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

Good morning, everyone. Thank you for joining us at Goldman Sachs' 28th Annual Global Retailing Conference. I'm Kate McShane. I'm the hardlines, broadlines and grocery analyst here at the firm. It's my pleasure to introduce the members of the management team for Lowe's, and we will be -- I will be moderating our fireside chat. Today, we have with us Marvin Ellison, Chief Executive Officer of Lowe's. Marvin was appointed in his current role in 2018 and has more than 30 years of leadership and operational experience in the retail and home improvement industry. And we also have with us Dave Denton, Chief Financial Officer. Dave joined the company also in 2018 and has more than 25 years of finance and operational expertise. So I want to thank Marvin and Dave for joining us today. Thank you for everybody who's dialed in. It's nice to see you.

Nice to see you. Thank you for having us. We appreciate it.

So I sent you guys a list of questions a couple of weeks ago in terms of what we're going to talk about today. But I feel like out of all the questions, we could spend the most time on the first question, which is the question that we always get from investors is, you've had these 18 months, almost 2 years of very, very strong growth, a lot of incremental dollars in terms of sales. And the question at the beginning of 2021 for Lowe's and other retailers was, well, how are they going to comp the comp? And now that we're getting closer to 2022, the question still is, how are they going to comp the comp and the 2-year comp? So I wondered if you can talk a little bit to us about how you feel about demand on the macro level and we can go from there.

Yes. So Kate, first, it's great to be with you again. I'll take the first part of that and I'll let Dave jump in. Well, you obviously -- it's always challenging to look at the upcoming year and have great visibility to what demand will be, and this current environment makes it even more difficult. Having said that, we feel really good about 2 things. We feel great about the level of confidence in our strategy and how we're executing in these very turbulent times. We think our results, not only the first half of this year but throughout last year, reflects that this is a new focus, this is a new commitment at Lowe's to being consistent and having a high level of execution and serving our customers well. We also look at macro indicators that really have little to do with the pandemic that will continue, we believe, to create a little bit of a tailwind not only for the back half of this year but going into next year. We look at macro indicators specific to the age of housing stock. We look at the fact that we still have historically low interest rates. We look at the end supply for homes that is currently in an imbalance that is driving customers' desires to move into homes, and there's just not a large supply on the market, which leans customers to want to invest more in their existing homes. We look at home price appreciation. And we said many years in home improvement, you can always determine the health of the market when a customer installs a granite countertop and they see it as an investment and not an expense, or they put STAINMASTER carpet in and they do it with confidence knowing that they'll get a return on that investment. And so when we look at the macro indicators, we feel really confident that the home improvement marketplace is going to be rather robust going into next year and we think for years to come. It's our objective to execute our Total Home strategy in a way that we can drive Pro, DIY, online, installation services and continue to elevate our product categories to just take advantage of the demand, and we feel confident we can do that.

And Kate, I just would also just add a couple of things to Marvin's point, that the home is becoming such a critical asset to almost everyone as people now are, despite people coming back to work, there's still going to be a lot of flexibility to be able to work from home. And so the utilization of the home is much more intense now. And roughly 2/3 of the products that we sell are some type of repair and maintenance type products. So I think the demand for those kind of products are going to continue to be elevated and so a nice tailwind for the sector. And then secondly, I do think through this whole process over the last 24 months, consumer behavior has changed. And I think those companies that are well capitalized, that are invested in the omnichannel capabilities, like Lowe's is doing, are going to have an advantage. At the same time, consumers have very specifically consolidated trips into bigger boxes. And I think those 2 trends from a macro perspective are likely here to stay. And I think we're nicely positioned to capitalize on those trends as we lean into the back half of this year and into the next couple of years into our business.

That's very helpful. And I wondered if I could maybe ask about another possible trend that we've heard anecdotally about, I think, right before the few years leading up to the pandemic. It seems like the housing formation for millennials was a bit stalled. And I think there was quite a bit of catalyst during the pandemic or maybe the seeds were sown beforehand. But just whatever the case may be, can you talk a little bit about your view on if an older millennial or a millennial with a healthier balance sheet could be a driver of longer, more sustainable home improvement demand?

