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

Good morning. I'm Greg Melich. I cover retail broadlines and hardlines here at Evercore ISI. And it's my great pleasure to have with us Dave Denton, who is the Chief Financial Officer of Lowe's. Dave has been there since late 2018. So about 2.5 years, it probably feels more like 10 given everything that's gone on, Dave, and frankly, a lot of the progress you guys have made in terms of margin and share goals and sort of reinvigorating the business. So a lot done in 2.5 years and excited to spend the next 30 minutes figuring out, yes, where we can go from here. So Dave, welcome.

Hey, thanks for hosting us. I appreciate everybody's interest in Lowe's. And we're on a interesting journey and an interesting time in the evolution of the company and really excited about where we are. So...

That's great. So let's start right there with -- I guess to get it on the table, the biggest question we get is given this, the unprecedented surge in home improvement demand last year, how are you guys managing to, if you will, cycle the surge and handle what seems to be an inevitable 2-year comp decel? Like what sort of trends are you seeing? What things are stickiest from the consumer or from the Pro to help keep this momentum going?

Yes. Well, I think a couple of things that are happening here is that as we've gone through the pandemic, a few things have really shifted the dynamics of, I would say, the home improvement industry. One, first and foremost, the home has just become such an integral asset to individuals because not only is it a place for dwelling now, it's a place for work, in many cases, a place for school, a place for entertainment. So just the emphasis on the home has continued to elevate the housing market. And at the same time, the utilization of the home day in and day out has elevated as well. So think about repairs and maintenance and all the effort that goes into maintaining that home in its current status has really been a nice tailwind to the industry. And by the way, I think a tailwind that's not going to dissipate for some period of time. I think this is a permanent shift. And then secondly, I do believe that consumers now are looking more to the omnichannel. I'm sure we'll talk about this later, method of engaging with retailers. And I think we've been very fortunate leaning into that space. And we continue to make sure that we've sorted our business appropriately. We've got really solid plans to continue to support the demand in the industry. And our service levels have been relatively high across our business. And I think that has supported us as we've gone through Q1, very strong Q1, and we said the trends going into Q2 also are very solid and that continues.

So on that sort of 2Q trying to start, we definitely get the omnichannel. But just to circle back, we also saw a surge in lumber price inflation, a lot of supply chain challenges. How have you been able to keep up with that and stay in stock and is -- now that lumber is rolling over, is that something that sort of peaked year-over-year in the first quarter and now will ebb in terms of top line support?

Yes. Well, I think obviously, we've seen unprecedented increases in commodities, particularly lumber, over the last 12 to 18 months. Our anticipation and our plan was that, that would decelerate throughout the back half of this year. Obviously, you can see it just as commodities, you watch commodities, you see the lumber beginning to pull back a bit. So part of our plan is that, that will come down through the year. So we'll put pressure on our top line. But again, consistent with our plan is what -- essentially what we expected for the balance of the year. I think the question a little bit, the unknown, is how rapidly that happens. It's certainly going to happen in '21. But is it going to happen over a 6-week time frame or over a 5-month time frame? Hard to predict that. But I would say that our merchants teaming up with our finance team are really working hard and diligently to make sure that we manage ourselves through that process. So again, I think it's -- we're focused to make sure that we have the right assortment in our stores and the right service in our stores to meet the demands of both the DIY and -- as well as the Pro customer.

Have you been able to get the inventory you need for spring and early summer?

Yes. We were good. We're very good and fortunate from a spring perspective. We actually planned the buy and the delivery of the buy earlier than what we anticipated the prior year. So while there might have been a little bit of delays, we actually had -- we had spring inventory well in advance of the season. So we're really nicely positioned from there. I would say the supply chain, just in general, not within Lowe's, but across the industry, across the U.S. and internationally, is largely catching up. We have pockets of areas where either COVID-related or unique-related circumstances have caused some disruption, but nothing of any material levels at this point in time. We feel pretty good. We feel pretty good. We like to be better in stock, but we're not out of stock. How's that?

I feel -- and I don't want to put words in your mouth. But if we go back to the back half last year, there was probably phases where you could say, wow, if we had, had more inventory, sales could have been 50 basis points better or something like that. It doesn't feel like maybe there's something left there, but it might be 100 basis points. It's not -- would that be a fair way to put it?

