Lowe’s Companies, Inc. (Lowe’s or the Company, rated A (low) with a Stable trend by DBRS) is attempting a different retail strategy to stay competitive with other home improvement and hardware companies by closing 47 locations across North America. DBRS sees little impact from this on the retail market, on commercial mortgage-backed securities or on Lowe’s itself. This is because unlike traditional retail stores, Lowe’s and other big box home improvement stores have largely been immune to the rise of e-commerce and the “Amazon effect” since there is little product overlap between them, though the overlap continues to grow. Despite surviving the changes in retail that claimed other departments stores, the home improvement giant still faces stiff competition from competitors like The Home Depot (rated “A” with a Stable trend by DBRS).
The recent appointment of CEO Marvin Ellison brings a new strategy to the table. Lowe’s will be scaling back on square footage to save on costs while maximizing the profits of performing stores. Since the U.S. store closures are generally located within ten miles of another location, the Company should not lose much in the way of its customer reach. The approach in Canada is similar, since the Company has not made many restructuring changes since the 2016 RONA Inc. (Rona) acquisition other than some rebranding. In this commentary, DBRS looks at the overall retail markets of the locations being cut, reviews how Lowe’s compares with the competition and evaluates DBRS-rated assets to measure performance metrics.
The majority of the Lowe’s closures across the United States are concentrated in California, which has been continuously outperforming the national average for economic growth. Lowe’s announced four store closures within the state, which does not put a dent in the Company’s supply of 106 locations, as these closures cause only 3.8% of California supply to go offline. This trend does not exactly indicate whether or not Californians are less interested in home improvement, nor does it reflect general retail attitudes. The same holds true for the other states as listed in Exhibit 1. Because the number of closures only amounts to a small fraction of Lowe’s supply, the spate of closures is expected to have a negligible impact on the Company’s supply potential and may modestly improve revenue per square footage.
In Canada, the closures may have a greater impact, as they account for about 17.0% of the Company’s presence in Ontario and 15.0% of the store count in Québec. Other provinces can expect a similar percentage of stores to close. Lowe’s continues to digest its 2016 acquisition of the Rona home improvement chain. Through the acquisition, the Company expanded from 42 stores to over 500 and began rebranding many of the stores in 2017. As with many retail acquisitions, the closures may represent an opportunity to eliminate underperforming or redundant locations from Lowe’s portfolio so that it can focus on integrating the Company and growing its brand in Canada.
The retail markets experiencing Lowe’s closures across Canada have largely performed well. According to Colliers International’s National Retail Report Canada: Spring 2018 Edition report, Ontario was the highest-performing retail market with $216.32 billion in actual 2017 sales (a significant 37.0% of the total national retail sales). Québec is the second-largest market with $125.72 billion in 2016, or 21.0% of the total national sales in its given year. This means that the provinces experiencing the most number of closures are well performing and will be well poised to fill in the vacancies with other tenants due to implied strong retail property performances. Other well-performing provinces in 2017 include Alberta and British Columbia. According to the Colliers International report, Newfoundland and Labrador took a retail hit with -1.44% Q1 year-over-year retail sales growth in 2018. The east coast province is due to lose six Lowe’s locations. Above all, the Canadian retail market should have little trouble filling in its vacancies.
Leading up to the announcement, Lowe’s financials had increased steadily year-over-year and reported an annual EBITDA of $8.0 billion in 2018 (+9.6% five-year CAGR). While this growth is solid, sales growth at its largest competitor — The Home Depot — has been even more robust, with reported 2018 EBITDA of $16.5 billion in 2018 (+12.1% five-year CAGR). Strategically closing underperforming properties, doubling down on nearby locations and capitalizing on its e-commerce model may help Lowe’s begin to narrow the gap in financial performance metrics with industry bellwether The Home Depot. This tactic tends to be routine when leadership changes hands and finds room for improvement.
From a commercial real estate standpoint, it may be more difficult for big box locations in secondary and tertiary markets to backfill the vacancies that Lowe’s leaves behind. Although California’s economy has been relatively strong for the past several years, the stores Lowe’s is closing have underperformed. However, the stores are located in Orange County and the Bay Area, real estate markets that DBRS expects to remain stable, which may allow the spaces to be backfilled or redeveloped. The Company is closing stores in Manhattan and suburban Dallas, markets that DBRS considers to have better prospects. Other areas such as Flint, Michigan; Mankato, Minnesota; and Shippensburg, Pennsylvania, may struggle to find new tenants for their spaces.
DBRS identified 15 retail properties tenanted by Lowe’s in DBRS-rated transactions. On average, these Lowe’s tenants take up about 127,193 square feet (sf ) of the properties they are located at (or about 55.5% of the total square footage of the property). None of the stores in a DBRS-rated transaction are expected to close. With the Company’s renewed focus on its performing assets, it may be able to boost its existing sales at its remaining stores. Refer to Exhibit 5 in the Appendix for a complete rundown on Lowe’s properties in DBRS transactions sourced from Viewpoint.
Closing the gap between Lowe’s sales performance and The Home Depot’s will be a challenging task, but it starts with severing the weakest links while imposing a stronger sales strategy on the locations that are performing well. The majority of the shuttered stores are within ten miles of another Lowe’s location, leading to the cannibalization of both revenue and possibly internal resources. Lowe’s will also look to streamline logistics and gain operating efficiencies by closing three fulfillment facilities in Canada, as the retailer works to pare its product offering and skew it more toward its professional customer segment. Tailwinds in the housing market and general economic growth, as well as the nationwide renovation fever that many property flippers and homeowners have caught in recent years, factor into strong sales for home improvement stores. The new leadership at Lowe’s will aim at building a strong enough foundation to weather the storm in any economic downturn.
For a copy of the report, refer to the DBRS website or e-mail firstname.lastname@example.org.
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