Lowe's Cos. Rating Lowered To 'BBB+' On Less Conservative Financial Policy; Outlook Stable

  • Home improvement retailer Lowe's revised its leverage target to 2.75x from 2.25x. We see the company reaching its new leverage target over the next year as it issues debt to fund share buybacks, resulting in weaker credit metrics.
  • S&P Global Ratings lowered its issuer credit rating on Lowe's to 'BBB+' from 'A-'. We affirmed our 'A-2' short-term rating.
  • The stable outlook reflects our expectation that Lowe's approach to leverage will be consistent with its new leverage targets, while modestly growing earnings and cash flows in the next one to two years.
NEW YORK (S&P Global Ratings) Dec. 12, 2018—S&P Global Ratings today took the 
rating actions listed above.  The downgrade reflects our expectation for 
higher leverage as the company adopts a less conservative financial policy to 
increase shareholder returns. Lowe's has a relatively new executive management 
team, including a recently hired CEO and chief financial officer, but we 
expect the shift in financial policy won't limit the ability to fund and 
execute new operational strategies. The new management team has substantial 
retail experience and includes executives with prior employment at Home Depot. 
We forecast debt to EBITDA increasing to the high 2x area over the next year 
(about 2.3x currently) as the company uses proceeds from debt issuance along 
with excess cash flows to repurchase shares.    

The stable outlook on Lowe's reflects our view that after issuing debt to fund 
share repurchases, the company will maintain leverage in the high-2x area. We 
expect positive sales trends to continue and good cash flow generation over 
the next two years. Favorable trends in the repair and remodeling sector and 
good business execution including store and supply chain investments are 
factors underpinning our growth expectations.  

We could lower the rating if we expect leverage to be sustained at 3x or 
higher. This could occur if Lowe's adopts a more aggressive financial policy 
and capital allocation plans such that debt increases more than we anticipate 
without offsetting profit growth. A downgrade could also occur if Lowe's 
performance weakens materially from store execution issues that lead to flat 
to negative same-store sales or EBITDA margins declining by about 150 basis 
points with no offsetting reduction in debt.  

We view an upgrade as unlikely over the next two years because of Lowe's new 
financial policy. Still, a higher rating would be predicated on the company's 
commitment to a more conservative financial policy such that we would expect 
leverage to remain below 2.5x and for performance, including same-store sales 
and profit margins, to remain good.   

North Carolina-based Lowe's is the second-largest home improvement retailer 
worldwide, based on annual revenues of nearly $71 billion (as of Nov. 2, 
2018). The company currently operates 2,133 home improvement and hardware 
stores in the U.S., Canada, and Mexico. 

  • We believe modest economic momentum will drive spending at home improvement retailers. We forecast U.S. GDP growth of 2.3% in 2019 slowing to 1.8% in 2020, unemployment rate below 4%, rising wages, and aging housing stock support decent growth in repair and remodeling activities.
  • Comparable same-store sales between 3%-4% over the next two years as Lowe's benefits from industry tailwinds and operating initiatives;
  • Adjusted EBITDA margins improving about 75 basis points to the high-12% area over the next two years from in-stock execution at stores, merchandise resets, and supply chain efficiencies;
  • Robust free operating cash flows of over $5 billion annually after operating cash flows of about $7 billion each year and capital spending for technology investments and store initiatives; and
  • Additional debt issuances between $3 billion-$5 billion in 2019 primarily to fund incremental share repurchases and upcoming maturities.
Based on these assumptions, we now expect debt to EBITDA to increase to about 
2.7x over the next year, from about 2.3x currently. Our forecast leverage 
metrics are more in line with the 'BBB+' rating and do not afford much room 
for more aggressive shareholder remuneration. We think if the economy slows, 
Lowe's has some flexibility to manage its capital allocation plans by pulling 
back on debt-funded share repurchases to offset profit declines and from its 
high real estate ownership.  

We revised our liquidity assessment on Lowe's to strong (from adequate) to 
reflect the company's significant cash flow generation driven by profitability 
and good working capital management. We expect cash sources to exceed cash 
uses by around 1.5x over the next 12 months and to remain over 1x thereafter. 
The company has high standing in the credit markets and a solid relationship 
with its banks as illustrated by its history of bond issuances and debt 
refinancing at attractive rates.

Principal liquidity sources:
  • Cash and short-term investments of about $1.7 billion as of Nov. 2, 2018;
  • Borrowing availability under the company's revolving credit facility expiring in September 2023, which backstops the commercial paper program; and
  • Our projected cash flow from operations of around $7 billion annually.
Principal liquidity uses:
  • Manageable debt maturities over the next two years;
  • Peak-to-trough seasonal working capital needs;
  • Capital spending averaging about $1.5 billion annually;
  • Annual dividends between $1.5 billion and $1.6 billion over the next two years; and
  • Significant share repurchases that can be reduced in a stressed environment.
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