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

Good afternoon, everyone. Thank you. It's my pleasure to introduce the management for Lowe's. Today, we have with us Marvin Ellison, Chairman, President and Chief Executive Officer. Marvin was appointed in his current role in 2018 and has more than 30 years of leadership and operational experience in the retail and home improvement industry. I am going to turn the podium over to Marvin for some prepared comments. We're doing this one a little bit differently as my questions are going to be non-deal-related topics. And with that, I will turn it over to Marvin.

Good afternoon. Thank you, Kate. So I look forward to speaking with Kate here in a moment about our quarterly earnings results and the trends that's impacting our industry. But before we begin the Q&A, I'd like to take a few minutes to provide some context to the recent announcement we made last month on the acquisition of Foundation Building Materials or FBM. So FBM is a leading distributor of interior building products specializing in drywall, metal framing, ceiling systems, insulation and commercial doors and hardware. FBM serves a diverse large pro customer base with approximately 45% residential mix, which spans single-family and multifamily construction and 55% commercial mix, which is split fairly evenly between new construction and repair and remodel applications. We've been engaged with FBM's leadership team since the beginning of the year, and we've been consistently impressed by their deep industry expertise and a track record for profitable growth. Founder and CEO, Ruben Mendoza, leads a very talented leadership team with over 200 combined years of industry experience and with an average tenure of over a decade with FBM. Their national footprint of over 370 branches complements Lowe's store base, especially in urban areas of California, the Northeast and the Midwest, where we have less of a physical store presence. FBM also has a strong track record of both organic and inorganic growth as they've successfully integrated more than 60 acquisitions onto a single ERP system, oftentimes within 60 to 90 days. This single ERP made FBM a more attractive acquisition target versus the industry peers. Having a single ERP also makes FBM more than just a collection of roll-ups, which you traditionally see in this space. And post closing, we'll bring FBM and ADG under the same umbrella to create a differentiated offering to serve the large pro within this $250 billion total addressable market. This unlocks new opportunity for Lowe's as we don't serve this customer segment in a meaningful way today. And FBM also brings capabilities that Lowe's doesn't have, things like a fleet of over 1,200 boom trucks, 1,100 trailers, 900 flatbed trucks and over 400 tractors. These assets provide us with advanced capabilities for job site fulfillment and also the ability to serve large complex orders. We'll also gain access to digital tools like the MyFBM app, which offers real-time pricing, ordering and delivery tracking for these complex orders in both English and Spanish. FBM also gives us something that we desire, and that is a strong trade credit program, which is often key to serving the large Pro customer orders. We're also excited about the cross-selling opportunities for this combined organization. Lowe's customers will gain access to FBM's core assortment and fulfillment capabilities through our new Pro extended aisle system available at the Pro Desk in our stores. And FBM's customers will benefit from access to Lowe's' complementary products like tools, safety equipment fasteners that drive greater attachment. With an estimated 18 million new homes needed by 2033, we also see a unique opportunity for both FBM and ADG to work together to develop a comprehensive interior solutions platform for homebuilders, providing them with everything from drywall to ceiling systems to insulation to doors as well as flooring, cabinets and countertops. Overall, these two acquisitions accelerate the evolution of our total home strategy and strengthens our ability to serve the Pro customer, small, medium and large. We believe this will enhance our scale, expand our capabilities and support faster, more sustainable top line growth while also delivering long-term shareholder value. So thank you for your time. And Kate, I now look forward to taking your questions.

Thank you. So thanks so much for joining us today. I think there's a lot of conversation happening about what exactly is going on in home improvement today. I think we saw better results out of both you and your competitor in the second quarter than was expected. And I think everyone is trying to figure out what do we attribute that to and how sustainable is it?

I think for us, we've been focused for 7 years on what we call retail fundamentals. And that's a very basic way of outlining key things that we believe every retailer must do well to have sustainable growth. And quite candidly, 7 years ago, we were not doing any of them very well. We had a great balance sheet, wonderful energetic frontline employees that we call associates, but we had a strategy that was not designed for a modern retailer in an omni-channel world where brick-and-mortar and digital has to connect. So we made a lot of investments. And we believe what we saw in the second quarter is a combination of a couple of things. Number one, as you saw throughout the quarter, our comps improved from negative comps in May to positive comps in June to a 4.7% positive comp in the month of July. So we had a really strong exit rate coming out of the second quarter. That was attributed to, in some cases, a seasonal shift from earlier in the quarter to late in the quarter to much improved seasonal weather, but also we had category performance across areas like paint and flooring and strength in appliances and seasonal categories. So it was a combination of a lot of things coming together, including seasonal shifts in weather, but also core categories performing well. So we're cautiously optimistic that the consumer, specifically our homeowner consumer is a healthy consumer and that they're willing to spend, especially when they can get a value. But we're also cautiously optimistic that hopefully, we're going to see some trends beginning to shift in a more sustainable way, but it's just too early to call that. I think you probably heard pretty consistently today that the back half of this year will be more focused on managing tariff cost-related challenges that we're all going to face. We're preparing for that. We're tracking it daily. We're very aware of the elasticity of our consumer and of our product categories, but we have to wait and see how the back half consumer responds to this tariff environment before we can have a definitive point of view that we've hit an inflection point or there's light at the end of the tunnel or whatever analogy you'd like to use. But we feel great about our business. And overall, we feel great about the health of the consumer, which happens to be a homeowner that really serves us on a day-to-day basis.

