Lowe's profit, sales surged in Q1

Yahoo Finance’s Alexis Christoforous and Brian Sozzi break down the latest earnings reports for Lowe’s, Home Depot, Target, and Walmart with Morgan Stanley Retail Analyst Simeon Gutman.

Video Transcript

BRIAN SOZZI: Lowe's shares are ripping higher this morning after the company posted huge beats on profit and sales last quarter. Simeon Gutman is a Retail Analyst at Morgan Stanley and joins us now on the phone fresh off the Lowe's conference call today. Simeon, I guess the-- the age-old question here, what's the better investment, Home-- Home Depot or Lowe's? Both of these companies put up some pretty big quarters.

SIMEON GUTMAN: Yep. Thanks, Brian. Look, we like them both. Home improvement is seeing a surge. On a relative value basis, Lowe's looks a little more attractive. It's traded at a multiple discount to Home Depot for a long time.

They have some work cut out in order to narrow it, and that's partly narrowing the margin gap between the two. And that's going to be driven by better comps over time. And that's what happened this quarter. They put up a stronger comp than Home Depot. We got a long path to see those multiples completely converge, but that's-- that's where the relative value sits.

ALEXIS CHRISTOFOROUS: You know, Simeon, Lowe's, as you know, has been trying to build out its e-commerce platform now. It wants to attract sort of those higher margin professional home builders and contractors, as opposed to sort of, you know, you and me, the sort of do-it-yourselfers. Did they talk at all about that segment of-- of the demographic and whether or not they're making inroads there?

SIMEON GUTMAN: Yeah, so two pieces. First, I'll talk about the online piece, and then I'll talk about the pro. First of all, the online business was up strong this quarter. That was up 80%.

Their website is not really ready for prime time yet. They will tell you the same thing. It's under-- under repair, their website, ready for prime time more in the back half of the year. The plus 80 shows that it was capable of handling some of the surge.

The big question, I think you mentioned the pro, and this has been a big call it advantage, I think, for Home Depot, much higher mix for them than Lowe's. Lowe's is somewhere in the 20-ish percent range. Home Depot, it's closer to 50%. It sounds like the pro is making progress.

They talked about the pro-business keeping pace with the do-it-yourself traffic in the quarter. They also talked about the surge they've seen in April and in May, the pro-business starting to pick up. Some of the changes they've made, job loss quantities, carrying the right assortment for the pro. And that seems to be having an impact. Look, it's not going to be overnight, where you get this business, but it seems to be making progress under-- under the new management's watch.

BRIAN SOZZI: Simeon, I'm already starting to think about the back half of the year for these retailers, back to school, the holiday shopping season, which is the main quarter for a lot of these-- lot of these retailers. How profitable will the holiday season be for a Walmart, a Target, a Home Depot, Lowe's? Don't they have to maintain some of these social distancing investments? But also, too, I don't know if I'm willing to be waiting outside of Home Depot in the snow for a Black Friday sale, or if they're even going to continue to make us do that.

SIMEON GUTMAN: Yep. And I don't know if I'll be there either. But let me divide it into two pieces. First, the sales component, and then the profitable-- profitability component. The sales component's tricky, right? We have this big surge at the moment. We're having this big shift towards home spending.

On top of that, we have stimulus. And then when does this-- if we start to break out of the economy or start opening a bit more, will we see the same level of home spending? In theory, we're going to be in recession.

I say in theory because we're technically in one now, but we're not seeing that through retail result. And so home improvement likely decelerates throughout the back half of the year. And consumer spending, for that matter, should as well. And you mentioned Walmart and Target, and those businesses are experiencing big surges at the moment as well.

Then the cost of doing business, and that has profoundly and fundamentally changed as we speak. And that's because there's just-- physical retail is going to cost more to operate, sanitation. Think about all the changes that stores are making for now. And then plus, people shopping at physical stores will probably be lighter than it was a year ago, just given social distancing.

And as we know, the mix of business that happens online tends to be less profitable. So profitability is definitely going to be weaker than it was the prior year. I think the market understands this. I think it's more about what happens in '21 as we march towards some type of normalization. But yeah, second half is going to be tricky from a top line and profit perspective.

BRIAN SOZZI: Simeon, are you modeling in some of these hourly wage increases? I put this question to Brian Cornell, CEO of Target, on a media call last night if they're going to make these wage increases permanent. To me, it sounds as if he wants to make them permanent. But how are you thinking about pricing them into your models and if it just becomes a cost of doing business?

SIMEON GUTMAN: Yeah, I would say it is cost of doing business. Target has been marching towards a $15 minimum wage by the end of this calendar or fiscal year, irrespective of what's happening in the background. It's going to be hard to see, you know, other parts of retail not match them over time. It depends on which part of the workforce, whether it's the store or the distribution center.

But yeah, I think cost of business is going higher. One of the temporary side effects is there's going to be more available labor over the next few months and quarters and possibly the next year, right, where we're expecting unemployment to be somewhere around 10% by the turn of the year. So in theory, you're going to have a more available labor force, which could create some deflationary pressure on wages.

But that said, if you have the retail leaders, Target, setting a wage at a $15 level, it's going to be hard for others not to match that at some point. So there will be a recovery in that. But yeah, cost of business going up. SG&A continues to creep higher. But you know, that's the importance of getting these share gains for some of these big companies.

ALEXIS CHRISTOFOROUS: Simeon, having said that, how strong is Lowe's balance sheet versus a Home Depot? I mean, I know that Lowe's is sitting on something like $6 billion in cash. They just had a $4 billion debt raise. How well positioned are they versus Home Depot when they come out the other side of this pandemic?

SIMEON GUTMAN: Yeah, they're well positioned. I would say Home Depot is slightly healthier. They carry a slightly lower amount of leverage on their balance sheet. Matter of principle, like Lowe's was-- was gearing to push leverage up a little bit to fund some stock buyback.

Something we learned this morning, today in the release, is that Lowe bought a lot of stock back in the first quarter, but has halted buyback for the rest of the year. But balance sheet is no issue. They did firm it up, as you mentioned, with the $4 billion raise. But relatively strong compared to the rest of retail. I would say Home Depot looks a little stronger, given that they have slightly low-- lower leverage though.

BRIAN SOZZI: All right, let's leave it there. Simeon Gutman, Morgan Stanley Retail Analyst, one of the best in the game. Appreciate you taking some time this morning.

SIMEON GUTMAN: Thanks for having me. Appreciate it.