out.

And Peter, the only other thing I'd add to that is we do watch externally mobility to make sure that we understand where in pockets where mobility is high is our business performing differently where mobility might be still constrained a bit. And I say the good news is we're seeing really strong demand in both of those situations. I do think one thing that is happening a bit is as people have opened up a little bit, sales are moving around within the week. I think the weekends, people are traveling a bit more. So they're spending more time kind of during the week spending versus on the weekend. So we're getting a little concentration from that perspective. But that's the only thing that's been a little unique or a little different. But -- and that's really around the edges. It hasn't been a dramatic shift, but we did -- have seen some movement on Saturday, Sunday into the work week a bit.

And Peter, one other thing that I'll add, look, it's devastating as the pandemic has been housing metrics relative to home improvement remain really strong. If you take a look at all the positive macro factors that really drive our business, housing starts, the age of housing stock, interest rates, the investment that homeowners are making in their homes, all those things still appointing in positive directions for us. When there is a shortage of new homes, on the market or a shortage of homes for sale, that's good for home improvement because the vast majority of our business is remodel maintenance and repair. And when customers start to see home price appreciation in their existing home, that gives them confidence that they can put in those granite countertops and those hardwood floors and they can build that deck and finish the basement because they know that they're going to return on that investment because of the appreciation they're seeing in their neighborhood in their area. So I think sometimes it gets lost that what drives home improvement oftentimes is not the same that drives new home building. So from a home improvement standpoint, we feel like that the macro environment is about as positive and as constructive as we've seen in many years.

Yes. No, that's great to hear. And that's actually a good segue into my next question, which is really around your initiatives to engage more with your Pro customers. You've seen some nice growth and success on that front of late. Maybe talk about where you think that's just more engagement with kind of your existing Pros? Are you starting to win over new Pros yet? I know you did some store reset activity. I'm curious how the Pros are responding to that. And then as part of that, you mentioned -- we hear about the loyalty program, CRM, tool rental, there's a lot going on to engage to Pro. So maybe just give us an update there, Marvin, as to what you're seeing.

I'll give you a couple of highlights, and Dave can jump in. Overall, we feel really great about our Pro strategy. And just a little bit of a history lesson, Lowe's made a couple of strategic decisions 7-plus years ago to get out of certain national brands and be more private brand focused in the Pro area, remove leadership and staffing and things that Pros look to. And so we responded quickly to really improve what we call the foundational areas with Pro, job like quantity, staffing, loading, delivery assistance, supervision at the Pro side of the business. And so we did that first. And now we have enhanced things in place. You talked about the U.S. Retail Reset, which was done primarily to create the right adjacencies for Pro customers. I mean, a year ago, if you were just trying to do something as simple as replacing a toll, you got to shop on 4 different aisles for the toller, the seat, the supply lines, et cetera, it really made no sense. And that's just a microcosm of how we didn't think about assorting the store to help the Pro customer shop in a more time-efficient manner. So that reset has really allowed a more intuitive shopping environment for Pros. Pro Loyalty is something that we launched back in 2019. We paused it last year for obvious reasons. And now we're back up and going again, and we're really pleased with what we're seeing. I mean it's exceeding all expectations relative to frequency of customers who are Pro Loyalty customers versus customers who are not, ticket of customers who are Pro Loyalty versus customers that are not. And all those things are pointing in the right direction. I mean it's early days, but the team is excited, and we're continuing to ramp that in the right direction. In addition to that, we feel really good about not only the number of new Pro customers but also how our existing customers are shopping more. And Dave and I have said numerous times in the past. If we didn't attract one net new Pro customer and simply increase the share of wallet of our existing customers, that would be sufficient enough to drive the business for many years to come. So we're seeing a combination of new customers and a combination of existing customers spending more, which is the right balance that we're excited about. And I give the Merchant team a lot of credit for some of the new brands. We just launched FLEX over the last couple of months, we're having a great results from bringing Simpson Strong-Tie into the assortment last year. And we're continuing to have great partnerships with DEWALT and Stanley Black & Decker to get the right level of brands there. So overall, we feel like we're heading in the right direction. We're going to continue to work this. Because there are other big strategic elements like tool lawns you talked about that we're launching. And our goal is to get 100 to 200 open every year, going forward. And so we're kind of marching down that role. But again, a lot of exciting things in Pro and the numbers reflected as in the first quarter, Pro outperformed DIY for the first time in 4 quarters, and we think that trend will probably hold up for the rest of the year. But the team is excited, and we're going to continue to push forward.