We think so. The data tells us that by 2035, the millennial generation will be the largest group of homeowners in the U.S. And I remember years ago, there was a lot of future risk predicting that millennials would pull back from home ownership based on the devastation they observed their parents and grandparents go through during the financial crisis, and that has proven not to be true. And what we learned last year more directly is that millennials are demanding flexibility in how they shop. As Dave just mentioned about omnichannel, if you are a single channel or you're limited in how you can give choices to the millennials on how they choose to shop, whether it's online, whether it's in-store, whether it's buy online, pickup in a locker, curbside, inside, you have to have the agility to provide a high level of service in all those areas. And candidly, 3 years ago, we could even do the in-store part really well. And so we've made a lot of investments. We've hired some very talented leaders, and we feel very confident that the investments we've made, not to mention the fact that we replatformed the entire Lowes.com site to the cloud last year, has given us the ability to serve those millennials' current state and then also to be here for them when they continue to invest in their current and future home choices. And we think, again, the investments are going to pay off.

And I think also, what we're seeing is those -- the formation of households from a millennial perspective is happening largely suburban and rural at this point in time, which actually leads into a bit of the strength of Lowe's in our footprint. So I think that's another avenue, which we're happy to capture some of that shares. That trend continues and will likely continue for the next several years.

Okay, great. And I think just because of what we've been living through the last 18 months, I think it's easy to forget a little bit that Lowe's is in the middle of a transformational strategy. And Marvin, you mentioned it in the last question a little bit, about the investments that you've been making and the strategy changes you've been enacting since you came in, in 2018. I wonder if you could talk about how the events of the last 18 months has impacted the overall transformation strategy. And have you uncovered any incremental opportunities as a result?

Yes. Maybe I'll start with that. The good news is, as we looked at our plan prior to pandemic and we look at our plan now, the road map's pretty consistent on the items that we were going to -- that we're executing upon. So we feel really strong that our plan is accurate, correct, appropriate to drive a lot of value over time. We did pivot our plan from a timing perspective. We pulled forward, really, investments in the omnichannel space that were on the road map 2 and 3 years from now into 2020 and into '21 to make sure that we had -- we now have touchless lockers across our entire platform. We have curbside across our entire platform. We've increased our assortment online really dramatically through this period of time. And so we've really pivoted to make sure that we're meeting our customers where they want to be met. And so I think that's one pivot that we've made. Absent that, our road map still maintains largely intact as we think about the back half of this year or into the next couple of years.

And then if we can just get into the customer dynamic between the Pro and the DIY, which has also been a big topic of investor conversation just because of what we saw at the beginning of the pandemic and what we're seeing now. And if we could maybe start with the Pro. For a long time, you've talked about the Pro being 20% to 25% of your sales. And I think on the Q2 call, you mentioned you were closer to 25% of sales. I know the overall pie has been growing, given the strength of the business over the last 18 months. But what is the linchpin or maybe multiple linchpins getting Pro to be a bigger piece of the overall pie?

