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

Good morning, everyone, and welcome to the Lowe's 2022 Financial Outlook Event. I'm Kate Pearlman, Vice President of Investor Relations. Here with me today are Marvin Ellison, our Chairman and Chief Executive Officer; and Dave Denton, our Executive Vice President and Chief Financial Officer. Before we begin, I'd like to take a moment to review our notice regarding forward-looking statements. This information is also included in our press release and presentation, both of which are available on Lowe's Investor Relations website. During this event, we will be making comments that are forward-looking, including our expectations for fiscal 2021 and 2022. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the risk factors, MD&A and other sections of our annual report on Form 10-K and our other SEC filings. Additionally, we'll be discussing certain non-GAAP financial measures. A reconciliation between reported U.S. GAAP and non-GAAP financial measures is available in the appendix of today's presentation, which is posted on our Investor Relations website. Following our prepared remarks, we will host a Q&A session. Thank you for your participation in today's event. And with that, I'll turn it over to Marvin.

Thank you, Kate, and good morning, everyone. Thank you for joining us today for this virtual investor event, and we look forward to returning to an in-person format at our Analyst and Investor Conference next December. Look, I'll begin this morning by discussing our view of the home improvement market as well as the key growth initiatives in our Total Home strategy that's driving our market share gains. Then Dave will outline our 2022 financial outlook and our key financial priorities for next year. After that, we look forward to taking your questions. We take our responsibility at Lowe's as a Fortune 50 retailer very seriously, and we are committed to supporting our associates and our communities while promoting the health of our planet. We've made significant strides in reducing the environmental footprint of our operations and in supporting our customers in their own efforts to live sustainably. To support our associates, we have a strong commitment to promote a diverse, equitable and inclusive workforce where our 300,000 associates can grow and thrive. And since 2018, the company has invested well over $2 billion in incremental wages and equity programs for our frontline associates. In demonstrating our commitment to our communities, last year, we contributed more than $150 million to support communities where our associates live and work. This includes $55 million in grants to support rural and diverse small businesses hit hard by the pandemic. And this year, we're celebrating our centennial with a $10 million investment in 100 communities across America as a testimony to our long-standing tradition of community service. At Lowe's, we are proud of our ongoing commitment to our associates, our communities and to our planet. Now allow me to transition to the business. We are very fortunate to be operating in a robust sector of the retail industry, which we expect to benefit from secular tailwinds for years to come. The traditional drivers that support home improvement demand are all pointing in the right direction, beginning with home price appreciation. The combination of strong housing demand alongside limited supply of homes has been supportive of meaningful increases in home prices. And if homeowners are confident in the increasing value of their home, they will consider upgrades and enhancements to their homes as an investment rather than an expense. And because of the limited supply of homes, many homeowners are choosing to upgrade and modify their existing home. Our research indicates that it will take several years of homebuilding for supply to catch up with demand. And in the meantime, the housing stock in the U.S. continues to age with more than half of the homes in the U.S. over 40 years old. Also given the recent level of stimulus and the impact of limited consumer mobility, consumer balance sheets are very healthy. In housing, affordability is supported by mortgage rates that are hovering near all-time lows while income continues to rise. But with the onset of COVID last year, several new demand drivers developed that we expect to persist. There's been a longer-term shift in the consumer mindset about the importance of the home. A view of the home as a sanctuary that may need to serve several multiple purposes, residence, office, school, gym and a gathering place for indoor and outdoor entertainment. And given the extension of remote work, we are expecting a permanent step-up in repair and maintenance cycle. And as a reminder, approximately 2/3 of Lowe's annual sales come from repair and maintenance activity. Finally, we're seeing both younger and older generations more focused on home ownership. Millennial household formation has accelerated at the same time that baby boomers are increasingly looking to age in place in their own homes. And in a moment, I'll speak to how Lowe's is addressing the unique needs of each generation as they strive to live in their homes in style and in comfort. All of these factors are expected to contribute to a long-term wallet share shift to the home. Given both the traditional drivers of home improvement demand as well as the incremental COVID-related impacts, we are very bullish about the long-term health of the home improvement industry. And at our 2020 investor update, we unveiled our new Total Home Strategy, which reflects our commitment to offering a full complement of products and services for our Pro and DIY customers alike, enabling a total home solution for every project. We saw an opportunity to expand the products and services that we provide for both our DIY and Pro customers. Our Lowe's Total Home Strategy has enabled us to accelerate our market share gains as we focus on 5 key growth areas of the business: intensifying our focus on the pro, accelerating and modernizing our online business, expanding installation services, driving localization and elevating our product assortment. I'll spend the remainder of my time this morning discussing a few of the critical Total Home Strategy initiatives that we'll focus on in 2022, including our continued efforts to transform and modernize our supply chain. Let me begin by discussing our enhanced focus on the pro. As a reminder, our target Pro customer is a small- to medium-sized business owner who shops more frequently and across multiple departments, driving higher ticket purchases. In 2018, we began addressing the basics for the pro, expanding our Pro brands and product assortments and investing in job lot inventory quantities while tailoring our service for this busy customer. Then last year, we shifted to a more strategic phase of growth by resetting the layout of our stores with the Pro in mind, we're aligning the store's footprint across product adjacencies to make the stores faster and easier to shop. And we launched a Pro loyalty program that provides members-only benefits while this year, we've continued to deepen our relationship with the Pro as we launch a data-driven Pro CRM platform. And we continue to expand our Pro product offerings with the launch of SPAX fasteners, FLEX Power Tools, Mansfield's plumbing products and LESCO fertilizer this year. These additions further complement our powerful Pro brand lineup, which already includes Simpson Strong-Tie, DEWALT, Eaton, SharkBite, Bosch, Spyder and many others. This year, we also re-platformed Lowe's for Pros to the cloud to enable