Downturn makes upscale harder sell at Lowe’s

Like every company in the home improvement business, Lowe’s is weathering a tough stretch that started last year and promises to extend at least through the summer. Lowe’s ceo Robert Niblock touched on this at the company’s annual meeting on May 25, as he outlined the challenges that saddled Lowe’s with a 5.3% drop in same-stores sales in the fourth quarter last year.

“We faced higher fuel costs, deflation in lumber prices, difficult year-over-year sales comparisons and a significant slowdown in housing turnover,” said Niblock. And that slowdown continued this May when existing home sales fell for the third straight month to their lowest level in four years.

But despite the challenges of a slow housing market that’s not expected to rebound soon, Lowe’s is forging ahead with ambitious growth plans that call for opening up to 160 stores in 2007, after opening 155 in 2006. And the retailer is coming off a year in which it posted an 8.5% increase in sales of $46.9 billion and a 12.5% increase in earnings of $3.1 billion.

Niblock doesn’t expect the housing market to improve much in 2007 but the company is still projecting a 7% increase in overall sales this year, driven mainly by new store openings that will push Lowe’s store count close to the 1,500 mark by the end of the year. It’s an ambitious agenda, given the state of the industry, and one predicated on a simple fact Niblock shared with shareholders in May when he said, “Consumers can and will continue to spend on needed repairs and maintenance of their homes.”

But, Lowe’s is also keeping its expectations reasonable for 2007 after receiving sobering first-quarter results. Lowe’s reported a 12% decline in net earnings of $739 million for the quarter and a sharp 6.3% decline in same-store sales, with total sales for the quarter inching up 2.1%. Lowe’s cited bad weather during the first two weeks of April as a key reason for slower sales as well as a slight downturn in appliance sales, which is typically a strong area for Lowe’s.

In fact, the appliance category was one of only three in which Lowe’s reported a downturn in market share in the first quarter. It cited a move by consumers toward more energy-efficient appliances (which carry higher price tags), heavy promotions by its competitors and bad weather as reasons for the slowdown.

But the trend in appliance sales is also being driven by something that typically happens in a slow economy: a migration towards products with lower prices and away from high-end appliances from suppliers like Frigidaire, Bosch and Whirlpool that Lowe’s thrives on. At a Sanford Bernstein investor’s conference in June, Lowe’s president and coo Larry Stone acknowledged that its average basket has been down for three consecutive quarters, saying the trend requires a short-term change in strategy.

“We’re seeing sales migrate toward opening and mid-range price points on most products,” said Stone. “So we may have to adjust our advertising and promotional activity this year away from the premium end toward the products that customers are looking for today.”

Aside from its problems with appliances, though, Lowe’s was relatively happy with the early returns from 2007. It produced $12.2 billion in total first-quarter sales and said its market share increased in 17 of its 20 product areas. And it continued to sign new deals that give it exclusive access to premium brands including the recent addition of an exclusive Martha Stewart line of paints in stores.

In a May report, Deustche Bank analyst Michael Baker shared Lowe’s fairly optimistic outlook, describing its first-quarter performance as “good in a tough environment” while predicting that “weakness in bigger ticket items is likely to persist.”

Looking beyond 2007, Lowe’s expects to continue to expand at its current pace—though it has yet to confirm earlier reports that it will open about 150 stores in 2008—but it may have to shift its strategy as it approaches store saturation in the United States. Stone estimates the U.S. market can currently support up to 2,000-plus stores, a count that Lowe’s would hit within five years at its current rate of expansion.

That growth cap, however, is subject to change as Lowe’s continues to evolve. Like Home Depot, the retailer has experimented with smaller store formats to reach rural markets. “We [are] looking into developing more flexible store formats to facilitate growth in the future,” said Stone. But he added that the company isn’t likely to open any stores smaller than 94,000 square feet.

And, for the first time, Lowe’s is looking beyond the United States for expansion opportunities. It plans to open its first store in Canada this summer and is looking to expand into Mexico in 2009 (see story).

But for the time being, Lowe’s is going to stick to the basics as it waits out a slow housing market that may not heat up again until 2008. “If we stay focused on our customers, take care of our employees and maintain our excellent standards in stores, we’re going to do well,” said Stone.