Yes. It goes back to kind of what I talked about earlier and that's kind of focusing on foundational elements first. I mean, we called it retail fundamentals. And it would simply, what are some of the things that every great retailer does consistently well? And so we wanted to start by just creating what I'll just simply describe as a stable foundation. And when you think about the Pro, as we surveyed our Pro customers, call it, 3 years ago and asked a simple question, "What do you need from us, from Lowe's, so that you can put us back in your consideration set as a place where you can shop?" And from that, we narrowed the focus down to the small and medium-sized Pro because we felt as though we had a greater opportunity to gain share with that specific segment out of Pro. And we also felt that the opportunity was available for us to address needs that we felt were not being addressed in that customer segment. And they basically said to us at that time, you need better, more consistent service levels, basic things like loading assistance when we pull up to a store, basic things like having consistent staffing at your Pro desk with someone that actually has basic knowledge that can help us solve some of the problems that we need. We need to have job lot quantities. Your inventory levels are too low, they're too inconsistent, too sporadic. I mean, it was those kind of baseline things. And so we made investments in getting those things done. And then they said to us, "We need to have more pro-related national brands." Lowe's had pivoted some years back to put private brands to try to serve the Pro customer, and Pro customers are really reluctant to switch from a national brand to a private brand. And so we had to start to remedy some of those bad merchandising decisions that had taken place over the last 5 to 10 years. So we call those things retail fundamentals. And so now the question is, now that we have a good baseline in place, how do we take share? How do we continue to grow? And so we now are launching Pro Loyalty. We were operating in a segment for a customer that is really interested to earn points and save based on the volume they spend, and we couldn't even address it because we had no really credible program. So now we're rolling out Pro Loyalty. In addition to that, we're rolling out a CRM tool that's best-in-class, designed specifically for the Pro customer for a couple of reasons. Number one, if you go back in the past, our associates working in our Pro business in the store had no idea the value of a customer when they walked in. They couldn't tell you if that customer was a multimillion-dollar annual spend or a new customer. They couldn't tell you if it was an electrician or a plumber. And they couldn't tell you, equally as important, what the customer was buying, what they should be buying and what they were not buying. And so now we're rolling out a CRM tool that'll give us the ability to know the customer intimately and serve them a lot better. You will continue to see us enhance our credit offering, which what is small and medium customer is a really important part of their business. And we're going to just aggressively go after additional national brands for the Pro customer that you'll hear us talk about over the next couple of months and years as we continue to add these different brands to our assortment. We think by doing these things really well, in addition to things like replatforming our LowesForPros website to the cloud that just happened the first half of this year and continuing to improve our job site delivery, we think we have nothing but increased opportunity to continue to take share with this segment of Pro and to continue just to drive overall top and bottom line performance in our stores.

That's helpful. And if I could just ask one specific question about one of your initiatives, which is the national brand piece. I know that's been something that you've been building on. It goes to something pretty broad like CRAFTSMAN, but then you have some very specialized brands for plumbers, electricians, et cetera, that you're building back. So I wondered if you could maybe tell us how that's going, how big of an ask has it been to go back to some of these brands and ask them to come back to Lowe's? And where do you think you are in that journey?

Well, it -- really, it's all about credibility, and I'll just be very candid. I mean relationships matter and credibility matter, doing what you have stated you will do and making sure that you're committed to helping these various suppliers grow their business. Lowe's made decisions in past management teams to transition to private brands to chase a gross margin rate, not understanding that this is a customer segment that is highly dependent and highly committed to a national brand just because of familiarity and because of comfort level. So we've had a chance to bring brands like Simpson Strong-Tie, SPAX, fasteners, Bosch, Spyder, SharkBite, LESCO. We just launched FLEX, which is a large power tool brand in the U.K. that we think can have relevance here in the U.S. And I can go on and on and on. These brands were either in a very small presentation assortment here to now we're making large commitments. DEWALT is still the largest pro power tool brand. We're working to continue to expand our assortment in that category. And so we've made great progress. We have a couple of coveted brands on our list that we continue to work. And we're not going to stop until we feel confident that we are giving our Pro customers what they need. But the good news is we feel very comfortable that we have the brands in our assortment today, that we can serve our customers well, we can continue to grow market share, and we can also continue to improve our presentation. It's now about executing and it's now about continuing to make sure that we have good vendor partnerships so we can help our customers win, help our suppliers win. And if that happens, then Lowe's will win also.

I think, Kate, that almost circles back to the first question we started with. Our suppliers, we probably have a better relationship with our suppliers now than we ever have because they need to comp the comp as well. So I think leaning in, building nice programs and platforms to drive really solid sales progression and profit progression, delivering real value to our customers, I think there's a way in which we're, to Marvin's point, putting our money where our mouth is and increasing our credibility in the marketplace.