I think that's a fair way. I don't know about the math on the numbers there, but I think we're better in stock today in key categories than we were 6 months ago. And I -- so I think we're in pretty good shape from that perspective.

So maybe to transition a little bit, still on top line but sort of focusing, dipping in a little more deeper on these initiatives. I know you did a reset of the store, getting more Pro products upfront. Could you sort of give us an update on those initiatives, the key few ones that you had this year to position yourself for the recovery we're seeing?

Yes. So first and foremost, we did do a fairly large reset within our stores last year, making sure that our adjacencies across the store platform were appropriate and then we have the right depth of A and B velocity items within our assortment. So I think that really with a focus largely in the Pro to make sure it's easier for that Pro to get in and shop the categories and get out in a rapid fashion. So I think with the whole focus of improving service and shop -- I call it shopability in our stores largely behind us, we have a few more stores left to do, seeing nice momentum in the categories that we touch, but that's going to build over time. Secondly, I would say we're on this journey to improve our omnichannel experience. We leaned into it heavily in 2020. We're now kind of optimizing that as we platform the site. We're making our buy online, pick up in store and curbside programs much more effective and customer service focused. We're expanding our assortment online to make our assortment align with the needs of our customers. So a big focus in that area. And over the last -- we've essentially doubled our online business over the last 18 to 24 months. So just the momentum there is pretty staggering and we continue to lean into that. And I think the third area -- or maybe 2 more areas. The third area that we are focused against is the Pro business. Again, kind of fixing the service model, I feel like we've made nice progress there. The next push is making sure that we have the right loyalty program, the right CRM tool such that we can really identify that Pro, engage in that Pro in a personalized manner and lean into that Pro customer to be able to drive greater share of wallet over time. And then finally, as you know, we've been investing in our supply chain. We currently have a very inefficient, I guess, process in which we deliver our key items to consumers' homes. And what we're trying to do is really out of all of our stores. So what we've done is kind of move -- working to move all that up 1 node in the supply chain and build out a market delivery program. And we have it up and running in 1 region today and making nice progress there, nice progress. We have a lot of work to do there.

And so when -- if that works, what you're doing in that 1 market, and I'll throw out Houston for some reason that was in my head, but if you don't want to say it, don't. But if -- how long would it take to sort of roll that out? And would it be appropriate to roll it out nationwide if the decision is...

Yes. What we do -- it wouldn't be a big bang. We would roll it out kind of market by market by market. It's probably a 24 to 36 months kind of roll out. Again, what we're trying to do is make that 1 market, I'll say, battle hardened such that we can just easily replicate it across the U.S. and just working out all the kinks. And I think we're on a really nice path at this point in time. And we'll have -- by the end of this year, we'll have -- likely have 3 markets up and going.

Got it. And then maybe once you get those 3 markets, then you can get an idea. But this is something that if you did it, it would take more than a year to roll out. Is that...

Without a doubt. Without a doubt. I think the challenge is not so much -- there's a little bit of a challenge of making sure you get the right facility assets in place. But importantly, there's kind of a change management training program that goes along with our store associates on the front lines. And that -- we want to make sure we get that right.

Got it. So of all the things you listed there, a lot of places I'd love to follow up. But I guess I would start with the DIY and the Pro one because I think one of the big questions we've gotten all this year, frankly, started after COVID is when -- how do we cycle the DIY surge last year and when does the Pro come back and sort of make up the difference? And I think you had a -- your paint partner talked about how their Consumer Brands business actually was a little softer than they thought through the second quarter. Can you just sort of update us on how you're transitioning in that DIY to Pro trade-off?

I'd say a couple of things. One, around that point specifically is our paint business is performing exactly as we planned it. So I think our partner might have had different planning assumptions, but we actually planned our business thinking and knowing that or at least anticipating the fact that DIY demand would soften and Pro demand would likely accelerate. And we're actually seeing that dynamic play out in our business. And so we feel really good about where we stand. And I would say in totality, as we said coming out of the call in Q1, our sales performance and the market performance is actually exceeding our expectation. The demand has grown above and beyond what we call the robust market scenario that we laid out for investors back at our investor update in December. And so we continue to see really strong momentum kind of across our business knowing that Pro would likely recover and lean in more aggressively in '21 versus DIY.