more personalized offers as we enhance features like rapid reorder, which allow Pros to quickly reorder items that they frequently purchase. And we added new conveniences including Pro trailer parking and free air stations. This helps Pros get in and out quickly from our stores and for Pro customers, time is money. All of these enhancements enabled us to drive 24% growth in Pro through the third quarter of this year on top of 18% over the same time frame in 2020. I'd like to take a moment to thank our Pro team for their tireless efforts to deliver these outstanding results, and we are confident that we have a compelling product and service offering for the Pro that will enable us to earn even more of their business. As we capitalize on this opportunity, we expect our Pro sales to grow at 2x the market rate over the next several years. But let me be clear, we also plan to grow our DIY sales during that time frame and continue to capture market share and improve operating profit with both DIY and the Pro customer. And as I mentioned earlier, with the onset of COVID, we saw an acceleration in the trend of baby boomers seeking to age in place in their own homes. And last month, we announced a unique collaboration with AARP for our new Lowe's Livable Home product and installation services that are designed to help our customers modify their homes to meet their lifestyle needs. Our affordable on-trend solutions include bathroom remodels with walk-in tub, grab bars, stair lifts and mobility aids like wheelchair ramps. Our collaboration will leverage the trusted AARP brand and expertise with the goal of providing a project manager-led, one-stop shop for customers who desire to modify their homes to meet their changing mobility needs. And last year, we announced our intention to expand our private brand penetration, building on the success of some of our popular brands like allen + roth and Cobalt. Although our Pro customers gravitate more towards national brands, our research indicates that DIY customers are more brand-agnostic, especially in the core categories. They tend to be interested in high-quality, on-trend products at a value. And the extension of our private brand portfolio will allow us to meet these customer needs. And I'm particularly excited to introduce our new modern brand, Origin 21, which is designed to appeal especially to the millennial homeowner who has shared their preference for modern decor with us. And as we continue to drive further private brand penetration, we will expand the share of wallet with our DIY customers as we provide them with end-to-end total home solutions for all of their remodeling project needs. For example, customers looking to create their dream bathroom can find everything they need at Lowe's from paint to fixtures to tubs and even towels. And for customers who don't want to do it yourself, we can also provide installation services, truly a total home solution for your dream bathroom. And in April, we announced the acquisition of the STAINMASTER brand, which is the most recognized and trusted carpet brand on the market today. In 2022, we plan to extend the STAINMASTER high-performance characteristics in lifetime stain-resistant warranty to laminate, tile and vinyl flooring. And over the next few years, we will continue to extend the brand into other non-flooring product categories. We look forward to updating you on the continued expansion of this very valuable asset. Our private brands' expansion will not only drive customer loyalty and differentiation, it will also support our commitment to expanding operating margins. One critical step in our journey to becoming a best-in-class omnichannel retailer is the modernization and the transformation of our supply chain. At the center of that transformation is the market delivery model. To understand what an improvement this represents, you need to start by understanding the legacy store delivery model. Our current legacy delivery model is tremendously inefficient, with each store functioning as its own distribution node for big and bulky products. In this model, we hold appliances in the stock rooms and in storage containers behind the stores. And then we leverage our store-based delivery trucks and associates to deliver to customers' homes. These deliveries have been conducted without routing software and customers can only purchase the inventory that's available in that store for delivery. In this new market delivery model, big and bulky products flow directly from the supply chain to the customers' homes without ever flowing through the store. We've converted our entire Florida and Ohio Valley markets to this new model. And as we deploy the new model, we are seeing higher operating margins and appliance sales, improved inventory turns, reduced damages and better customer satisfaction with higher on-time delivery rates. Customers can also choose from a wider selection of inventory located at the bulk distribution centers for next-day delivery to their homes. We plan to convert the entire U.S. market to this new market delivery model over the next 18-plus months. This new model will enable us to drive sales while improving inventory turns and operating leverage through a technology-enabled, simplified, customer-focused process. And as we modernize our supply chain, we'll continue to focus on expanding our omnichannel retailing capabilities. We began by transforming the online user experience as we replatform Lowes.com to the cloud from a decade-old platform to facilitate a best-in-class user experience. We are building on that success with further innovation to offer a truly integrated omnichannel shopping experience where customers can try out our products virtually and even measure their rooms using just their smartphones. We're also expanding our buy online, pick up in store or BOPIS options, including the launch of curbside pickup and touchless pickup lockers across all of our stores. And with the rollout of the market delivery model, we're opening up space in our stock rooms, which allows us to expand our parcel store fulfillment network while also expanding our same-day and next-day fulfillment capabilities. We were pleased that our strategic focus and progress as a company is resonating with our customers, the marketplace and the investment community. And we're honored to be recognized by several prestigious organizations this year for our efforts to promote sustainability and diversity and inclusion in our company. And I'm particularly pleased that Fortune Magazine recognized Lowe's as the most admired specialty retailer for the first time in 17 years. Looking forward, I remain confident that we are making the right investments to accelerate our market share gains through a Total Home Strategy by enhancing our investments in Pro, online, installation services, localization and elevating our product assortment. We're making targeted investments to win with the DIY customer across generations of homeowners, across geographies and across a spectrum of taste and styles. And we're also investing in the Pro to ensure that we have a consistent competitive offering for this busy customer. I am as excited about our ability to win with the DIY customer as I am about our ability to grow market share with the Pro as we expand our share of wallet with both the DIY and Pro customers by providing total home solutions for all of their project needs. Now I'll turn it over to Dave for him to provide our 2022 outlook and discuss how we will continue to deliver long-term value for our shareholders as we expand operating margins and improve return on invested capital.