That's great. And if I could just ask 1 more question about Pro and then move on to our next set of questions. You said that you'd focus on the small and midsize Pro. Is that the long-term strategy? Is there any interest or would you ever look towards a larger-sized Pro?

I think the short answer is we want to start with what we think is the foundational segment in the Pro space, and the foundational segment is small and medium-sized. In my estimation of working with this customer for many years, if you can't serve that customer well, you have no chance of serving the larger pro. And so what we didn't want to do is, so to speak, get over our skis and start to chase a larger customer, trying to go after a larger fish, so to speak, and we're not taking care of the fundamental baseline of the customer segment. And so we think when we can get to a comfort level and a market share level with the small and medium-sized Pro, we think we earn the right then to pursue a larger, more industrialized customer. But one of our key objectives and one of the key things we've done the last 3 years, we've been very disciplined around not trying to overreach or trying to add too many elements to our strategic plan. We feel like the reason why we performed so well during the pandemic in 2020 and we've outperformed in the first half of 2021 is because we've been very disciplined around the customer segments that we're going to pursue, and we've been very disciplined around our initiatives and how we service those customers and how we execute on a daily basis. And so we'll earn our way to a larger customer, but for now, the small to medium-sized customer is our target.

Okay, that's helpful. I just wanted to just make one housekeeping announcement to those listening, and we are going to be taking a few questions at the end. I've noticed there's a little bit of a delay. So if you want to start sending your questions in now just to make sure that we get them in time for when it's the Q&A portion, that would be great. So the place I wanted to pivot to next is the supply chain. Obviously, there's been some disruption in the supply chain for some time. But I feel like within the last couple of weeks, you've heard quite a bit more about some of this disruption. And I wondered, specifically for Lowe's, where is the biggest bottleneck currently within the supply chain? And what are some of the levers that you're leaning into to alleviate some of this disruption?

Yes, Kate, maybe I'll kick this off. I think the good news is if you look at our inventory position and our supply chain, we're better today than we were 6, 8, 12 months ago. So we're actually getting better, not worse. I do think the scale and breadth of our supply chain and the size of our import business is at a level that allows us to, one, get capacity into those channels; and two, negotiate, I'll say, the best price possible, given the conditions that are happening right now. We made a very strategic decision to order and bring product into our warehouses and into our stores earlier for each of the seasons. We already had Halloween early. If we look at the Christmas holiday, that is coming in earlier than we originally planned last year. So we're taking advantage or managing the situation by pulling forward, from a timing perspective, some of that product. So I think we feel really nicely positioned. I think where the whole industry is struggling a bit is in really high velocity items, A and B velocity items. I think what we've tried to do is lean in with our suppliers, give them visibility to the needs that we have in those areas and actually maybe accelerate or give bigger orders so they can run bigger line, bigger runs in their lines to give us some capacity into our stores from those products. It's a hand-to-hand combat, if you will, to make sure that we get those products. I do think if you look at how we, Lowe's is positioned, we're positioned better than most, if not everybody else in the marketplace. So I think we're taking advantage of that. Would we like to be better? Sure. I don't think we're hampering customer service at this point in time.

And then I wanted to move on quickly before we got into the audience Q&A, just operating margins. You've recently upped your expectation for operating margins to 12.2% for this year. Obviously, there are quite a few initiatives in place to get there, though. And knowing you're not giving guidance for 2022, we are just curious if negative comps would prevent you from taking the steps forward to continue to drive higher margins.

The short answer is no, they would not. We've actually built our operating model to be a lot more agile than what it was previously, such that we can flex up and down the cost in our infrastructure based on the demand patterns in the industry. And Kate, obviously, that's with a certain level of parameters that, that's the case. But I think we feel pretty confident that we've built in those levers to be able to manage very effectively. And as you said, we start out the year not knowing where demand was going to be. You saw demand probably outpace our original expectations. We were able to lean into that demand, be more productive. Now we're increasing what we thought would be maybe a 12% operating margin up to a 12.2%, really on a path to, in the medium term, get to 13% over time. We do have line of sight to all the efforts both from a margin perspective and then from an SG&A perspective to get to those levels of operating profit.

