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

Good afternoon, everyone. It's good to see everybody in person. I'm Michael Lasser, the hardline, broadline and food retail analyst from UBS. We could not be more excited to have the team from Lowe's with us today. To my right is the distinguished David Denton, who is Lowe's CFO, who's been with the company since 2018. Prior to that, he was at CVS in a similar capacity. We also have Kate Pearlman, who's the company's Head of Investor Relations; and Amanda Bryant. We are thrilled to be able to have this conversation.

Dave, where I want to start off is you -- as I mentioned, you came from CVS. You spent 25 years navigating through the United States health care system. You probably thought relative to the complexity of the U.S. health care system, effectuating a transformation at Lowe's was going to be a piece of cake. So a, as you reflect on how far Lowe's has come in the last several years, what surprised you? What's gone as well as you thought? What has not? And I imagine that as part of this transformation, key has been really transforming the company's culture. How far along is the leadership team in transferring the culture in where it needs to be?

Yes. Well, first, thank you for having us. We always enjoy spending time with our investor base and spending time with you. And it's just great to see everybody back face-to-face. It's so much more engaging than on a Zoom call. And listen, I think I've been with Lowe's now about 3.5 years. Obviously, the company prior to the new management team had not performed exactly the way we had hoped it could perform or certainly, to its potential. And we embarked upon a pretty regimented improvement effort, really around improving the fundamentals of the retail operation. And I think we were making really nice progress in many of those efforts, shoring up the foundation, the processes, the technology. And then the pandemic hit, and we saw demand escalate pretty dramatically. And I think we're really fortunate in the fact that we were on this pathway, and we're far enough along in that journey to be able to capitalize that spike in demand. So I think really nice progress. I think I'm just really proud of the fact that our road map that we laid out in 2018 really hasn't changed. Our road map of the efforts that we were embarking upon has largely stayed the same. What has happened is we reprioritized and moved them around a bit. I think some of our supply chain efforts got pushed out because we couldn't build as rapidly as we'd hoped. Some of our technology efforts got pulled forward because we leaned into how the consumer wanted to engage with Lowe's through online -- through the online channel, through curbside and touchless lockers, et cetera. So we reprioritized very effectively. I think we will be able to do that because of a little bit of the cultural change that you talked about. As you know, Marvin Ellison came in, put in a new executive leadership team, but importantly, instilled a really disciplined approach around setting clear objectives at the C-suite level, setting clear measures of performance at the C-suite level, but then push those down to the store manager. So we were all aligned top to bottom. And I think it was really interesting. We brought in a lot of veterans from the home improvement sector that really expanded our knowledge fundamentally of the space. At the same time, those veterans worked really hard with their Lowe's -- legacy Lowe's colleagues and associates to really align ourselves, push forward and really lean into this improvement effort. So we couldn't be pleased and we're pleased about that. I really feel like the team, top to bottom, is working really well together. And I feel like that's kind of one Lowe's, if you will. There's not -- there's everybody focused on the prize.

Is it a culture where you thought it would be at this point?

Yes, it is. I think if anything, the pandemic has probably brought the culture along even more rapidly despite the fact that we were doing a lot of things remotely because I think we were all in the trenches together, trying to navigate this very uncertain environment. And because of that, we had to work more closely together. So I think it's built even a deeper foundation and consistency across the application across the company.

And the leadership team deserves a lot of credit for rewarding and recognizing your employees along with -- as evidenced by a nice bonus just in the last few weeks.

Yes, I think if you look at in 2021, I think somewhere in the neighborhood of over $400 million of incremental wages we pushed down to our frontline associates because we really -- as the company has done better, we want to make sure that we're rewarding those people on the frontline because they're really the economic engine of any retailer. It comes to life with them in front of the customer. And I think we're trying to build that momentum, and I think success breeds future success. And we strongly believe that -- in allocating resources to that.

As one of the principal architects of trying to forecast and navigate through this environment, you -- the team has recently indicated that they're a little bit more optimistic about the year ahead by raising the guidance to up 1% to down 1% for the comp for this year. Behind that, what are you assuming for how the market does, for how housing does and how Lowe's does?