Thank you, Marvin, and good morning, everyone, and thank you for spending time with us today. Marvin began this morning with an update on the key strategic initiatives of Lowe's Total Home Strategy to aggressively grow market share. And I'll begin this morning by reviewing Lowe's value creation strategy. By way of reminder, we first introduced this framework at our 2018 investor conference. This framework is focused really in 3 key areas: first is to drive operational excellence throughout the enterprise; second is to consistently generate high levels of free cash flow; and finally, to employ an optimized shareholder-focused approach to capital allocation. Over these past few years, we have driven significant improvements in operating performance while creating meaningful shareholder value, which remains our top priority. We are confident that our disciplined approach will continue to unlock additional value going forward. We have delivered impressive improvement in operating performance in a relatively short period of time. When considering our 2021 outlook, we are expected to deliver 3-year improvements across several key metrics. First, a 36% increase in sales per square foot to nearly $460. This result was driven by our enhanced brand and product offerings as well as improved customer service, resulting in both higher Pro and DIY sales and increased sales productivity. Second is a 380 basis point improvement in operating margin to an estimated 12.4%. We continue to drive productivity across the company and leverage our fixed costs with improved top line growth. And importantly, a 22-point increase in ROIC to over 33%, improved operating performance, a disciplined focus on high-return investments and our robust capital allocation program continued to enhance our returns. This outstanding operating performance has enabled us to return more than $30 billion to shareholders in both share repurchases and dividends over the past 4 years. We look forward to updating you on our long-term targets and our key strategies at our next Analyst and Investor Conference in December of 2022. We will be particularly excited to discuss how we plan to substantially close the margin gap with our largest competitor and to provide the building blocks to the next operating margin milestone. Now this morning, we are reaffirming the 2021 financial outlook that we provided on our third quarter conference call. And I'm pleased to report that our quarter-to-date performance is tracking slightly ahead of our guidance. We are expecting total sales of approximately $95 billion in 2021 and comparable sales of approximately 33% on a 2-year basis. We expect to lever operating margin by 160 basis points to approximately 12.4%. This is on top of 170 basis points of adjusted operating margin expansion that we delivered last year as we continue to drive productivity across the enterprise. Gross margin rate is projected to be up slightly versus 2020 as we utilize our pricing and product cost management strategies to more than offset higher supply chain and product costs. Our reported 2021 results to date reflect not only the successful execution of our strategy, but also the continued momentum in home improvement spending. Lowe's continues to increase its share of the consumer wallet despite improvements in consumer mobility across the nation. Our sales have also benefited from our competitive in-stock position as we utilize both our scale and our carrier relationships to secure capacity. We also took possession of inventory earlier this year, utilizing our expanding coastal holding facility network to help mitigate the impact of unforeseen delays. We expect CapEx of up to $2 billion this year as we focus on high-return investments that will drive long-term growth. Consistent with our shareholder-focused capital allocation program, we are now planning to return approximately $12 billion to our shareholders via share repurchases this year. This is $3 billion higher than our original outlook due to both better-than-expected performance and a clear reflection of our commitment to drive meaningful, sustainable shareholder value. And finally, we are expecting return on invested capital of over 33% this year as we remain laser focused on a disciplined strategy that prioritizes high-return investments. We are proud to be operating above 30% return on invested capital. As Marvin highlighted, we expect secular tailwinds to support home improvement demand over the next several years. This is both due to traditional drivers of home improvement spending as well as new COVID-related trends. Looking ahead to 2022, the home improvement sector is likely to contract modestly given that the industry benefited from both higher inflation and government stimulus this year. While it still remains difficult to predict the market performance precisely, we are expecting a demand decline of mid-single digits on a mix-adjusted basis. Keep in mind that Lowe's has lower Pro and online penetration relative to the market. In short, while we are planning for a modest sector pullback in 2022, we remain confident in the long-term growth drivers of the home improvement market. Similar to 2021, we expect to continue to outperform the market next year, with sales ranging from $94 billion to $97 billion. Keep in mind that this includes approximately $1 billion to $1.5 billion in sales in the 53rd week. Comparable sales are expected to be in a range of flat to down 3% as compared to our expectations for fiscal 2021. This excludes the impact of the 53rd week. We forecast that Lowe's sales performance continues to outperform the market by approximately 300 to 400 basis points as we plan for continued gains in market share. Our sales outlook for 2022 takes into account the fact that we are cycling over an estimated $2.7 billion or approximately 260 basis points of growth in '21 due to commodity inflation and government stimulus. We expect Pro to continue to outpace DIY next year. We will drive momentum with the Pro with our improved product and service offerings and our enhanced Pro loyalty and CRM tools. Operating margins are expected to be up 10 to 40 basis points to a range of 12.5% to 12.8%. And importantly, we anticipate repurchasing approximately $12 billion of our stock next year. Our plan includes