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Morningstar | Focus on Lowe's Core Business Could Take Time to Win but Supports Brand Intangible Asset

Lowe's is the second-largest home-improvement retailer globally, with annual revenue of $69 billion. Its scale enables consolidated purchasing power, leading to a low-cost position, while an automated distribution network puts vendors, distribution centers, and stores on one platform, driving operational efficiency. The firm retains some of the cost savings and passes the rest on to its customers through everyday low prices. These competitive advantages support a wide economic moat.With Marvin Ellison recently taking the helm, a massive overhaul of Lowe's C-suite and board ensued, which we expect will stem structural changes. Our confidence that Lowe's can capture profit growth is rising, thanks to new efforts to institutionalize processes that were inefficient, including labor management, reset efforts, and inventory controls, all which could squeeze meaningful operating margin expansion out of the business if they are implemented properly. Furthermore, the wind-down of Orchard Supply brand, a potential sale of the Mexico business, and the shuttering of smaller incremental businesses should lead to better working-capital efficiency. We expect fresh financial goals from Lowe's in December, updating existing objectives including operating margins of 11.2% and returns on invested capital of 22% in 2019. The targets imply more than 200 basis points of operating margin expansion in 2019, a pace Lowe's couldn't even capture coming out of the housing recession. A relatively stable housing market, rising household formations, and consumer confidence will lead consumers to spend more in the home-improvement category, supporting sales growth and expense leverage. Furthermore, Lowe's still has opportunities in underserved domestic markets (city) and via broader professional penetration, particularly with the tie-up of Maintenance Supply Headquarters and Central Wholesalers. This drives our average sales forecast of 3% over the next five years, lower than Lowe's goal of 4%-plus growth. With ongoing initiatives pressuring near-term profitability, we forecast 2019 operating margin remaining below 10% and returns on invested capital reaching 21%.