Yes. I think what we've assumed, and we did this for 2021 and now we're doing it for 2022, we have a perspective on how we think the market in the home improvement sector is going to perform, is our expectation to be down slightly to kind of mid-single digits. And then we at Lowe's would perform better than the market, in the tune of 300 to 400 basis points better. And so if the market does better, we expect our performance to do better. And if the market doesn't do as well, we should still outperform the market. I would say, as I sit here today, leaning into Q1, we actually did raise our guidance because there are several things that are happening in the business. One, we're seeing still some inflation in the lumber category specifically, is driving top line performance for us, although we do think that's going to stabilize in the back and revert back to, I'll say, normal levels in the back half of '22. I think our Pro -- we've seen really strong demand and performance in our Pro business. I think that -- those pros are telling us they have tremendous backlogs at this point in time and are really busy at this point in time. And we're seeing that come through in the unit demand in the Pro category. So I think that's a real strength for us. And then finally, we've built a really tightly integrated cost management pricing ecosystem within the finance merchandise team. And I feel like we've now continued to harvest that enhanced process. And now we have a little bit better line of sight to improving gross margins, both in '21, but importantly, again, as we cycle into '22.

And just in the last few weeks since you provided your updated outlook, the world has become a bit more of an uncertain place. Top of mind for the capital markets is what's going on with inflation and all these commodities. How do you think the home improvement market is going to respond -- demand in the home improvement market is going to respond when gas prices hit a recent high levels and the consumer is going to be a little bit more pressured on spending on nondiscretionary items?

Yes. I think it's interesting. Obviously, in historic pattern -- in the past, when gas prices have gone up, demand in this sector has kind of gone down a little bit. But I think what has changed a lot, not -- there's not nearly as many miles being driven because there's so much work from home. So I think the effect of that might be somewhat more muted in this environment than maybe what it has been historically. So I don't know if you can draw the same -- or draw the same parallels there. I do say that if you look across the nation, you do see that the home -- that just the home space is -- and the home sector, home prices are appreciating, the utilization of the home is -- has increased and therefore, repair and maintenance and the demand for that, those categories has actually increased as well. And so I think as I sit here today and know that as the backdrop of the home improvement sector and turn around and look at the health of the consumer with a really strong balance sheet comparatively now than probably what it's been over the last probably 8 to 10 years, we feel like the demand for the home and continued investment in the home is going to be top of mind to those consumers. And again, we're seeing that come through a bit in our Pro business as we sit here today.

And is there a macroeconomic factor that you'd be most mindful of? Is it gas prices? Is it the broader inflation measure? Is it...

I think the biggest thing that we'll watch is probably home price appreciation. Just home prices have appreciated pretty significantly. If -- I do think those are going to hold, if not even continue to expand. But I think we'll probably watch that closely. The good news about this space is the Pro business is pretty stable and certainly in the medium term, pros have backlogs in 12 and 18, 24 months in duration at many times. Those backlogs just don't evaporate overnight. So it gives us a bit more confidence in how we think about planning for '22 and the demand profile of '22.

And if some of this macro uncertainty does have an impact on the business, where do you think you'll see it first? Is it traffic? Is it big ticket?

It'll probably be in big ticket. And the reason why I say that is traffic is going to be a little unstable at different points in time really because of the overlap. If you look back over the last 2 years, you've seen huge traffic in, let's say, certain categories like cleaning products. The demand for cleaning products throughout the pandemic was astronomical. That is not sustainable once the pandemic is behind us. So I think there's areas in our business that we plan for and compression and traffic based on those kind of dynamics in the marketplace.

In response to some of these inflationary pressures and uncertainty, have you already started to hear from vendors who were saying, we're going to need to pass this along to the consumer with the noncommodity-related items?

Yes. We are seeing -- we're not immune from price increases, either in the supply chain or certain commodities that are within the products that we buy from our vendors. So yes, we are -- we -- first and foremost, if we get a proposed cost increase, we actively push back on that. Secondly, if we do accept it, we make sure we understand why we're accepting it because if things do revert back to a more normal period, we expect to claw that back. And then third, we do take a portfolio approach as we think about pricing, and we are passing those prices on at retail.