roughly $2 billion of CapEx with ROIC expected to expand to 35%. Our strong operating performance and shareholder-focused capital allocation strategy would deliver approximately $12.25 to $13 in earnings per share. Note that due to our disciplined capital allocation program, EPS is expected to grow at roughly triple the rate of operating income. Now I'd like to spend just a few moments discussing the puts and takes that we expected to impact our operating margin performance next year. We are expecting our gross margin rate to be roughly flat to 2021 levels. This expectation is being delivered in an environment of higher levels of product inflation and unprecedented rate increases across the global supply chain. Our teams will continue to drive improvements in product margin through our data-driven pricing and product cost management strategies. Our dynamic market level pricing will allow us to quickly address prices in a rapidly changing market condition. We will also continue our targeted EDLP promotional strategies to remain relevant in the marketplace without being overly dependent on promotions to drive sales. And finally, we will continue to increase private brand penetration. Private brands allow Lowe's to capture additional margin while delivering exceptional value to our customers. We expect our improvements in product margin rate to be largely offset by several factors. First, higher distribution costs from the long-term impact of the global supply chain disruptions will pressure margin. While we are effectively managing these cost increases, we are not immune to the pressures in the rising cost environment. Second, the ongoing rollout of our market delivery model will pressure margins next year. Keep in mind, while this model will ultimately benefit overall operating margins, it pressures gross margins while reducing SG&A in our store base. We are expecting to lever SG&A by 10 to 30 basis points versus 2021 levels next year as we continue to drive productivity throughout the organization. Our perpetual productivity improvement or our PPI initiatives will continue to drive store-level productivity by introducing numerous technology-driven enhancements in our store environment like streamlining our checkout process, improving store fulfillment and reducing search time with our new store inventory management system. We're also driving efficiencies by leveraging our purchasing power to reduce nonstrategic costs. We expect these benefits to these initiatives to be somewhat offset by higher wages in 2022 due to labor market pressures. Keep in mind that we already offer a highly competitive package of both wages and benefits for our frontline associates. We continue to invest in training and development to promote a more rewarding work experience and drive retention. We also expect to continue to incur COVID-related expenses in 2022, including compliance costs associated with the new OSHA regulations. And finally, the market delivery model will modestly benefit our store operating expenses, including lower store labor and damage-related expenses as we roll it out across additional markets in 2022. I am confident that even if the home improvement market demand slows next year, there are a number of levers that we can pull to continue to drive operating margin expansion. Our continued focus will be to drive growth in market share and improve operating margins over the long term. Over the next 3 years, we expect the company will continue to generate significant levels of cash flow. Assuming a disciplined financial plan, the company could generate operating cash over this time frame of approximately $32 billion. If 20% of this cash is invested back into the business, $26 billion in free cash flow would be generated. As we move back towards our target leverage ratio of 2.75x over the next 2 years, additional cash of about $14 billion could be made available. This would result in approximately $40 billion available to enhance shareholder returns, which roughly represents 20% of the company's current market cap. Based on this confidence in the company's continued business momentum and strong cash generation capabilities, our Board of Directors just approved an additional $13 billion in share repurchases. This brings the total share repurchase authorization to $20 billion. We expect to utilize our substantial cash generation capabilities to create value for our shareholders through disciplined capital deployment. Our capital allocation priorities remain unchanged: first is to invest in our core business on high-return projects to position the company for long-term growth; second is to support our 35% dividend payout target; and finally, returning excess capital to our shareholders through value-enhancing share repurchases. We remain committed to maintain a healthy balance sheet and a solid investment-grade rating with a target leverage ratio of 2.75x. Our strong balance sheet is critical to creating the flexibility we need to invest in our business and to return capital to shareholders. This is truly an exciting time for Lowe's and the future of our company. We operate in a great industry that will continue to benefit from numerous tailwinds over the next several years. At the same time, big box retailers that are well capitalized and who are investing for an omnichannel future are expected to outperform over the long term. This is due to both the considerable scale advantage that big box retailers enjoy as well as continued consumer preferences for consolidation of shopping trips. For Lowe's, these past 2 years has presented a pivotal opportunity for both growth and transformation in our journey to become a best-in-class $100 billion omnichannel retailer. And yet, we still have significant opportunities ahead of us to both accelerate our market share gains and to drive further operating margin expansion. I share Marvin's confidence about our plans to expand both our DIY and Pro market share and we have a proven track record of returning capital to our shareholders through a disciplined capital allocation strategy. The company is well positioned to drive long-term shareholder value. So with that, thank you for your interest and for your time today. We'll take a quick break, and then we'll be ready to take your questions. [Break]