You've talked about mortgage rates of 5.5% to 6.5% likely being the sweet spot of when maybe housing turnover could start to improve. Do you still view this as the right level?

Kate, it's a difficult question to answer. What we believe is that if we can get to a sub 6% mortgage rate, we think psychologically, that may be a bit of an unlock for a lot of our consumers. I mean, today, roughly 90% of our customers either have their houses paid for or they have a mortgage rate of less than 4%. So these customers are in what we call a lock-in effect, where they've generated a lot of equity. I think the data tells us have roughly $33 trillion in equity available in the current marketplace. So we're at almost record equity. Our consumer has low unemployment, wage growth, but they still have a bit of concern about the macro and the mortgage rate environment is forcing them to just stay put the weight it out. And the question that you're asking is the right question that is what level of mortgage rate will unlock this lock-in. And we believe that it's probably sub-6%, but we just have to wait and see. Now the good news is even if the consumer remains locked in and they're unwilling to venture out into this higher mortgage rate environment, at some point, they're going to have to make a decision on their existing home. And what our Pro customers tell us in the surveys that we provide on a quarterly basis is that customers are not canceling projects, they're postponing them. They're just waiting to see if the mortgage rate environment improves. They're waiting to see if there's going to be another economic shooter fall, so to speak, in the marketplace. But at some point, they're going to have to make a decision on what they do with the existing home, whether they remodel the kitchen, whether they do a room expansion, whether they add a garage. And so we are perfectly positioned for either scenario. If the mortgage rate environment opens up and customers decide to go out, our acquisition of ADG and FBM puts us in a position where we can take advantage of that $250 billion total addressable market. If they decide to stay put in their existing homes and just invest in an upgrade or an enhancement, then we're perfectly positioned with the investments we've made in the last 5 years to take advantage of that as well.

If we can just move on to tariffs and pricing. You've noted that you're taking a portfolio approach to price. Can you maybe talk a little bit about how you've managed through this environment, what you've had to do on the assortment side, how well you've mitigated the additional costs and what the consumer can expect to see?

Yes. Really for us, it's three things. It's about our global sourcing footprint. It's about our negotiation with our suppliers and about, to your point, how do we balance out our assortment. And so let me just take a step back and kind of level set on where we are from a global sourcing perspective. So today, roughly 60% of our goods are sourced from the U.S. Roughly 20% are sourced from China, 10% from Mexico and then the remaining 10% in areas of Southeast Asia, India and Canada and around the globe. And these percents represent direct and indirect. In other words, they represent private brands where we are the direct sourcer of the product of record and also indirect where they have national supplier that may be manufacturing and sourcing product around the globe. These percents are dramatically different than they were 7 years ago when I arrived. We have a much greater percent of products being sourced in the U.S. and a lower percent in areas of China. So we've been working really hard to just continue to lessen our dependency on one country of origin, and we made a lot of progress in that regard, working with our suppliers to find just the right locations for us to just have minimal risk relative to being oversaturated in one area. And so along with that, we've been working with our suppliers to share in the cost increases that the tariff environment has brought to bear. And we've had really good partnerships and understanding that we have to try to find win-win scenarios for each. And now we've had to just take a look at our portfolio and making sure that we understand the price elasticity of our consumers. And as you know, pricing in retail is dramatically different than it was even 5 years ago. Today, it's highly sophisticated with built-in algorithms designed on internal financial targets, competitive scraping and also the understanding of price elasticity around all your merchandising categories and also the customer segments that you're serving. And so when you factor all these things together, you create a dynamic environment where, in some cases, prices go up, in some cases, prices go down. It's a very dynamic portfolio. But the one thing that we've been committed to is offering the customer value because we think in this environment, customers still respond to a value, and that's been proven throughout the year but also to remain competitive. I mean we're not going to put ourselves in a position where we're going to lose market share in this environment because we're going to be priced inappropriately relative to the competition or inappropriately relative to consumer demand. And as you can appreciate, we're literally tracking this on a daily basis. We're tracking units, and we're tracking overall performance geographically by Customer segment, and it's something that we're going to continue to manage. We've created really strong systems and analytics that gives us the ability to be agile and dynamic. So we're not locked into a specific point of view as much as we are locked into trying to serve the customers as best we can.