So Kate, when we talk about our perpetual productivity initiatives, it's really a renewed way in how we think about running this business. In the past, it was really more of a reactive set of tactics that the company would employ to try to meet the quarterly financial targets. And we're way beyond that. We now have line of sight, as Dave mentioned, to multiyear initiatives that we have a road map that's built out, call it, beyond 3 years, what we can see initiatives that we are implementing or will implement. And we understand the value that those initiatives will bring to our operating margin that gives us confidence that we can achieve those targets even with flat to slight negative comps, even though we don't anticipate that unless there's some macro event that we don't foresee. Having said that, it's all about disciplined execution and implementation of IT initiatives, of operational productivity initiatives and improvements within the supply chain that gives us confidence that we're going to hit our 12.2% target. We'll go beyond that. We'll hit our 13% target in the future, and we think there's room for us beyond 13% based on the line of sight that we see with these improvements.

There are 4 questions we are asking. Actually, it's 4 questions, with the fourth question having 2 parts that we're asking every company that are attending our conference today and tomorrow. And it's multiple choice. So the first question is, how do you think about consumer demand? And we kind of touched on this a little bit. But as we move further away from stimulus, do you expect to see momentum accelerate, decelerate or stay the same through the end of 2021?

I would say, for us, I, mean, we gave our outlook, so I think our outlook kind of gives a reflection that in certain areas, it will accelerate. In some areas, it's going to stay the same, but we don't see a mass deceleration. I mean, our outlook provides a level of confidence in our top line performance versus last year. Although last year comps are challenging, we still think that we'll continue to drive incredible market share gains. And then we gave an outlook that provides some level of confidence in gross margin and operating margin performance, so I think it's a combination of staying the same and accelerating sort of.

Yes. I think if you just take seasonality out of it, call it the same.

Yes.

Okay, okay. How do you think about digital penetration in 2022 relative to what we saw in '21?

I think we're on a path to continue to increase digital penetration, back to kind of how we started the conversation yet again today, is the consumer now, more so than not, is looking at the omnichannel as a way to engage with retailers as particularly well-capitalized, that have a robust omnichannel presence like Lowe's. And so I think penetration is going to increase over time.

And look, and just a couple of kind of points of context to that. 3 years ago, we had roughly 400,000 SKUs online. We have over 2 million today and growing. Three years ago, our buy online, pickup in store process had over 14 steps for our associates to execute it, and now everything's digital and mobile. And we have touchless lockers in every store in the chain, and we have curbside pickup in every store. And 60%-plus of our online fulfillment comes out of our stores. So that kind of gives you a sense that we're very serious about continuing to be a very efficient omnichannel retailer.

Okay, great. The third question is, how should we think about promotions in 2022? Will it be higher or lower versus 2021?

I would say the same but definitely not higher. We inherited a high-low promotional strategy that we were very transparent that we felt like was not the right business model for a home improvement retailer. And so we start to work our way to an everyday competitive price. Positioned from a promotional standpoint, we're not going back from that. So we think that you'll see it equal to what we've done this year.

Okay, great. And then my 2-part fourth question is, and again, we've touched upon all of this a little bit in our chat already, but if you had to identify your biggest lever to mitigate supply chain pressures, is it increasing the lead times or shifting production or other? And do you expect inventories to grow faster or slower than sales in the second half?

Well, we touched on it a little bit. I think, really, we've managed it this year through lead times for the most part. We obviously have a fairly robust cost management program that allows us to lean in and try to manage those costs as effectively as possible. The moving, I guess, supply locations is -- has a longer lead time for us in this sector. So it would be -- that would be a multiple-year journey if you were to do that.

Okay, great. And we've gotten a few questions from the audience, so I'm going to ask a couple now in our last 8 minutes here. The first question is, how are you thinking about the pace of debt issuance for the buyback program? And what level of cash do you want to run at in the short and longer term?