Yes. And is the perception that consumers got a lot of savings and so it's been willing to maintain the same level of consumption as price increases have been passed through, not just within home improvement, but across the economy?

That has been our experience. And what we've done is as they made price adjustments within our environment, we have a fairly precise measurement so that we can look out and if -- as we made these price changes, if the performance is different than what we expected, we can pretty quickly pivot. But I would say, Michael, that over 90% of our -- the times that we've made those changes, it has performed as we expected.

You touched on housing a little bit. It's obviously a key driver for the home improvement industry. How did you factor in how housing and the underlying housing market is going to perform this year as you were planning business?

Well, it's interesting. I think the housing sector is actually net-net positive for us into the space, both probably in '22 and probably into '23, even. What's interesting, you're seeing house over -- housing turnover slow a little bit, but slow for kind of a different reason maybe in the past. It's slowing not because of an economic compression, it's slowing because there's not any supply in the marketplace. So what's happening, if you can't find a new home, you can't buy yourself into a bigger place, you're going back and reinvesting in your existing home, replacing your kitchen, creating a study so you can work at home more effectively, actually using the outdoor space from a garden perspective to create living areas outside of the home and the proper home. So I think you're seeing consumers still invest pretty significantly in those areas in the home.

And you mentioned home prices as being the critical metric to really keep an eye on. Presumably, it's going to influence not only the consumers' willingness but also their ability to invest in their home. Is it -- there was a 20% increase in home prices last year. If there's a modest pullback, presumably that's okay. At what point would it start to concern you if home prices give back some of the...

Yes, I don't know if I have a magic number to that.

You have a lot of magic numbers. Come on, you can share them.

But I -- listen, it wouldn't surprise me if it pulls back a little bit. That would not be alarming or concerning to us. I think reverting back to pre-pandemic, which I don't think is in the line of sight anywhere that might give us pause. But...

And along those same lines, one of the natural responses to this inflation will be rising rates. Is there a level on the 30-year fixed rate mortgage or the 10-year treasury that you would start to say, that's going to give me a little bit of pause?

Yes. I think we're a long way from that. If you look back in history and you look at times which rates were rising and the economy was pretty solid, you saw a fairly healthy demand profile within the home improvement sector. And I think now with the consumer, just the health of the consumer, rising rates off a really low base, we've got a long pathway before I think we get to a level that would start to compress that in any material way.

And is it more so the pace of increase in rates rather than the ultimate level?

I think it's the ultimate level. I really do.

Okay. Shifting gears. It's been quite a couple of years for the home improvement market. People who have been stuck at home doing a lot of work around their home. You would just spend your weekend in the local Lowe's store, observing how hopping the Lawn & Garden area was. To what extent do you think that this is -- the pandemic has caused behavioral changes such that we're just -- we're going to be spending more time in our homes, and as a result, there will be more investment in -- so the overall home improvement market is structurally higher than it's been in the past?

Yes, I think we've structurally changed. And when I say that, I look back at the home improvement market and the housing market kind of before the pandemic, which was pretty constructive. Then you turn around a layer on top of it the fact that now the home, as an asset, is just much more important to you as an individual. Many cases, you're working from home, you're -- as of right now, you have entertainment from home. Your kids are taking classes from home. No more snow days as we discussed earlier, which is sad for them. But I just think because of that, the need to have that home really solidified and really productive for you as in all those different capacities as you use it has structurally changed how consumers think about that asset and the investment required in it.

In looking back over the last couple of years, these surges in demand have impacted different categories, whether it's immediate -- thinking back to this conference 2 years ago, immediately after the onset of the pandemic, people went out and bought new appliances to be able to hold on to more food than they had been in the past or bought a lot of outdoor furniture to evolve how they use their home. Where do you see the potential for the greatest risk of demand being pulled forward because consumers have binged on the consumption of some of these goods?