And remind me, the robust scenario was a negative 2% comp for the year. Was that...

Correct. Correct.

So maybe circling back to omnichannel. So a lot of rules have been changing the whole platform of the business last year. Could you help us understand a little bit more about what that's really allowing you to do to win more customers and to get digital not just 8% of sales, but 10% or 12% or whatever?

Yes. Keep in mind that you probably -- when I joined the company back in '18, our digital penetration or online penetration is probably around 5%. We're probably closer to 10% now. So we've almost doubled that penetration. And largely is what we've done is stabilize the platform, which is first and foremost. Greg, you remember the -- kind of the bad days back in '18 when once the volume got to a certain level, the Lowe's website would actually shut down and have issues. We're actually running above those peak levels when the website would shut down pretty consistently now every single day and our uptime is extremely high. So we're really excited about what's happened there. Secondly, we're really now leaning into the ability to make that interface and that engagement with the consumer almost seamless to make it easy to shop, working to improve our, we call it, kind of collections to make sure that it's easy. If you're going to buy a patio set that you can buy the whole set in totality versus going out and picking out each item individually. So we're just on this journey, if you will, to modernize our program. And at the same time, our assortment online has been pretty anemic. And so now we're going back with our merchants and filling out the assortment. And if you look at just our penetration today, we lag our biggest competitor pretty significantly. While we made a lot of progress, the opportunity for continued growth in that channel is pretty significant and one of the drivers that we see going forward.

Right. And the -- you're at a point now where you can show inventory visibility at the store level. So I think some of the other metrics, you can show a different price for delivery. Some of the other constraints over there, those were all lifted?

We're largely on the journey to fix all those. I would say we're not 100% done. We continue to work on those. I think the idea here is to make sure that as a consumer, that if you place an order online, you can actually track that order from time of placement to time of delivery and be able to really manage, if you will, that order. And that's an infrastructure that Lowe's hadn't historically had in place and we're building that today. And we're actually going back and making sure that we're breaking apart kind of our delivery cost from pricing so that our price visibility and our price competitiveness online is a lot more transparent.

Look, I want to make sure we spend time on margins and returns and profitability, but we're getting into the halfway point. So let me I guess finish it with sales and maybe early on in the pandemic, there was some talk about the flight to the suburbs or more rural areas and with that, how would that impact store performance. So I'd just love to hear from you to sort of level set us now. Are you seeing your rural stores do better than more urban stores? Are there any other shifts in terms of consumer behavior? Like does housing turnover matter anymore or less than home prices when you look at some of the regional data?

Yes. Interesting. If you look regionally for the most part, Greg, you're seeing pretty consistent performance across our business. And I put a little asterisk by it, adjust it a bit for weather. So when -- obviously, when you see the north, the south have a big storm that interrupts consumers kind of mobility, if you will, you're seeing some implication from that perspective. But if you look fairly consistently across our business, urban stores and rural stores are performing quite well and pretty similar. I think in the past -- I think back right when the pandemic hit, we saw our rural stores kind of elevate and our -- and maybe our urban stores lag a little bit, I think that's kind of normalized at this point in time.

Okay. And on the region side, it's really just weather. Anything else on like customer demographics, whether it's millennials or first-time buyers? Any sort of other behavior changes you see there?

I do think what you're seeing now a little bit, Greg, is that whole millennial population, we knew they were going to get in the home market. But I think the expectation was that was going to be largely in 5, 8, 10 years from now. I think what you've now seen is that shift in demand has actually probably been pulled forward. So I think you're seeing that population now get itself more engaged in home, suburban, rural locations than what we originally planned. So I think again, back to these, I'll say, tailwinds over the long term, that's probably a tailwind that's here for multiple years.

And if you look at the other side of it to get that supply on the market, the -- are you seeing more baby boomers as they enter retirement stay in place and try and fix their home up? Or are they...