[Operator Instructions] Our first question is from the line of Kate McShane with Goldman Sachs.

Thanks for all the great detail this morning and certainly around the comp build. Just to dive into the comp guidance a little bit more. I was wondering if you could tell us how you're thinking about the flat to down 3% guidance when it comes to price versus units. And with regards to the composition of sales, are you expecting certain categories to lift comp more than others, either because it's an easier compare or you're seeing any emerging trends? And finally, is there a way to build up how much of the comp is going to benefit from repair versus more discretionary?

Thank you for joining us today. Great question. I think first and foremost, as we cycle into next year, price will continue to -- and ticket will continue to kind of drive the comp progression as we think about a little bit of pullback from a DIY perspective. Obviously, we're planning for a robust spring as we go into next year. Keep in mind that we're overlapping a pretty significant amount of both inflation and stimulus, certainly in the first half of next year and particularly in the first quarter. Keep in mind, in my prepared remarks, roughly about $2.7 billion or about 260 basis points of comp this year will not -- were overlapping from both a stimulus perspective and an inflation perspective that are kind of headwinds as we think about our progression into next year. Obviously, as we said, the Pro business continues to be kind of our strength from a growth perspective, with that business growing at kind of 2x the market rate at this point in time.

And Kate, the only thing I'll add to that is it's really difficult as you can appreciate forecasting in this environment. But we're very confident with the initiatives we laid out, specifically the Total Home Strategy, that we're going to outperform the marketplace by 300 to 400 basis points. And so I think to me, that's the baseline. We can't predict what the macro environment is going to deliver, but based on the track record of the last 20-plus months and the initiatives really starting to kick in, we think that we're going to outperform the marketplace by 300 to 400 basis points. So we think there's upside potential just based on the initiatives and based on the level of execution that we've delivered.

Your next question comes from the line of Peter Benedict with Baird.

You spoke to plans to substantially narrow the margin gap with HD over time. And I know you're going to give more on that a year from now. But I'm just curious, how do you think about the components of that gap? And maybe what's most addressable? And what areas are maybe structural, if any? I'm just curious if you'd maybe expand on that a little bit, Marvin.

Peter, maybe I'll kick it off and then ask Marvin to give his color commentary on some of that. First and foremost, we're making the right investments in our business to drive long-term growth. And I think we've -- we're very focused on what we're doing, both from an online perspective and importantly from a supply chain perspective. Secondly, I do believe the COVID trends that we've seen over the last couple of years have really leaned into Lowe's strengths, both from a rural perspective and from a DIY perspective. And I think as we step back and think about the marketplace, we really believe the opportunity for consistent growth and market share gains in the DIY category are both very significant and opportunistic for us as we think about both the core and private brands, as we think about growing value for our consumer, but at the same time, harvesting a bit of margin for us. And finally, we're just now beginning to go into the next phase of growth from a Pro perspective. I think that allows us to continue our momentum in that space to begin to close that margin gap more aggressively than what we had thought in the past.

So if you think about the 3 areas we were most deficient versus our largest competitor when we arrived as a new management team a little over 3 years ago. It was Pro, it was online and it was really just base systems that really tie to omnichannel and just operating efficiency. And so as you think about Pro for a second, we've been able to grow at 24% year-to-date on top of 18% growth last year. So we're committed to growing 2x the market. I gave you a long list of some of the new and existing brands that we think is going to help accelerate that business. So now let's think about operating income for a second and operating margin. The investments that we're making in operating margin already has given us 380 basis points of improvement since 2018. And now we're going to be leaning into pricing systems that's giving us tremendous short-term benefits. The market delivery rollout is incredibly important to taking down SG&A in the store and creating efficiency. And the overall technology investment is going to continue to drive operating improvement in the store because we're taking that labor that's now task-driven and very costly, we're eliminating that, and we're driving productivity through our PPI initiative. So all of those things, we think, will help to close that gap. And when we get together for our full blown Analyst and Investor Conference in December of next year, we're going to give a very detailed list of kind of how we put the measurements to those initiatives in driving and closing that gap. So hopefully, that answers your question.

