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Can Lowe’s Expand Its Fiscal 2Q16 Operating Margin?

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Gross margin expectations

Lowe’s Companies’ (LOW) gross margin dipped by 43 basis points to 35% in fiscal 1Q16. The decrease in the fiscal 1Q16 gross margin was due to the negative mix impact of low-margin products, planned promotions, and markdowns related to the reset activity.

Analysts expect Lowe’s gross margin in fiscal 2Q16 to come in at 34.4%, compared to a gross margin of 34.5% in fiscal 2Q15. In the 1Q16 conference call, Robert Niblock, Lowe’s chief executive officer, expressed concerns over the impact of low-margin products on margins for fiscal 2Q16 and the rest of the year. However, he was also optimistic about sales growth in fiscal 2Q16.

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Higher operating margin

Lowe’s operating margin increased by 170 basis points to 10.4%. The increase in the fiscal 1Q16 operating margin was due to a decrease in SG&A (selling, general, and administrative) expenses as a percentage of sales by 188 basis points. This reduction in SG&A expenses as a percentage of sales was primarily driven by 105 basis points of expense leverage due to a non-cash gain on a foreign currency option contract associated with the RONA acquisition. The fiscal 1Q16 operating margin also benefited from lower employee insurance costs due to a favorable claims experience.

Peer comparison

In 1Q16, Lowe’s peers reported the following operating margins:

  • Bed Bath & Beyond’s (BBBY) operating margin was 7.8%, a dip of 220 basis points compared to 1Q15 due to flat sales and higher SG&A expenses.
  • Williams-Sonoma’s (WSM) 1Q16 operating margin was 5.8%, a dip of 120 basis points from 1Q15 due to a nonrecurring restructuring charge of $13 million.
  • Home Depot’s (HD) 1Q16 operating margin increased by 109 basis points to 13.5% due to expense leverage on higher same-store sales and efficient cost control.

The SPDR S&P Homebuilders ETF (XHB) invests a total of 17.5% of its holdings in Lowe’s, Home Depot, Bed Bath & Beyond, and Williams-Sonoma.

Margin expectations

Analysts expect Lowe’s to deliver an operating margin of 12% in fiscal 2Q16, compared to 11.4% in fiscal 2Q15. Based on the guidance issued in May 2016, Lowe’s expects its fiscal 2016 operating margin to increase by 80–90 basis points. It should be noted that Lowe’s operating margin guidance excludes the impact of an impairment charge related to the company’s Australian joint venture, which negatively impacted the previous year’s margin. This guidance also excludes the impact of the 1Q16 unrealized gain on the foreign currency option contract related to the RONA acquisition.

For more updates on this sector, visit our Consumer Discretionary page.

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