Yes. No. I think you're actually right. I think you're going to see those baby boomers largely age in place. And I think that in -- with that focus is making sure that we have the right assortment to support that aging in place. And we actually have a program from a merchandising perspective to lean in to make sure that we support people as they can reconfigure their home with that focus going forward.

But sort of an aside, it seems like with what happened with a lot of nursing homes, I imagine there could be 1 million plus households that want to stick around in the house.

That's correct. And as you know, across the nation, the supply of homes is pretty limited. So it's not like you can just trade up into a different home. A lot of times, you're like, okay, I need to take what my existing infrastructure and make it better. So that really leans into the home improvement sector as opposed to just the general housing market.

Got it. Well, so look, for our last 10 minutes, let's sort of turn to the margins, profitability, cash flow, lots of things I know are close to your heart. So I would start maybe near term, last year, there were a lot of extra costs related to COVID, I'll say, around labor, supporting employees, all made a lot of sense. I know that -- I think early in the year, there was a number I want to say it was roughly $900 million of the extra costs that you might get back. Does that still feel right? Or is there -- is the market shifting enough that, that needs to be less or more?

No. I think that is right. I think we're very focused, Greg, on when we leaned in and put in, I'd say, incremental cost in the business last year, areas that are not needed, we had planned to pull that cost out. And I think we are very diligent and focused on getting the cost out. And so nothing has changed in our mind from that perspective.

On that front? And so then maybe to position that within the 12% margin goal that you hit and basically raised it to $13 million in terms of progressing towards that, how do you feel about the ability to flow through the demand? Are there other things that could constrain that when we think about the...

Yes. No. I don't know if there's things that can constrain it. I mean obviously, we're very focused on, first, achieving our 12%. And then once kind of we tick that off our to-do list is ultimately drive ourselves to 13%. Keep in mind, Greg, what we are doing is we are making investments in I'd point mostly to supply chain that when you make investments in supply chain, the first few periods of those investments, you're not operating those assets at full capacity. So they obviously are dilutive. And so as we feather those investments in, we're working from that 12% ultimately to that 13%. So there will be some both tailwinds and headwinds as we think about moving along that path. But again, we have a very solid financial plan longer term to deliver against those programs.

But the -- maybe to think about that, I know your -- I think the CapEx now closer to $2 billion, a little higher than it was. Does that $2 billion -- how should we think about that number going forward? Does it go as -- grow as a percentage of sales? Could it run higher if you decide to roll out these market operations that you talked about for a few years? How are you thinking about that?

I would say over kind of the short-term planning horizon here, I think $2 billion is about the number on an annual basis. I don't think you should see it go up or down pretty dramatically. Obviously, Lowe's has been a little bit in a, I'll say, catch-up phase to get ourselves modernized. At some point in time, we will catch up, but we've probably got a couple of years left to get that kind of behind us. And just to be clear is that we're not necessarily capital constrained, Greg, on programs and efforts. I think we have a very thoughtful, [ fanful ] program that's going to deliver over the next several years. We're not thinking about pulling forward big investments into this year or into next year because it's not -- again, it's not an issue of capital. It's an issue of bandwidth. I think we have the right level of initiatives and the right amount of initiatives that we can manage very successfully. And I think adding more to that probably doesn't make a lot of sense right now for us.

And so the constraint is clearly not capital given the strong cash flow. I guess what do you do with the very strong free cash flow in the meantime knowing -- as you balance how to deploy it?

Yes. I think we're really fortunate in the fact that this business throws off a ton of free cash. We're very focused on improving our shareholder returns from that perspective. Again, we're going to invest in the business at the appropriate level. We're kind of on this march to kind of -- to support our dividend. But at the same time, any excess cash above and beyond what we invest in the business, supporting kind of a 35% payout ratio, think about that as cash available to support share repurchases in this business. And I think we've demonstrated the fact that we've leaned into that. I think it's a great way to reward our shareholders and drive a lot of value. So you should expect us to continue that march.

I mean I know it's a volatile environment. So you're not alone and burning cash heavy over the last 12 months. But you have a debt-to-EBITDAR target of 2.75. Has that changed? How long are you comfortable running under that just given that EBITDAR is a lot higher than it was 18 months ago?