Yes, good question. We'll have probably more to say about the debt issuance, over time. I would just point out that we're probably, at this point in time, at roughly 2.1x adjusted debt-to-EBITDAR versus a target of 2.75x. So we have a lot of capacity, if you will. We're holding excess cash on the balance sheet at the moment, and that's just probably us being a little bit more conservative, just given the dynamics in the marketplace. I kind of feel like a lot of the really potential jolts to the system are behind us. So you should see us begin to get back into scaling up closer to that 2.75x over the next year or so. And clearly, we have a pretty, I'll say, robust capital allocation program. We, one, invest in our stores and invest in our business to drive enhancements in ROIC. We have a -- we're marching towards a 35% dividend payout ratio. And then I -- and I think we are a big believer that the share buyback program can add a lot of value to investors, and we're leaning into that pretty aggressively this year, and that's going to be a major pillar of our program going forward as well.

The next question we received is asking about your updated thoughts on lumber demand and lumber pricing and how you're managing your inventory levels there.

Well, it's been unprecedented obviously. We gave some level of visibility to what we think it will look like in the back half. And as it looks right now, we're continuing to manage it. We think we'll be sold through most of those lower layers here in the very near term. And even with that, our margin outlook that we gave on our Q2 call provide us a level of confidence that we have, that in the face of the really volatile environment that we're facing with lumber, we still think we can manage the overall business to a point that we can have our margin slightly up versus LY for the full year.

Okay. One question we also had on our list that we didn't get to that we just got pinged on is the workforce. Just if you could tell us if you're having any difficulties in hiring or retaining associates. And just, has your outlook on wages changed since the beginning of 2021?

Well, what I would say as a reminder, we invested roughly $1.4 billion in wage equity and just, overall, what I would call a compensation for our frontline associates the last 2 years. We didn't make a big announcement, any big press release. We felt like it was just the right thing to do to remain competitive. And Lowe's has always been one of the top-tier average-wage retailers in the marketplace. So I'll give that as a backdrop. We have pockets around the country where we have hiring challenges just based on the available pool of candidates. But overall, it is not a material factor to our ability to staff the company. When we look at it holistically, we feel very confident that we have the ability to staff and to meet the demands that we need to serve customers. Where we have those pockets, we are giving our local team flexibility to make the necessary changes that they need to make relative to wage or other incentives. Having said all of that and factoring all of those things in, we still have extreme confidence that we'll be able to hit our 12.2% operating income outlook for the year. And we don't believe wage or any type of wage inflation will have any material impact on our ability to achieve our operating margin targets that we've laid out over the long term.

Okay, that's helpful. Another question with regards to inflation, this is more on the cost side. Just have you seen a lot in terms of product cost inflation? And have you seen or have you been raising prices as a result? And just what the customer reaction may be to any kind of higher ASPs?

Actually, Kate, we've seen both. We've seen unprecedented deflation, particularly like we just talked about in lumber, that's kind of taking prices down dramatically, at the same time, largely driven by importation costs and transportation costs. We are experiencing price pressure or cost pressure on some of our products. I would say that, again, we stood up a team, about 2 years ago, to work pretty actively to, one, push back and manage that appropriately but also lean into areas where price should be coming down based on what's happened in the marketplace to offset increases in certain SKUs with decreases in others. At times, we have adjusted prices to be appropriate in the marketplace to ensure that our margins are maintained over time. And I think we've gotten just a lot more sophisticated to understand where we have elastic or inelastic demand within certain SKUs and product categories, such that we can adjust price slightly and understand the implication of that to our, one, our top line but importantly to our bottom line. So it's actively -- we're actively managing it day in, day out, week in, week out, and we feel confident that we're able to mitigate that over time.

Okay, great. That's helpful. And I think just with us getting towards 1 more minute, I don't think we have time for any more questions. So I just wanted to take this minute to thank you for joining us today. It's always great to hear from you and hear your insights, and thank you to the audience for dialing in.

Great. Thank you.

Thanks, Kate.