Our next question comes from the line of Simeon Gutman with Morgan Stanley.

I hope you can hear me okay. So my question is on the outlook for 2022. So you're saying margin expansion on flat to down sales, which is all SG&A. So can you talk about is this a preview of what the algorithm will look like? I know you're spending a little bit on the market model and you said that's going to hurt your gross margin. So might we see a little gross margin expansion down the road?

Yes. Simeon, yes, that is the algorithm that we think will play out and our financial plans have over the long term. Think about us, again, continuing to improve the top line as we lean into Pro online and importantly, the DIY consumer. Secondly, we're managing product cost and price very effectively and efficiently, and we think there's opportunities over time to expand that. But at the same time, that's being eaten away as we roll out our market delivery system across the country. Having said that, that market delivery headwind from a gross margin perspective is more than offset with SG&A reductions across our store base, thus expanding operating margin. And that's the financial algorithm that we -- that's the core of our financial plan and the line of sight that we have to growing operating margin over the next several years.

And Simeon, it's a little more than just SG&A. And SG&A is important because it's not just taking labor out of the store and diluting service, it's the replacement of tasking labor with technology, with an inventory management system that we think will be best-in-class, with mobile technology, with improved point of sale, improved project management software, all of those things are allowing us to take labor that was just noncustomer-facing, and we're replacing it with more modern technology. In addition to that, we can't overstate the importance of localization. And this is part of our Total Home Strategy of elevating our product assortment. Specifically, I've given plenty of examples of where we've just had such poor assortment decisions in the past with riding lawn mowers in Brooklyn and 12-seat patio furniture in West Philadelphia, et cetera. Now that we have better allocation systems and a field merchandising team, we're putting the right product in the right stores and it allows us to minimize markdowns coming out of the season. And our price management system gives us tools that we've never had before. 3.5 years ago, we had the same price and cost model in Brooklyn as we had in Jackson, Tennessee. And obviously, that's not the way you run a national business with stores in a lot of different locations. Now we have the ability to do market-based-pricing, store SKU combination pricing that gives us a lot of leverage and flexibility that we didn't have 3 years ago, we didn't have it candidly 18 months ago, and that's only going to get better. So a combination of all of those things give us those levers that if we don't get the top line based on macro environment, we still have leverage to drive operating margin improvement.

Our next question comes from the line of Eric Bosshard with Cleveland Research.

Two things. Just first of all, a clarification. The $2.7 billion of inflation and stimulus in '21, just first of all, does that number go to 0 in '22? Or is there a figure there? And then the second point, a more meaningful question. Talking about a year where sales are down, I'm curious how you're managing the inventories into that environment and how you're thinking about inventory levels. And then also how you're planning and thinking and perhaps expecting promotions to behave in a contracting sales environment.

Yes. So Eric, it's Dave. On the $2.7 billion, we think about it as essentially 0, and let me explain that a bit. One is part of that is government stimulus. So we are expecting no stimulus next year. And the second piece of it is commodity inflation, and we expect commodity inflation next year to basically be neutral, having no impact from that perspective. And then obviously, as we think about our business going into next year, clearly, we're making sure that we're planning kind of the categories in the right assortment as we think about demand in certain -- both periods but important both from a Pro perspective and a DIY perspective.

Yes. And look, Eric, I think most importantly, all the investments that we're making in Pro, we're seeing that continue to pay off. And we think, again, irrespective of the macro environment, we think that we can outperform by 300 to 400 basis points just based on our investments. And relative to inventory, I think you are well aware that we've been chasing inventory really for the last 20-plus months. And so we don't have any concerns with getting ourselves in trouble from an inventory perspective if sales are flat or slightly down. Now if sales are flat and slightly down for us, we're going to outperform 300 to 400 basis points. It means we're going to have a macro environment that's going to be tougher from some other competitors out there. So we feel great about our ability to manage inventory, both domestically and import. We have a much improved distribution model and a much improved product allocation model. So we think irrespective of the macro environment, whether the sales are flat or up, we're going to be able to manage inventory without getting ourselves in trouble.

Yes. And Eric, I'd just also just say, we will get more productive from an inventory perspective as we cycle into next year. To Marvin's point, we are chasing inventory to some degree, even though our relevant position is really strong in the marketplace. But despite that, despite us leaning into inventory, we believe we will improve our turns profile into '22.

Yes, for sure.

Our next question is from the line of Greg Melich with Evercore.

Great, very concise update, guys. I guess I'd love to follow up on the TAM size, the $900 billion that I guess is half Pro and half DIY. I think last year, they used the same number. So I'd love to get some more color on maybe MRO, other breakpoints of that $900 billion and why it hasn't grown from a year ago.