Yes. Listen, I think 2.75 is the right target for us. And my expectation is that over the next several periods, we're going to get back to that level. But having said that, we are in a really unique, volatile period of time just in -- coming out of this pandemic. So I've probably been a little bit conservative in making sure that we probably are underneath that level at this point in time. But kind of once everything's opened up, stabilized and everything is kind of, I'll say, back to more normalized environment, you should start seeing us kind of getting back into that level.

And so I ask a little more directly, what's -- what -- how much cash do you need to carry just to run...

Yes. We're probably sitting in I think roughly around $6 billion. We need to carry much less than that. We can probably operate in the 1 to 2 level easily because a lot of that's extra cash in transit, to some degree. So we have a lot of cash that's available to us at the moment. And then secondly, just thinking about getting our debt levels back to that 2.7x avails ourselves with a lot of additional cash that we can use to put to good work to drive shareholder value.

Well, and on that, you mentioned the dividend payout ratio of 35% and sort of making sure that keeps moving forward. And when you say moving forward, is it basically keeping it with the earnings growth of 35%? Or is the inclination that maybe that should be 50% -- is 35% more likely go to 50% or go back to 25% I guess is the...

No. I would say the 35% is more likely to stay roughly at 35% and just progress as earnings progress. At the same time, any extra cash, I think a better use at this point in time is in the share repurchase game.

Got it. And that's -- you're on plan for that. It sounds like...

We're going to lean into about $9 billion this year, and I keep saying $9 billion at a minimum. And -- because, again, we're still below our adjusted debt-to-EBITDAR target at this point.

And maybe just a bit on working capital, again, such an unprecedented area. Obviously, you want in stock, that's important. How do you think about that when you're doing this equation? Like are -- we always want inventory turns to be faster. But do you think that maybe we -- should we get a little too focused on optimizing inventory turns going into this pandemic?

I don't think we got -- no. I think the short answer to that is no, we did not. And the reason why I say that is we were just trying to catch up from an inventory perspective as demand accelerated through the pandemic. Now the question is let's make sure that we're -- our inventory levels are appropriate or back in stock in key categories and key items, but not get ourselves over our skis and have excess inventory in areas that aren't turning as rapidly. So we're still on the, I'll say, a little bit of a catch-up level at this point in time. So we're not yet at the level of "optimizing."

Got it. Well, so look, we're -- we have our last couple of minutes. So I'm sure I forgot something. I could keep talking forever. But David, what we've gone through, what -- you've been there 2.5 years now. Stepping back a little bit, what are you most excited about in terms of where you're getting traction? And is there anything that I didn't ask or didn't bring up or talk about that you wanted to make sure that we all took away today?

No. I think you hit on the big thing. I do think that, one, is we've really stabilized the business model. And I feel really strongly and really proud about that. Secondly, I think about the opportunities over the next several years is really leading into our Pro business, making that a more meaningful portion of our customer set. And then secondly is making sure that our omnichannel environment is robust and appropriate. And I think that's also a nice tailwind as we think about the next several years of growth in this business. And then you touched on it, this business throws off a ton of cash. And the objective here is let's make sure we take that cash and drive to improve return on invested capital and really enhance the value of our shareholders. That's kind of job 1 from my perspective, and we have a lot of tools at our disposal to do that more effectively over time.

Well, that's great. And it sounds like in terms of the restructuring activities, I know -- I probably should have mentioned it earlier or I probably -- you -- are you sort of done with the store closures and other areas that maybe you were exiting? Those boxes have all sort of been ticked? Or is there anything left?

They've all been checked that largely, all that's behind us. Obviously, we move a store, relocate a store here and there, wherever, once in a while, but nothing of significance there I think.

There's no other M&A or new type of store format you want to roll out or geographic region that's...

No. Maybe, Greg, there's always a little filling-up activity here and there, but nothing of any significance. Yes.

All right. Well, Dave, I really appreciate the time. We're coming up on our half hour. So thank you, everybody, for watching and look forward to hearing from me again I guess in just a few weeks when we get the whole quarter.

That's right. Well, thanks again, Greg. Thanks for hosting us. And again, thanks to everybody in their interest in Lowe's.

Thanks, Dave.

Thank you.