Yes. And listen, I think what we've tried to do is, as we've cycled into '22, we built up a very detailed category-by-category plan with a lot of input from merchandising finance team within Lowe's, but importantly, our vendor partners, and overlaying that with what we have seen cycle over the past couple of years. And so not every category is created equal, we've planned certain categories down, certain categories up. Good example is, I think, early in the pandemic, everybody painted everything because, right, because that's a really first introduction to a fairly simple project for a DIY-er to perform. And so demand for paint was really elevated. I think now that in that category, that demand profiles back down to more normal customers and consumers are taking on bigger projects, not smaller paint projects. So we've gone through and kind of forecasted out the demand in all these areas with that input into us. So I think that's certainly one. We talked a bit about cleaning is going to be a category that over compared to the last couple of years is going to be challenged based on the demand profile.

And presumably, even if there is some demand pull forward or a shift in wallet because the consumer is getting back to doing some of the behaviors that they did prior to the pandemic, there is a lot of inflation, and there is this long-term interest in housing such as that will provide some of an offset?

Yes, I think the net effect of all of this is there's going to be puts and takes. I think what's happened in this home improvement sector, as you've seen, an elevated increase in demand. You're not going to see that pull back. You're going to see now us growing off of a higher plateau.

And if you look geographically, would you say there's any areas of a country that you would be more mindful of? The perception is the South had been less -- there had been less behavior modification in the South versus the North. Anything in that nature?

No, it's interesting. If you look across kind of our platform across the states and across our markets, we've seen very consistent performance from a demand profile perspective. And I think that's encouraging because if you look back in certain areas of the country where maybe the pandemic wasn't as influential on consumer behavior, let's take maybe Florida or Texas when those states have been opened up really for the last year or so, those are some of our best performing areas of the country. So I think there's been a worry that, wow, once the -- once everything opens back up, consumers are going to change their spending behavior within home improvement. We are absolutely not seeing that at all in the markets that are opened up.

Okay. That's encouraging.

It is encouraging.

Yes. And as you mentioned, part of what drives your confidence is the backlog of the Pro customer, and that's now 21%, 22% of the business. And Lowe's has gone to lengths to improve its positioning with the Pros. So can you provide a sense of where the opportunities are now? And what's been the progress with what Lowe's has been able to do and what's still left to be done?

Yes. Listen, I think we've gone on a pretty big journey here with our Pro customers and how we've gone to market from a Pro perspective. I think we -- first order of business was to what I would say is improve and fix the service model. We added additional staff that side of the building. We bought into and leaned into job lot quantities to make sure we had the right -- the correct depth of product to support our Pro customers. As you know, we went on a fairly sizable investment journey to, I'll say, reconfigure the inside of the store to fix the adjacencies such that products that would normally be purchased together are merchandised together, so it's easy for that pro customer to get in and out. And so largely, I feel like we've elevated our service to pretty much world-class at this point in time. I think now we're on this journey of leaning into loyalty and to personalization. We just rolled out and launched a national Pro loyalty program that rewards our best Pro customers to the kind of buy more, save more and get rewards as they shop our outlet. And importantly, now creating a data repository that we can really glean insights into the behaviors of these customers and then ultimately drive actions that affect the behaviors of those customers to shop more across all the categories in our business. And so that's really the next piece of work to be done, and we're actually pretty excited about it. I think there's a comment, we talked about this before, coming from CVS, right, we always ran a big loyalty program, and I understood the power of knowing and having insights around your customers and how to use those insights to drive incremental revenue and profits. We're going to have that at Lowe's before long, and it's going to be impactful to us.

And what's been the initial response to the launch of the loyalty program?

It's been -- we're early days. In our test markets, we've seen pretty substantial improvements from a buying behavior in these pros, but it's early days. I think we're excited about it. We think there's a big path to run to improve our performance here. And I think the real excitement is the loyalty program is great, but I think the insights that we glean out of the data that we capture will overshadow over time, even the loyalty program.

And can you provide the market with the sense of how it's different and how it's positioned to capture incremental Pro share versus some of the competition that you have?

