Transformation of Lowe’s Companies Faces More Hurdles

Submitted by Investing Daily as part of our contributors program.

On July 18, Investing Daily’s Jim Fink wrote that the U.S. housing market may finally be in recovery mode. He based his view on a number of recent positive developments, including gains in housing starts, single-family home construction and homebuilder confidence.

Certainly, the situation remains fragile, but since Jim’s article there have been other encouraging signs. On Friday, for example, the U.S. government reported that home-building permits had risen to a level not seen since August 2008, pointing to the potential for stronger future growth.

An increase in housing-market optimism is one reason why Home Depot (NYSE: HD) stock has been on a roll this year, rising 34%. As Fink notes, homebuilders, too, have been gaining, with Lennar (NYSE: LEN), a leader in this space, skyrocketing 60%.

But not every home-related name has benefited. Case in point: Lowe’s Companies (NYSE: LOW), the nation’s second-biggest hardware retailer, which just posted its second consecutive quarter of disappointing earnings and a second straight cut to its profit forecast. As a result, the company’s shares have barely budged so far in 2012, rising just under 3%.

Latest Results Bring More Bad News for Lowe’s Companies

In the quarter ended August 3, 2012, Lowe’s profits slumped 10.0% from a year ago, to 747 million from $830 million. Earnings per share were flat at $0.64 on fewer shares outstanding. (The company bought back and canceled $1.0 billion of its stock in the quarter.)

Sales fell 2.0%, to $14.2 billion from $14.5 billion. Gross margins also declined, and sales at stores open at least a year dropped by 0.4%. The company’s 2012 fiscal year had one less week than fiscal 2011; that chopped its latest profits by $0.03 a share.

The latest earnings from Lowe’s Companies were well short of the Street’s expectation of $0.70 a share in profits on $14.44 billion of sales.

In light of the weak quarter, the company now expects to earn about $1.64 a share in its 2012 fiscal year, which ends January 31, 2012. That’s sharply from its previous prediction of $1.73 to $1.83 and well below the consensus forecast of $1.80.

“I think the real key here to keep in mind is that this reflects Lowe’s issues and not some type of weakening in home improvement demand, because I think home improvement demand is actually picking up quite nicely,” said Brian Nagel, a senior equity research analyst at Oppenheimer, in a CNBC.com article.

Lowe’s Companies Is in the Same Boat as J.C. Penney

Part of the reason for the lower results from Lowe’s Companies is that the company is shifting to an everyday low prices strategy and away from its current approach of having sales on certain products.

The thinking here is that shoppers will come into the stores on a more regular basis instead of holding out for bargains. The problem? The strategy denies the company a key marketing tool, and training customers to adapt to the new model is a huge challenge.

That’s what J.C. Penney (NYSE: JCP), under former Apple (NasdaqGS: AAPL) marketing head Ron Johnson, is finding as it attempts the same switch from the 590 discount sales it held last year. Like Lowe’s, Penney posted more disappointing results in Q2, which prompted Forbes to speculate on how long Johnson, who was just appointed in November 2011, can hang on to the CEO job.

Lowe’s situation isn’t that bad, but it is dragging on longer than the company expected. It had said that it would take until the end of 2012 for the strategy to start paying off, but it now feels this will take until the middle of 2013.

“We knew it would take time to see the full benefits of our actions,” Lowe’s chairman, president and CEO Bob Niblock said in a Bloomberg Businessweek article. “The team is making progress on these initiatives, but frankly, the benefits are accruing at a slower rate than I had expected.”

Quebec Adventure Is Turning Into a Fiasco for Lowe’s

While attempting this delicate transformation, the company has gotten tangled up in a potential takeover in Canada that appears to have little chance of succeeding.

On July 31, Montreal, Quebec-based home-improvement chain Rona (TSX: RON) said that Lowe’s had approached it with a $1.76 billion (Canadian), or $14.50-a-share, takeover offer. Rona rejected the bid, saying it undervalued the company. Lowe’s has 800 outlets across Canada, with over 300 of these stores and roughly half of its 30,000 employees in the French-speaking province of Quebec.

Just a few days later, Quebec’s governing Liberal Party weighed in, saying it had concerns about the hardware retailer falling into foreign hands. “As one of the biggest distributors and retailers in Canada, I think [Rona] represents an important strategic interest,” said the province’s finance minister, Raymond Bachand.

Quebec on its own doesn’t have the power to disallow a takeover—that’s a lever held by the Canadian federal government—but Bachand suggested that the province, through its investment arm, could purchase Rona stock and attempt to block the deal.

Poor Timing Could Kill Lowe’s Takeover of Rona

Investors, for their part, can be forgiven for wondering what makes a hardware store chain an important national asset.

Part of the answer is that Lowe’s launched its bid just as the provincial government was about to call an election, and defending a Quebec company from a foreign takeover is a good way for politicians to curry favor with voters. Now, with the campaign underway and a vote set for September 4, the governing Liberals are trailing the more nationalist Parti Quebecois, which has also spoken out against the deal.

All of this adds up to yet another headache for Lowe’s, which looks like it’s now starting to get a sense of the obstacles its bid faces: “First and foremost, an acquisition is not imminent,” Niblock said in the post-earnings conference call.

This article was originally posted here.