Lowe's Is Becoming Enticing

This past holiday weekend I was talking to my four-year olds and they said that they wanted to get another bird feeder for the house. I asked them where they wanted to go and they both said "Lowe's" (LOW).

Hmmmmm. "What about going to Home Depot (HD)?," I asked. They replied that they did not want to go to Home Depot, they wanted to go to Lowe's. "Why?", I asked. "There is more light and people help us in Lowe's," they replied. Now, if a four year old feels this way, I am going to guess millions of other folks out there do also.

This comes off news that Lowe's recently increased its market share in 17 of 19 business categories last quarter. It also announced that it is increasing its dividend 60% and, here is a big one, adding $3 billion to their share buyback program. Last quarter Lowe's repurchased $650 million of shares and could buy more. This is a company that produces over $2.1 billion from operations each quarter, and after all its capital expenditures, share repurchases, debt reduction, still had a cool $250 million left to add to its piggy bank.

The new buyback announcement means it has a total of $3.8 billion worth of stock it is authorized to repurchase. At today's prices, that will take about 119 million shares of the 1.5 billion total or over 7% of off the market. That is a significant amount. The real beauty of this is that is can easily be done over the next year and a half with very little impact on operations or by adding any additional debt.

The dividend. At its new level, Lowe's will yield about 1%. This is poor when you compare it to the over 2% yield from Home Depot. Lowe's will spend about $450 million over the next 12 months on dividends (depending on the rate of the share buyback) at the new rate and while significantly higher than the $87 million it doled out in 2004, more is needed.

Now, the buyback will help and let's look at why. Let's assume for a minute that Lowe's does not increase the dividend and keeps it at its 20 cent annual level. Currently that means they will return $300 million to shareholders at the current 1.5 billion shares outstanding. After the buyback, there will be about 1.38 billion. This means that all thing being equal, Lowe's would only need to spend $276 million to keep the dividend at its current rate.

It also means that at the new rate (32 cent a share), it will be spending $441 million vs the $480 million it would have spent without the share buyback. So buybacks help both we shareholders, by allowing more of a company's profits to be available to us (higher EPS) and allow the company to increase the dividend without a direct dollar for dollar impact. A win-win.

The only thing stopping me from buying share now is the anemic dividend. In a rather mature industry, I would like to see more of a commitment to shareholders here. Lowe's is kind of a "tweener" in this respect. It is not really a growth company anymore and it does not yield much for potential investors. But, were shares to get hit and dive under $30, they would be very tempting for me. Very tempting . . .

LOW 1-yr chart:

Comments

[Josh Stern]

I had the very same thoughts about a year ago, but I didn't buy LOW because I was worried about housing. I was sort of right then about the fundamentals, but wrong about the net effect on the stock (it's up). Now I'm still worried about housing where meaningful price declines (as opposed to slowing growth) are just starting. There's potentially a triple whammy effect on LOW: 1) homeowners feel less wealthy, 2) homeowners estimate lower ROI for each home improvement dollar spent, and 3) the people fixing up homes to flip and sell them are out of the market now.

[John Scott]

I refer you to the June 4th (current) issue of Barron's. The first letter in Barron's Mailbag does a good job of explaining why share buybacks are preferable to dividends for individual (as opposed to institutional) investors. I took a position in LOW this spring and will add to it when the 5 new stores in Canada open this fall.

[Frank Li]

On share buybacks versus dividends, the best argument against dividends versus buybacks that I've seen is here:

Why Dividend Paying Stocks Are a Mistake