Yes. So Greg, realistically, some of that market size lags a bit from an economic perspective. Our expectation is that market probably is expanding a little bit, and so it's probably higher than that. Having said that, we monitor the market pretty closely from month-over-month, quarter-over-quarter progression. And to Marvin's point, our objective here is to grow more aggressively than the market, 300 to 400 basis points. And I think we're really well positioned to be able to do that both from a Pro and importantly from a DIY perspective as we cycle into next year.

And Greg, we talk a lot about the macro environment for home improvement being slightly different than the broader macro environment. And so when you look at that market size, you can debate the relevance of it. But the key for us is looking at the broader indicators like home price appreciation, aging housing stock, personal disposable income and historically low interest rates. In addition, we oftentimes get only compared to our chief competitor when we think about market size. But just the sheer size of this home improvement market demonstrates that it's still very fragmented. And that's one of the reasons why 2 of the largest competitors can still have impressive growth, both top and bottom line in a market that may not be dramatically growing because we're taking share from a host of competitors out there in both Pro and DIY. And I just want to remind you again that our expectation is, irrespective of the macro environment, we're going to grow by 300 to 400 basis points above the market, and we think that's something that we can deliver on.

And we do collect a lot of information from external sources as we think about the market as well as we run our own internal analysis based on our position within the market. And again, we use a combination of those 2 data sources to predict how we believe the market will perform and importantly, how we will perform in those relevant market scenarios.

Makes sense. And my follow-up would be on inflation. Like Dave, you mentioned in the guidance next year, commodity inflation is 0. But if I'm not mistaken, you guys talked about inflation being over 500 bps outside of commodities. Is there an inflation number for next year in your comp guide that's ex commodities?

Certainly, inflation does play a part in that. We probably haven't broken that out specifically. Keep in mind, what we're seeing is rate inflation into the global supply chain based on the market dynamics there and a little bit of wage pressure as we think about our wages across the nation, despite the fact that we have a very high wage profile for our frontline associates and very competitive, we are going to feel some of that pressure cycling in next year. We will work to offset that through taking cost out of our system and potentially adjusting price when relevant.

Got it. And is your strategy to protect dollars or rate when you go through that exercise?

We're trying to protect rate at the end of the day. Obviously, dollars come along with that, for sure.

Our next question is from the line of Michael Lasser with UBS.

To borrow the framework that you laid out last year around this time, you're essentially guiding to a robust market environment for 2022 despite having lapped a $2.7 billion stimulus and commodity-related inflation. So what is an offset that's going to lead to the robust market scenario despite having those headwinds this year that weren't really in place at this time last year?

Well, I think what you're seeing, Michael, is, obviously, we think the market over the longer term is going to be extremely constructive for us. We're just overlapping that stimulus. At the same time, demand certainly within the Pro business is going to continue. And even within the DIY business despite the fact that we're overlapping some very significant growth rates. And again, I'll just go back to what Marvin has now said a few times, irrelevant how the market is going to perform, we're going to perform better than that. And so if the market starts performing better, our outlook is going to go up as well. So I think we're just going to proportionally drive into the market there. At the same time, if the market were to contract a bit more than we expect, we feel very strongly that we've instilled the right levers to be able to adjust our operating margin to still expand operating profit from an operating rate perspective into '22.

So Michael, let me remind you of 2 things. So let's talk again about the macro and what the real indicators are. We're looking at historically low interest rates. We're looking at home price appreciation. We're looking at aging housing stock. As a reminder, 50% of the homes in the U.S. are over 40 years old, and 2/3 of our business is repair and maintenance. And we're looking at the consumer, the homeowner having more disposable income today than historically. In addition to that, we have a $900 billion addressable market. And so if we are expecting to outperform the market by 300 to 400 basis points, irrespective to the macro, we think that it's a prudent and a conservative view that we're going to be in a rather robust environment relative to how Lowe's is going to perform.

Understood. My follow-up question is how much can your sales be down and you will still have a flat to growing operating margin next year? And if we assume that you do a little bit better on your operating margin this year, should we just take that outperformance and then layer it on to have a higher base for the starting point for next year?

Well, certainly, our objective is to expand operating margin irrespective of how we end this year. So we will obviously come back and address that as we cycle into the first half of next year. So that would be our plan, number one. Number two, I just harken back to kind of the guidance that we affirmed today, which is really solid performance, both top line and bottom line. And I think our expectations are still within that realm, trending to kind of slightly beat to that, as I said in my prepared comments. Secondly, we will continue to focus on improving operating rate. Our objective is to both do 2 things. We are going to expand and grow market share, and we're going to improve operating margin. And that is our expectation for next year and the years subsequent to that.

And again, Michael, we're pleased that we've improved 380 basis points since 2018 and our price and cost management system, our market delivery rollout, our technology investments, all of these things are going to be -- will continue to give us benefits and continue to be mature in their development and their delivery going into 2022, even if the broader macro is not as robust as we think it will be. So we still are very confident that those levers will give us the ability to drive operating margin improvement.

Our next question comes from the line of Chris Horvers with JPMorgan.