Yes. I think on -- just from a loyalty perspective, it's, again, designed to reward our best customers in the form of incentives as it relates to products or services or goods within our stores. I think it also provides a pretty big wraparound from a paint incentive program to lean into paint more aggressively. And then finally, we have kind of a world-class credit offering that allows our Pro customers to have what I would consider an open to buy, to lean again using credit to drive their purchases to support the projects that they have. But I -- again, I have to go back to I'm just excited about that's all interesting and nice and great. I do think if we can better understand that Pro customer, understand how we can influence behavior from a personalization standpoint, that will be an unlock for us.

And where is Lowe's in that capability now? Do you have CRM system that's in an early stage that will unlock some of that capability?

Yes. We -- the good news from a technology standpoint, we largely have the ecosystem built. What we don't have yet is enough data over time to really understand and analyze it. So I think that's the exciting part that's going to come for us.

And where can the penetration of the Pro customer be over time? In light of Lowe's serving the small- to medium-sized Pro, you don't have to give more than a decimal place, just a rough number.

Fair enough. Actually, we -- Marv and I were talking about this yesterday, and we haven't really set a target. But we currently are in the -- roughly the 22%, 23% penetration level. Clearly, we should be in excess of 30% penetrated in this business for sure. Maybe some upside to that.

And is it -- can you get there with just the small, medium Pro?

Absolutely. We can get there with that. Sure.

And should we expect continued penetration over time? Or is it going to move more in a lumpy manner?

No, I think you should -- nothing's ever completely linear, but I do expect over the next couple of years that the Pro business to somewhat outpace the DIY business. Therefore, penetration is going to grow in Pro.

And one of the key unlocks has been having the inventory and the products to serve this customer, which probably hasn't been easy in this time of supply chain disruption. How does the supply chain stand today? Where -- is it better than it's been? Is it getting better? And when do you expect to be back to normal?

Yes. I would -- I'm going to answer that kind of in 2 ways. First and foremost, as we look at the global supply chain, I don't know that it's consistently different now than it was 6 months ago, largely the same. I will say, if I look at our inventory within Lowe's and our position of inventory, we are better positioned now than we were a year ago. And particularly as we lean into spring, this is our biggest season. We were very planful, we took possession of inventory earlier than in prior years to make sure that we could derisk any potential delays in the supply chain. So with that, we now have a spring product kind of within our 4 walls, either in the stores and in our distribution centers. So we're nicely positioned as spring begins to break in the South and moves up to the Northeast here.

Okay. And just as a reminder, if you have any questions that you want us to lead into the conversation, please submit them. As part of the technology, Lowe's -- beyond just the pro consumer, Lowe's has implemented a lot of initiatives to improve the positioning and the consistency of the business over the last few years. Over the next 12 to 18 months, what's going to be the most impactful?

Well, we have several things underway. And maybe I'll hit on a couple of them. But first and foremost, within our stores, we're constantly upgrading our technology and enhancing our processes to improve productivity. I think a couple of big efforts we have underway is -- one, is we have a store inventory management system that's rolling out that's going to allow our associates much more ability and enhanced ability to understand where inventory is located in our stores and alleviate a lot of those tasking efforts associated with that. So a big unlock for us. Secondly, we have historically run some fairly legacy old green screen type technologies in our platform in the stores.

That's so old school.

It's old school. It is old school, stuff that you might know about.

That's right.

F9, back slash, all that stuff.

F9, that's it.

And we've recently kind of now modernized that technology. So I think that's a big unlock, both from a training perspective but also just from a throughput perspective. Third, we're embarking upon self-checkouts that we've created specifically for the home improvement market that I think, worked really well in our application. And think about that in the Pro desk. A Pro customer who shops us multiple times a week, they really enjoy self-checkout because they understand the system, they understand our outlets. So they want in and out quickly. And this is a way for us to improve productivity, but at the same time, actually enhance the service level of that Pro customer. So that's a big unlock. The second thing that I would say is that we're on this journey around the supply chain. And we're in the process of rolling out what we call a market delivery model which is essentially taking big and bulky products out of our stores, pushing them up into one higher node in the supply chain, call it a cross dock basically, that's going to serve 30 to 50 stores in a market, alleviating a ton of work in the stores and just making our delivery platform much more efficient. Over the -- and we're currently in 3 of our 15 markets, we probably have 18 to 24 months to get that fully rolled out. That will be the next turn of really productivity and unlock in our business over the next couple of years.

