Lowe's: Drought Conditions

The retailer sees sales growth drying up in the current quarter. Is it gloomy consumers -- or just a lack of rain?

Lowe's (LOW) tried to lower Wall Street's expectations this week as the entire retail sector watches for signs that consumer spending may be slowing.

Sales at Lowe's are below previous estimates, a trend that should push earnings this year to the "low end or slightly below" prior guidance of $1.97 to $2.01 per year, the retailer said. Also, as chief financial officer Robert Hull Jr. said in a statement, "The current pressures will likely continue into 2008," lowering estimates for 2008 earnings growth to the "mid-single digit[s]." Faster growth should follow in 2009 and 2010.

The news came from Lowe's just as another big retailer, Target (TGT), warned it expects September same-store sales grow in a range of 1.5% to 2.5%, compared to the 4 to 6% growth expected. The news was alarming because Target has consistently turned in strong growth. The report "suggests a tidal change in consumer spending may have occurred, especially since much of the shortfall is attributed to a drop in customer traffic," wrote Bernard Sosnick of Oppenheimer (OPY). Target shares were off fell 4.59% to $61.35.

Expectations for Lowe's sales were already much lower than for retailers like Target. The decline in the housing market has taken a big bite out of the home improvement chain's sales. When same-store sales fell 2.6% in the second quarter, investors were actually impressed, sending the stock higher last month.

The big debate among analysts Tuesday was whether the Lowe's results were indeed a sign of a reluctant American consumer or merely an effect of bad weather. Lowe's blamed its weak sales on drought conditions in the mid-Atlantic, the Southeast and the West. The bad weather hurt outdoor categories like lawn, garden and nursery departments.

Many analysts, especially those who believe Lowe's stock is undervalued, acknowledged broader problems in housing or consumer spending, but said they believed bad weather was the main culprit. UBS (UBS) analyst Brian Nagel saw the news as a "buying opportunity" as shares dipped. The new, lower numbers can even be taken as a positive sign. "It signals that management is now more realistic with respect to the current environment," he wrote.

Lowe's shares fell $2.04, or 6.68%, to $28.51 per share.

One problem is that no one is at all confident where retail spending is going at the moment.

"Our sense is that the company is being very cautious in an environment where they have little visibility into future trends," Bear Stearns (BSC) analyst Christopher Horvers wrote. Sales seem to be volatile from weak to week, "indicative of the overall strain that the consumer is under."

Shares of both Lowe's and Home Depot (HD), its archrival, are off about 20% from their 52-week highs. At least so far, however, Lowe's seems to have done a better job containing the damage from housing's decline. Home Depot same-store sales fell 5.2% last quarter, double Lowe's drop.

That's one reason many analysts remain positive on Lowe's long-term growth.

Lowe's "continues to show significant pace of innovation (merchandising, systems, training), running too fast for [Home Depot] to catch up anytime soon," wrote David Schick of Stifel Nicolaus. (Stifel seeks business from Lowe's.)

Another hope for retailers and especially the home improvement chains is the recent cut by the Federal Reserve in interest rates. Cycles when the Fed is easing rates tend to be good times for these stocks, analysts say. UBS's Nagel says "most of the outperformance in Lowe's shares has occurred during periods of Fed easing."

Lower rates often stimulate demand for housing by allowing borrowers to afford higher prices. One problem this cycle, however, is no one knows how far home prices still have to fall before they hit bottom. On Tuesday, new data showed U.S. existing home sales dropping 4.3% in August.

(Lowe's is a UBS client, and a member of its research team owns Lowe's shares.)

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