Peter, the only other thing I'd add to that is what also has occurred over the last really a couple of years now is we were largely out of stock from a job-lot quantity perspective, servicing our Pro customer. I think we've -- the supply chain has obviously given us challenges at the moment, given the industry challenges at the moment, but we're so much better than where we were a couple of years ago. So now these Pro customers actually have availability of product when they're in our stores. So I think that's really elevated our game as well.

Yes. No, for sure. And that's super helpful. I think the next topic I wanted to touch on is your PPI kind of initiative, perpetual productivity improvement. You kind of kicked off 2021 by laying that out, kind of, a store operations optimization, I guess, program technology enhancements, new processes. Maybe talk a little bit about what you're trying to achieve there. And given what's going on in the labor markets, just curious how you kind of think about making sure the in-store service levels are not sacrificed in order to meet some sort of leverage goals. I mean, I know they kind of go hand in hand some time. Sometime they can work against each other. So maybe just give us a sense for how you're thinking about that.

Yes. Peter, maybe I'll kick it off on the productivity effort that we have in place is think about this as just a series of singles that we're running. We have a playbook that is laid out really over the next 3 years with a laundry list of initiatives that are largely technology-enabled that we're putting in place. And as we put these in place, we're reducing tasks in our stores and our distribution network and being able to pull hours out of the system. Most of the time, we're taking some of those hours to the bottom line in the sense of enhancing our operating profit. At the same time, we're taking a portion of those hours and investing them back into service on the floor to support our sales effort. And so I think that's kind of the program we're under. This is nothing glitzy or glamorous, this is just running the playbook that we have in place. And we're doing it largely coming about through the stores and the supply chain, but we're running the same play in the corporate office as well, just within finance. We're kind of just grinding ourselves through automating kind of the back end processes to take out tasks and improve our performance. And so that's what we're working on. And I think from a labor perspective, I'll let Marvin comment on it. But we're -- we feel like in January, we're really nicely positioned from a labor perspective. There's pockets, but I'll let Marvin talk.

So Peter, let me give you just an example of our PPI initiative to really go to the heart of your question. So let's say, for instance, 2 years ago, we did return to vendor a product in every store as an individual process. We had anywhere from 40 to 80 hours of payroll per week allocated to processing vendor returns in every single store. And it was done very fragmented in a very inconsistent manner. So we took a step back. We opened 3 central consolidation centers to process vendor returns and we reduced those hours, in many cases, from 80 to 40 hours more like 15 to 20 hours. And so you have a decision to make because all those hours are, we call them tasking. They're off to sales floor, they're not serving customers, they're not driving sales. So let's say, as an example, in a store, you say 60 hours of payroll because you take that process from in-store to a centralized location. Then the operations team works with Dave's team and they decide, okay, we're going to take 30 hours to the bottom line for productivity, and we will take 30 hours and add it to the sales force. So what we're finding out is even though we have a labor reduction, we have a service improvement. Joe McFarland talked about a couple of years ago how we initially looked at our labor spend as an overall spend in the stores, and then what was shocking is 60% of all of our labor was spent on something other than helping customers and driving sales. It was all behind the curtain task and nonselling, nonservice initiatives. And only 40% of the label was being spent to serve customers to drive sales. And so we -- to Dave's point, we had this long list of initiatives that we've been tracking on. And so when we entered this year, we totally flipped that entire equation. Now 60% of all our labor now is on the sales floor serving customers and 40% is task that was done entirely by the implementation of technology. So even though there's a net reduction in labor, there's also a net improvement in service because you're allocating more labor and more associated productivity to driving customer service. And so that's the magic of doing this correctly. In the past, the way we got there was exactly the heart of your question. We just cut labor and that ended up hurting the customer service and being a negative impact on the business. Now shifting to the labor market. I mean, obviously, there are parts of the country that are more difficult to staff in than others, but we have not seen a material impact on the company because of the difficulties that we have in the labor market today. We allow our local teams to have the flexibility to adjust wage based on the market they're operating in, so we can be competitive. We have taken the bureaucracy out of that. But as I sit here today, I feel great about the work the team has done to get hard up for spring and to have people in position to drive sales in these really busy days and weeks for us. And again, do we have pockets that are more difficult than others? Absolutely. But overall, we feel good about where we are.