And just to put a little more flavor around that. That means before you have stored big appliances in the back of the house and were delivering those from the store now, they'll be in a central facility. And Kate rightfully pointed out that it's -- there's less breakage when you're moving those big and bulky items with a forklift rather than 2 strong men.

Absolutely. It's even -- it was a little bit worse than that to some degree.

Give it to us. The dirty laundry.

Well, what I mean by that is like every store, we had 1,700 stores trying to keep a complete assortment of appliances in their back room. And it's very difficult to do that and not be out of stock in some SKUs. So we are missing sales opportunities as well because we didn't have -- we weren't spreading that inventory across multiple outlets or multiple distribution points. So this is a real way for us to get both. We're going to improve our top line. We're going to improve the economics of the business and really improve our turns over time as we roll this out.

And is it fair to think this is a few hundred basis points type comp? And -- or is it -- how do you frame the potential?

Yes. We probably haven't gone through that in detail. But it's my expectations, we'll give some color on this as we get further into the rollout. And -- but I think the good news is we're seeing in our test markets improvements top line, improvements bottom line and improvements in turn and inventory management.

And is this a type of initiative where you will see the benefits to the P&L along the way? Or does it really come at the end when this is fully deployed?

No, you'll see it along the way. The challenge that we have a little bit is when you first introduce one of these markets, that you're at very low utilization and you start ramping utilization until you get up to -- and so in the beginning, you're kind of almost running 2 supply chains a little bit until you get fully up to 70%, 80% utilized in those spaces, then you start to see it flip and be positive to us. So there'll be some pressure, which is built into our expectations for '22 as we roll it out.

And there's a change management piece because some of the legacy behaviors has been to order the appliance to the store from then which you would deliver it to the customer. And that's not the intention of the product.

Yes, that's correct. I mean the good news about Lowe's is our associates are very passionate about customer service. And what we found out is when we first rolled this out, Lowe's associates wanted to touch and feel the appliance because they want to make sure that the customer is satisfied, we actually had the right model. Now we've -- and so now we've actually solidified the process in such a way that they're comfortable and understand that the service level is actually going to go up.

And your -- one of your big competitors is pursuing a slightly different supply chain model. Is this -- does this provide enough capacity and enough advancement to Lowe's to bridge the gap?

It does. I think what you're referring to here is that what we're doing -- as we do this, we're going to free up a significant amount of space in our backroom. And that backroom space can be used for various things. But one option that we have is to use it as a landing pad for same-day next-day pro fulfillment to the job site. And so instead of going out and having to build a direct fulfillment center to the job site, we actually already have assets in -- within our portfolio that now we can leverage. We can leverage differently. And so we feel like, at least at this point in time, we don't need to go deploy that kind of capital in our investment, in our environment to be able to satisfy that customer demand and customer need.

Lowe's is currently in the process of piloting a test with Petco, where it's going to be offering pet products to its customers. This has been tried in home improvement in the past with mixed results. What's going to make this partnership successful?

Yes, we have it in just a handful of stores testing it. But I think what's important and taking a step back, what we're trying to do is this is all about localization, making sure that we have the right products and assortment at the local level. And this part of our rural strategy to make sure that in areas where you have more of a ranching, farming community that we have the right product and assortment to meet the needs of that customer and where we have maybe the right to win. And so we probably have that kind of a format and play in about 50 stores today that we're testing with an opportunity to get to several hundred of our stores with this new assortment. And we're doing the same in urban locations, making sure that our urban set is appropriate for the communities in which we serve in those areas. So this is just a series of programs that we have to just get closer to the customer and closer to the community and support the needs that they have.

And this begs the question, if Lowe's is now on this localization journey, where is it? Is it first or second inning? More like...

It's probably first or second inning. I think we fixed the national, I would say, assortment, and we feel really good about that. Now I think it is really early innings to make this effective. And partly, this was really difficult to do with our legacy systems. So as we've modernized our back office and back platforms from a merchandising systems standpoint, this allows us to really tailor those programs effectively and manage them effectively.