If we can maybe switch over to the balance sheet and capital allocation. I think it's a question that we are getting a little bit more often is if you are shifting your capital allocation strategy?

I would say it's not necessarily a shift as much as it is -- it's an ongoing transformation relative to the needs of the customer and how we believe we can deliver shareholder value. What we've always said is we're going to invest in the business. We're going to offer and continue to increase our dividend, and we're going to have a share repurchase strategy. And so the investments we've made in the last two acquisitions, in our view, is directly tied to continued investments in the business. And we think that, that's going to benefit our shareholders long term. And I'll give you thoughts on that in a second. We're going to continue to raise our dividend on an annual basis, which we're committed to. And we're going to reenter the share repurchase arena once we're able to continue to pay down debt and get back to our leverage ratio of 2.75x, which we're committed to. As we ask the question, how do we create more value for our shareholders, do we continue to buy back shares at the rate that we've been buying back shares for the last 5 years? Or do we look at ways to more aggressively invest in the business. We believe strongly that the investments that we're making in ADG and FBM, the two most recent acquisitions, will provide greater shareholder return because it gives us the ability to have more consistent and sustainable growth. We did a very simple analysis. We asked the question when the housing market recovers, what segments of our business will benefit from that recovery. And I'll just remind you of the data point I shared that you have -- you're going to have 18 million new homes needed by 2033. And the one thing that we quickly determined is that we could identify growth segments throughout our business and areas that we've made investments over the last 5 years. But the one area that was an incredible void was single-family home construction and multifamily because when you have this 18 million home deficit that has to be addressed in this country, it's going to come from single-family and multifamily construction. And we had no meaningful strategy to gain any financial benefit from that. So in other words, our concern was you're going to have this inflection that's going to happen in housing, and we're going to be on the outside looking in. And so the question was, how do we create a strategy and create a segment of our business that will give us the ability to benefit from this recovery that we believe is going to happen just based on supply and demand and the acquisition of ADG and FBM does that because we're going to design an interior solutions platform where we can go into a large homebuilder. Think about the large builders out there that we currently do business with ADG, Pulte, Lennar, D.R. Horton as examples. And we'll be able to have a broad portfolio of things that we can offer under one umbrella. Flooring, cabinets and countertops, insulation, ceiling systems, door hardware, appliances, and that can all happen under one umbrella, which takes a lot of complexity away from the project for the homebuilder, and it also gives us the ability to leverage internal capabilities and capabilities of ADG and FBM while making us now a significant player in a $250 billion total addressable market. So it's just -- it's not a change as much as it is a ratio in how we're spending relative to investing in the business and pausing share repurchases for a period of time, which we have every intention once we get to our leverage ratio to enter back into the share repurchase arena.

That's helpful. Thank you. I wanted to make sure we asked about marketplace because that is something new to the business model. And I think you're approaching it a little bit differently. It sounds very exciting in terms of the product expansion that we can see as a result of it. So could you maybe walk us through where you are in the process of developing this new muscle, if you will, and what you think it will do for the overall Lowe's enterprise?

Yes. So Kate, one of the things that we did a real simple analysis. We looked around the globe and asked a question. If you look at brick-and-mortar retailers that have had the most robust growth in e-com and commerce, what are some traits that we need to identify. And the one common trait we found was the existence of a product marketplace. And so for us, we made the decision really to be the first -- to start the first product marketplace for home improvement in the U.S. And it started with, number one, identifying the talent required to do this from individuals that have had history and experience doing this in other places. So we recruited a very talented team. They have to put the system in place. And so this Mirakl's operating system is a system widely regarded as a universal system across the marketplace environment. The reason why that's important is because if you're a successful seller in a marketplace, you just want a plug-and-play process where you have a system that you're already accustom to using and the ability for us to partner with Mirakl and to get the system up and going quickly was important. As a matter of fact, they awarded us recently a recognition of having the fastest launch on their platform of any customer that they've ever done business with. And that's just indicative of the level of talent we brought to this team. So our objective is to have what we call a closed marketplace. So it's not open to any seller who wants to come in. We want to make sure that we protect our brand, and we have a very thoughtful approach to how we're approaching this. Having said that, we're really excited about the early results that we're seeing. We're really excited about the percent of new customers that we're seeing shopping online that never shopped us before because we have a broader assortment of products based on what the early stages of the marketplace has brought us. And again, I would say, Kate, we're in the really early innings. I'd say probably in inning #1 or #2 in a 9 inning contest. But we have bold aspirations. We have people who have been there done it before, and we are really excited about what we're seeing and the early results are exceeding expectations across the Board, and we're going to continue to build.

And because you're only maybe in inning 1 or 2, it might be too early to ask about this, but the plans for integrating the marketplace with the Lowe's physical stores and using those existing fulfillment capabilities, how -- when does that come along?