Lowe’s Builds Up Leverage to Buy Back Shares: Corporate Finance
Lowe’s Cos. (LOW) is raising $2 billion in the bond market to finance stock repurchases as the second- biggest U.S. home-improvement retailer boosts leverage to reward shareholders even as its profitability wanes.
Lowe’s sold five-, 10- and 30-year debt yesterday, five months after the company that sells products from flowers to washing machines issued $1 billion of notes. The retailer may use proceeds to buy back shares, according to a regulatory filing. Lowe’s plans to increase its leverage to as much as 2.25 times from 1.8 times, Robert Hull, Lowe’s chief financial officer, told an earnings conference call in November.
That should raise concern among bondholders that the Mooresville, North Carolina-based retailer will add to a $9.2 billion debt load when earnings rise, according to Brookfield Investment Management Inc. The company plans to repurchase $4.5 billion of stock annually until 2015 even after same-store sales were little changed last year and margins narrowed.
“Lowe’s is willfully increasing its leverage in order to return more cash to shareholders,” Carol Levenson of Chicago- based Gimme Credit wrote in a report yesterday. “Subdued home improvement spending and a still cautious consumer do not exactly scream ‘Hey it’s okay to take on more debt’ to us.”
‘Turns Me Off’
Lowe’s sale yesterday was its biggest on record and accounts for the remainder of the $3 billion of debt that Hull said the company would take on by the end of this year as it boosts its ratio of lease-adjusted debt to earnings before interest, taxes, depreciation, amortization, share-based payments and rent. The company sold $1 billion of notes two days after he spoke on the November conference call.
“When a company turns toward financial engineering, it kind of turns me off,” said Joel Levington, managing director at Brookfield in New York, which manages about $25 billion. “Any bondholder has to be somewhat skeptical of the company given that they’ve changed their financial policies,” he said in a telephone interview.
Credit-default swaps linked to Lowe’s debt jumped 9 basis points yesterday to 71 basis points, the highest level since Feb. 22. The contracts, which pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, traded as high as 107 basis points last year.
Swaps for Home Depot Inc., Lowe’s larger competitor, rose 2 basis points to 47 basis points. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Confidence among U.S. homebuilders fell in April to a three-month low, a sign the industry is still trying to gain its footing as the country recovers from the worst financial crisis since the Great Depression, the National Association of Home Builders/Wells Fargo index of builder confidence showed yesterday.
Proceeds from the Lowe’s issue may be used for general corporate purposes including capital spending and acquisitions as well as share buybacks, according to the regulatory filing. The company said in December it expected to repurchase almost $18 billion in stock between 2012 and 2015, provided there aren’t other uses for its cash.
The home-improvement retailer issued $500 million of 1.625 percent, five-year notes that yield 80 basis points more than similar-maturity Treasuries, $750 million of 3.12 percent, 10- year debt at a spread of 115 basis points and $750 million of 4.65 percent, 30-year securities at 155 basis points, Bloomberg data show.
Lowe’s shares fell 0.2 percent to $31.98 at 10:54 a.m. in New York. The stock has gained 26 percent this year to the most expensive price relative to earnings in almost two years, Bloomberg data show.
The company last raised its target for maximum leverage to 1.8 times from 1.5 times so-called Ebitdar in 2010 after earlier lifting its target of 1.4 times in 2009, according to transcripts of conference calls.
“This transaction is consistent with our previously announced leverage target,” said Julie Yenichek, a spokeswoman for the company.
Moody’s Investors Service downgraded the company’s debt two levels in November to A3 after the leverage increase was announced in the conference call with analysts and investors, signaling a more aggressive financial policy that favored shareholders, according to Maggie Taylor, a senior credit officer at Moody’s. The company could be downgraded again if leverage using her firm’s measures exceeds 2.75 times earnings or if earnings to interest expense falls below 6.5 percent, she wrote in a Nov. 14 report.
“What happened today confirms the reason we downgraded Lowe’s,” Taylor, based in New York, said in a telephone interview. “Clearly their financial policy has gotten a bit more aggressive.”
Lowe’s posted a ratio of Ebitda to interest expense of 9.13 in its fiscal 2012 fourth quarter, Bloomberg data show. That’s down from 11.09 in the similar period a year earlier.
“Certainly as leverage increases, the chances of them being downgraded also go up,” Alexander Diaz-Matos, an analyst at Covenant Review LLC in New York, said in a telephone interview.
Standard & Poor’s yesterday rated the new debt A-, equivalent to the Moody’s grade, with a “negative” outlook.
Sales by Lowe’s stores open at least a year were flat in 2011, trailing Home Depot’s gain of 3.4 percent. Its net income margin dropped to 3.66 percent, from 4.12 percent in fiscal 2011, Bloomberg data show.
Lowe’s may lag behind its competitor in sales growth again this year, according to Peter Keith, a Piper Jaffray Cos. analyst in New York.
In an online survey of 440 homeowners, Piper Jaffray found that four in 10 plan to spend more on improvements this year over 2011. Twelve percent are reluctant to spend because of declining home prices, a lower percentage than Keith said he had expected, which may be a sign of “pent up demand getting released,” he wrote in an April 16 note.
“There is no question that we are behind in certain areas,” William Doug Robinson, Lowe’s senior vice president in charge of international operations and customer support services, told the Raymond James Institutional Investors Conference on March 6. Lowe’s hasn’t distinguished itself from Home Depot, which attracts shoppers because it has more locations, he said.
Lowe’s also plans raise its dividends as earnings increase to maintain a one-third payout ratio, Robinson told the Raymond James conference. It last increased its quarterly payment to 14 cents a share on May 27 for its Aug. 3 dividend, and it will boost the rate to 16 cents for the corresponding period of this year on May 21, according to Bloomberg Dividend Projections.
“It is often the case that a retailer decides to ramp up its share repurchases using additional debt to finance this at precisely the worst time for increasing leverage,” Levenson wrote in an e-mail. “With Lowe’s we don’t know where this intentional leveraging might end.”