And also, the systems investments have probably allowed Lowe's to further build out a home furnishings business that it had a relatively small size in the past. Where does home furnishings and other category adjacencies stand today versus where they can be in a few years?

A big opportunity. I think one thing that we realize and we probably underestimated it, we knew Lowe's had a gap in the Pro business, and we saw a line of sight to go after it, and we're aggressively working on it. And we feel like we've got nice momentum. But one thing that we realized is that we have a really strong and robust DIY business, particularly with the female consumer and particularly in the decor categories. And we have the right to win in those areas. And I think leaning into private brands and the right assortment, it can really be impactful for us to be able to continue to enhance our margin profile at Lowe's. We recently announced the acquisition of -- a small acquisition of STAINMASTER that's obviously in the carpet space. But think about that application in flooring or in pillows or what have you, to be able to really leverage the Lowe's platform with a strong brand to drive performance with enhanced margins. And so we currently have maybe private label in the 15%, 16% penetration level. We think it could be north of 20%.

It is that -- does that comes from STAINMASTER, that comes from home furnishings. Does it come from any other area?

Without a doubt. I mean I can tell you, across the core categories of home improvement, there are areas for us to lean into pretty completely in private label.

And this will be a margin driver? And you recently exhibited a lot of confidence with your margin outlook by taking up your gross margin forecast for this year to be up a little bit. What was driving that? And how are you thinking about in light of all this inflation, in light of consumer uncertainty, your gross margin?

Yes, what's interesting, Michael, is I think that private label opportunity is not as much '22 as it is '23 and '24 just because of the lead times associated with those products. But I think there's a real opportunity for that. That's the next driver of margin improvement for us. I think in the short term, what we've been able to do is really hone our cost management and pricing system and forecast, really making sure that we're tightening that down a bit. And I think that's -- and the strength in our Pro business has really given us the confidence to look at our gross margin progression for '22 and see that expanding in our line of sight to get that done.

And one of the drivers of Lowe's gross margin expansion last year was be more strategic with its approach to pricing and promotions. Is there still more room to benefit from that?

There is more room to benefit on the pricing side. I would say from a promotional cadence standpoint and our approach to promotions in the marketplace, we felt like we got there in '21. We're off the high-low cadence, we're now into more or less EDLP-type promotion -- EDLP-type platform, knowing that we need to be right in certain holidays and certain seasons, so we'll always shout a little value from that standpoint. But we feel like we're kind of -- that's now in the rearview mirror from us from a high-low perspective.

And you mentioned pricing could get a little bit...

Yes, I just think we've really elevated our gain from a pricing perspective. The next turn of the crank really is to get very micro at it, and just make sure that as we understand in a specific store, the competitive set around that specific store and the demand profile in those stores. And I think that's what we're trying to get to, and that's what we're working on later this year.

And if the world does become a more uncertain place, the consumer waivers, inflation becomes hotter, what are the prospects that home improvement becomes more promotional, whether it's you, your big competitor or other smaller places in the marketplace that are driving that?

I kind of think it's unlikely that it's going to get more promotional. And the reason for that is that either someone is going to invest in the home or not. It's a lot of times you can't incent some of that stuff. And I think the good news for us is because of the strength of the Pro business and the backlogs, is we feel like that demand is kind of -- I'm going to say it's completely locked in, but we have line of sight for that demand as we enter here into the spring season.

And one of the questions that constantly comes up with Lowe's is can it bridge the margin gap with its big competitor? What will it take to get there? And how close can those get?

Well, listen, we've been pretty clear is that we -- it's our expectation that we're going to substantially close the margin gap between us and our major competitor. And we're not going to close it the same way they did or get there the same way they've done. They operate more locations in dense urban markets, and those markets are typically more productive from a flow-through perspective per box. We're never going to change our platform for that. That's not going to happen. But back to my earlier point. We see big opportunities in private label and in the DIY consumer that we think we can lean in and really harvest over time. And so we'll -- we think those building blocks will help us substantially close that gap. And we're going to come back in December, we're going to have a big Investor Day in New York. So put it on your calendar.

Everyone better be there.

Everybody be there.