So my first question is I just want to follow up on the cadence commentary. So the stimulus lap is primarily in the second quarter you talked about. So is this sort of like -- do you expect comps to sort of flip to positive in the back half and 2Q represents the low of the year? And then could you also share some commentary on the margin side? Obviously, freight costs are high in the first half. But at the same time, you get some of the commodity lap back in the other direction and you're effectively pricing. So commentary on the margin side would be helpful.

Yes, Chris, that's probably a level of detail that we don't provide from a guidance perspective. But just stepping back, I would say the first half of next year, we are overlapping significant inflationary pressures as well as government stimulus pressure. So I think more so in Q1 versus Q2, but certainly first half, you would think about that as having the highest level of overlap pressure. And then we'll come back as we go through the years, we always do, give you additional color on how the cadence and the progression of both top line and bottom line will progress.

Got it. And then as a follow-up, in terms of the quarter-to-date commentary, is that doing slightly better on sales? Is that sort of a projection of how you expect to end given the rest of the quarter? Or is that a comment on sort of where you sit today?

It is both where it is today and how we expect it to end at the end of the quarter. We feel like we're really nicely positioned to have a strong December and January going forward. November, as I said as well, was really strong as well. So we're nicely positioned to finish out in a position of strength, and we continue to lean into inventory to make sure that we cycle into the first half of next year in a really nice position.

And Chris, we're just pleased that the strength is coming from both the Pro and the DIY segments, and it just -- it gives us confidence that our initiatives are really working, and we're starting to see sustainable momentum, and we hope that sustains for sure.

Our final question comes from the line of Zach Fadem with Wells Fargo.

So could you update us on how your Pro penetration trended through 2021 as a percent of your sales? And as you think about your long-term margin trajectory, to what extent do you believe the next leg of margin upside is predicated on improving that Pro mix?

So Zach, I'll take the first part of that, and then I'll let Dave talk about the operating margin segment. Today, our Pro penetration is still hovering between that 20%, 25% kind of ratio. As I said in my prepared comments, our expectation is to grow the Pro business by 2x the market. We have consciously not set a penetration target as a goal because my history teaches me that when you set a penetration target, you lose sight of serving the customer. If you serve the customer, the penetration target ultimately will take care of itself. Now we are very confident in our Pro strategy, with our new Pro rewards platform that we're going to be launching on a more global basis in the first half of next year, our new CRM platform and all of the great new brands like SPAX and FLEX and Mansfield and LESCO and some of the existing brands like Simpson Strong-Tie, DEWALT, Eaton, SharkBite, et cetera. So we feel good. And the great news is with our penetration between 20% and 25%, we got a lot of upside. And we know there's a lot of room to grow, and we're really excited about what that means for us in 2022 and beyond.

Yes. And Zach, hey, don't -- without a doubt, improving our Pro business is a big opportunity for us to continue to expand operating margins because that incremental volume allows us to really leverage that fixed and semi-variable costs within our infrastructure. So certainly, number one. But don't overlook the opportunity for us to continue to win in the DIY customer, both leaning into the core and private brands, we think, is a real big opportunity for us over the next several years and a place that we probably haven't leaned in as aggressively as we have. As we cycle into '22, we think we have a really nice start and some really nice momentum there. And then, finally, we are just continuing to invest in the supply chain, which allows us to further be just much more efficient across our enterprise. And with that, will really allow us to expand operating margin over the next several years.

Got it. And then looking at your SG&A line, you're expecting to take about $400 million out of that line in 2021, even while growing the top line by about $6 billion. So as we look at a similar $18 billion or so SG&A run rate in 2022, is it fair to assume that is a run rate for your business? And if you outperform the top line, to what extent would you reinvest or flow that through?

Zach, we have that -- when we over deliver from a top line perspective and have leverage within our infrastructure, we always have a debate around how much to, I'll say, reinvest back in the business versus kind of harvest to the bottom line. And I think we do a nice balance to make sure that we can deliver on both of that. I will say what's important in that commentary a bit. If you look at our customer service scores, despite the fact that our SG&A has performed really efficiently, our customer service scores have actually increased. So we're taking SG&A out and improving service at the same time, which is the algorithm and the methodology that we're deploying across our business to drive value here.

And Zach, one great example of that is the market delivery model we're rolling out. It allows us to take SG&A out. At the same time, we are improving appliance sales, and we're reducing damages, improving service and creating more profitability. And that is exactly what we want to create. We want to create increased sales, increase service and reduce SG&A. And great work by Joe McFarland and the stores team, Donald Frieson and the supply chain team, our technology team led by Samantha [indiscernible], Bill Boltz on the merchant. It's a collective effort where we're all working together. But when it works, it works really well.

Yes. Great. I'll just close out by saying, one, thank you for joining us today. Importantly, thank you for your interest and your investment in Lowe's, and I'm wishing you all a very happy holiday. See you in the new year.

Thanks again. God bless, everybody. Great Christmas and a wonderful holiday season.

This concludes today's event. You may disconnect at this time. Thank you for your participation.