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A change in financial policy at Lowe’s
admin | December 14, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Lowe’s management raises leverage target to fund $10 billion share buyback. Existing debt has widened to Home Depot but may weaken further when new issuance is announced.
Investor conference recap
Management at Lowe’s (LOW) held an investor conference this week where they reiterated recently revised full year guidance as well as provided initial guidance for fiscal 2019. For 2019, total sales are expected to increase 2% while same store sales are expected to be up 3%. In 2018, same store sales are expected to increase approximately 2.5%. Management is looking for the operating margin to grow roughly 235 – 250 bp in 2019. This growth will essentially offset the 240 -255 bp operating margin decline in 2018. Earnings per share will be in the $6.00-$6.10 range, up from the $5.08-$5.13 expected in 2018.
In a bit of an unexpected move, given the ongoing struggles to turnaround the business, management announced that it would be revising the leverage target from 2.25x to 2.75x. Additionally, LOW announced a new $10 billion share repurchase program which adds to the $4.5 billion balance of its previous program. We believe that LOW will use debt to fund its share buybacks and bring leverage closer to the new target level.
Moody’s and S&P Downgrade
Following the conference, Moody’s and S&P downgraded LOW to Baa1 and BBB+, respectively. Both agencies cited the less conservative financial policy, weaker credit metrics and reduced financial flexibility as reasons for the downgrade. As we noted earlier, this change in financial policy comes at a time when the company is investing in its turnaround program and is witnessing margin declines. On a LTM basis, LOW’s EBITDA margin of 11.2% is roughly 530bps lower than HD’s. LOW is expected to end the year with an EBITDA margin of 10.7%, relative to HD’s expectation of 16.4% for the year.
Relative Value
In our Outlook 2019 piece dated December 10, 2018, we had listed LOW 3.1% 5/3/27 bonds as a “pan” as we felt that LOW traded too close to Home Depot (HD) given that margins and profitability have suffered and that the turnaround could take longer than expected. Since the downgrades, LOW bonds have widened about 35 bp and now trade about 51 bp (g-spread) behind HD 3.9% 12/6/28. While we believe the trading differential should be closer to 40 bp (roughly 20 bp per ratings notch) we could see some further pressure on the name ahead of any debt issuance to fund shareholder rewards before spreads start to tighten. In looking at the new leverage target, the company could add roughly $4 billion of additional debt before hitting the target.
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