That's great. That's a terrific perspective. Thanks for that. Before I wrap up here, I want to make sure I get one in on supply chain. You guys have outlined a strategy to pivot your big and bulky from store-based delivery and fulfillment to a market-based model. Maybe talk about that transformation, where you stand on that? And how you think about kind of same-day next-day delivery as you think about serving your Pros better?

Well, what I would tell you is the heart of our supply chain transformation is exactly what you said. And that's going from a store-based delivery model to a market-based model. And we -- as the old saying go, we want to go slow to go fast. So we've taken a major market. We've transitioned every store, and we put them through our new, we call our [ XPD ], which is our cross docks and our bulk distribution center model. That has enabled us to reduce the amount of inventory for appliances in the store, pull it out, put it in a central bulk distribution center and to dramatically improve the system that the associates use and the customers have visibility to, to order, ship and have visibility to that. We are extremely pleased with the results of a pilot and even coming out of this most recent memorial weekend, which is typically a big appliance period for us. That was a really critical point for us to see how the model held up during that time, and we came out very pleased with the results of how the model held up versus the other parts of the country that's doing it the old-fashioned way. So you're going to see us aggressively roll this out. In addition to that, you're going to see us continue to make decisions on how we fulfill from an e-commerce standpoint. I mean, we stood up 4 fulfillment facilities around the country that will allow us to be 2 day in virtually every ZIP code in the U.S., and we have same-day capabilities in some areas. And we have aspirations to leverage more of our brick-and-mortar stores from a fulfillment standpoint, and we think that's going to get us closer to same-day capabilities across the country in the near future. We're not there yet, but we're working toward that. But I'll remind you that today, roughly 60% of all of our online fulfillment comes out of our store. So that's the model that we like, and we have enhancements that we're testing right now that we think is going to ramp that number up to greater than 60%, and that's going to give us the ability to really deliver on that same-day capabilities around the country, most of what we can do right now.

Fantastic. I guess the last one, I'll wrap up here about 2 minutes left. Dave, maybe one around capital allocation. Obviously, you're accelerating CapEx in support of a lot of the initiatives we've been talking about this morning. But you're also accelerating the pace of buybacks and a dividend recently. Maybe give us a sense of what you're thinking for CapEx? How -- what should we think about that? And then when you would expect to get back to your leverage target, 2.75x, maybe a little time frame around that.

Yes. Listen, great question. I think we're very fortunate. This is a company that generates significant levels of free cash flow. We're investing back in the business at about -- the clip of about $2 billion per year, which is we think is probably a pretty steady state for the next 2 to 3 years. And so we don't feel that or see that changing dramatically period-over-period. At the same time, we just leaned into and said we're going to do about $9 billion of share repurchases this year. Think about that a little bit as the minimum because, as you just said, we are under our leverage target of 2.75x, and we're probably going to be under that target throughout '21, but it's my expectation in '22 and '23 to get back to that target, we'll -- when we do that, we'll avail ourselves to over $10 billion of incremental cash just to get back to that leverage target, which, again, back to our point, is that first, best in the business; second, support our dividend at a 35% payout ratio. And then any excess cash above and beyond to get to that 2.75x, think about that as cash available for share repurchases. And I feel very strongly, that's a really nice way to reward shareholders, and we're very focused on that.

Yes. That's great. Well, listen, I think that's a great way to wrap it up. We really appreciate both of you guys being here today and sharing your thoughts. It's a great story. You've found a lot, but obviously, there's still a lot to go, and we look forward to monitoring and keeping track of what you guys are doing. So thanks again for participating in the Baird Conference. Really appreciate it, and we'll be sure to stay in touch. And thanks, everybody, for watching.