We'll have an opportunity to get back together.

Exactly. And we're going to walk through the component -- the actions that we're taking, the components to bridge that gap to go from where we end in '22 up to higher levels of margin performance after that.

And Dave, I think one of the constant debates, pushback on the investment case has been that Lowe's just in the past has not produced the consistency of the performance that maybe others in the industry have. Is Lowe's at a point where even as the macro is uncertain and there's questions out there that it can just produce more consistent results because of whether it's the systems, the culture, the execution, it's better today than it's ever been in the past?

I think it is. I don't have a perspective beyond back more than 3.5 years, but I know the culture is very focused on one, succeeding. One, we're very action-oriented with knowing that we have commitments to our associates, to our customers and to investors. And so we're very cautious and conscious of that and making sure that we can deliver on those commitments. And then finally, we've actually just built in through our processes and systems the ability to be a bit more agile and flex. As demand goes up and demand goes down, we can adjust our business model and our performance to deliver the right financial outcome.

And pivoting the conversation to capital allocation, Lowe's has been very aggressive with returning capital to shareholders. Is there more need to reinvest back in the business? You mentioned the supply chain, there's some technology investments. Is the company investing at the right level right now that's sustainable for the future?

Yes, we are. We are. The short answer to that is if you look back in time, the company prior to the new management team, which probably invested about $1.5 billion in CapEx annually, but at that same time, was investing in [ Australia ], in Orchard and in different various -- Mexico, various I guess, programs outside of the core. We've actually increased the CapEx to about $2 billion annually and dedicated essentially all of that capital to the core business. And so we've actually accelerated, if you will, the investment thesis that we have to make our business better. And we're not starving the business from capital. There's a certain pace and scope of the management bandwidth that we have. And I think we're maximizing that. And if we had a big investment that we saw, we make it, but we feel like we're adequately investing at this point.

And from an M&A standpoint, is there any big capability that's missing right now that would need to be acquired?

I wouldn't say anything big. We -- if you know, over the last couple of years, we've tucked in really small capabilities, whether it be technology or brands that are obviously really immaterial acquisitions. So yes, maybe in that space, there's nothing on the major acquisition space that's -- that we're looking at or we'll consider.

And last year, Lowe's bought back $13 billion of stock. Is that the right way to think about how to return capital from here? Would -- could there be a situation where Lowe's is a little bit more aggressive than that?

Yes. Listen, I think the good news is we bought back $13 billion worth of stock last year. At the same time, we actually delevered slightly from a balance sheet perspective. We're about 2x levered. My expectation is to get to 2.75x over 2 years and basically stepping that up pretty equally over the next couple of years. So that's going to unlock a significant amount of capital that we're going to deploy both in the business. But importantly, we're very focused on making sure that we're on this journey to enhance shareholder returns. And we think the best way to do that is, yes, let's invest in the business to make sure we can grow it strategically. We've set out a dividend target payout ratio of 35%. We're marching toward that. Any excess cash up to get that 2.75x, we feel strongly that the share repurchase and the allocation into share repurchase is the right way to reward our shareholders for the journey.

Lowe's has proven that it's got a great story, that it's executing well against its priorities. What are the biggest challenges ahead? What are the risks that the market should consider?

Yes. Listen, I think we -- this business is very fluid. I think what we've got to just make sure is that we keep our eye on the consumer. We keep our eye on our associates on the front line, who are kind of delivering day in and day out service to our customer. I think those are really critical that we do. Third is we've set up a whole program that we operate literally on a weekly basis. That is, I'll call it, a project management office for lack of a better term, where we're just dialing in on a weekly basis. We're looking at all the projects that we're rolling out, making sure that they're scoped correctly, they're staffed correctly. We've got key measures around them. And we're making sure that we're delivering on those investments. And I think that's -- I don't know if it's -- won't say it's a risk, but it's something that we're very focused against and making sure because the market is so dynamic and we're under -- we're doing so many projects that there's no balls that are dropped along the way.

Well, we're looking forward to seeing the continued progress.

Right. Thank you.

Please join me in thanking Dave Denton and the team from Lowe's for a great conversation.