Investment Thesis Highlights Macroeconomic Thesis

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1 Investment Thesis Concerns regarding the Home Improvement Industry have led us to evaluate LOW which is a current stock in the Washburn University Student Investment Fund. Even though LOW has maintained stable revenues over the past five years, Net Income, EBIT and EPS have all shown decreases since This is a large concern for the company s future profitability. Gross Profit margin has stayed stable over the past five years ( ), but Operating Profit Margin and Net Profit Margin have both decreased since OPM dropped from roughly 10% in 2007 to 7.5% in 2012 and Net Profit Margin dropped from roughly 6% in 2007 to 4% in This illustrates a ineffectiveness of fundamentals. Since 2009 the dividend yield has been relatively stable, but has not risen above 1.9%. Even though the dividend yield is stable, the level is lower than that desired yield for the Student Investment Fund. The Macroeconomic call the Applied Portfolio Management class developed calls for an economic slow-down which would decrease the value of this stock. This stock has reached a level that would allow for a profitable sale. Highlights LOW has been able to maintain a slow long term revenue growth rate of approximately 1.5%. LOW fiscal analysis stated that Operating Profit was expected to decrease.8% to.9%. The company estimates that.8% of that decrease would be related with store closing and discontinuation of products. LOW estimated that EPS would decrease to $1.37 from $1.40 for the fiscal year ended February 3, LOW also indicated that they estimate $.0.20 of the impact would be related to store closings and the discontinuing of products. LOW has declared a cash dividend since becoming a public company in Macroeconomic Thesis Consumer spending has been on a decline since 2009 and personal income has also seen a declining trend. LOW struggles under these conditions because most of their products are not considered necessities and are included under the consumer discretionary sector. An economy that is struggling to gain traction combined with the news of a weakening housing market portrays a glim future for LOW.

2 International Exposure LOW currently has 1712 stores in the United States and recently has begun to expand internationally. LOW has opened several stores in Canada and now has two in Mexico with plans to continue to increase international stores in the future. In 2009, LOW entered into a joint venture with Woolworth limited to development of chains of home improvement stores in Australia. These stores were set to open in late 2011 but not a single store has opened as of now. 1 Year Returns 6 Month Returns As shown on these four graphs above, LOW stock has been on an overall increasing trend. This upcoming trend can be accredited to a positive outlook on the housing market and reporting higher than expected profits due to a mild winter profit nationwide. However, the company analysis will support the theory that this increasing trend is not guaranteed to continue into the upcoming future.

3 Industry Presences Technological Improvements In 2010 LOW made the largest investment in stores technology in the company s history. This investment should lead to improvements in customer service, such as allowing for free Wi-Fi usage. LOW also made improvements to their website, which has led to a 70% increase in e- commerce sales in the past year. Market Share The home improvement/renovation industry generated approximately $300 billion dollars in In 2011 LOW generated 50.2 billion dollars in revenue which accounts for 16.7% of the total market share for this industry. LOW is second in market share to HD which generated 70.4 billion in sales in 2011 and has 23.4% of the market share. Low will see an opportunity to increase their market share in the future with Sears declaring bankruptcy. Sears competes with LOW in sales of appliances and hardware which account for 11% and 6% of LOW overall revenue. Revenue (in Profit Margin Dividend Yield ROIC billions) LOW % 1.9% 9.5% HD % 2.24% 14.4% Model Assumptions Our valuation of LOW was done using conservative numbers to assess the value of the company. Our discounted free cash flow model generated a current intrinsic value of $17.24, which indicates that LOW is currently over-valued. Income Statement Inputs Revenue Growth: Over the last five years LOW has experienced decreases in revenue in 2009 and 2010 of -.1% and -2.1%. This can be attributed to the recession of 2008 which led to a decrease in consumer spending because of a lack of discretionary income. These periods of negative revenue growth led to an average of 1.4% revenue growth over the last 5 years. LOW management forecast revenue growth between 2% and 3%

4 for the next year and slow long term growth in periods after. So to remain conservative in our forecasting assumptions we have chosen a long-term growth rate of 1.5%. Net Profit Margin: The NPM average over the past 5 years is 4.4%. Looking at the last three years percentages; we decreased the net margin to 3.8% which is the average from Year Net Profit Margin 3.8% 4.1% 3.7% 3.8% Share Growth: Recently LOW announced a plan to raise 2 billion dollars in the bond market to repurchase outstanding shares. The plan states that they will buy back shares annually through LOW had a common share growth rate of -9.3% in 2012 and we expect this level of buyback to remain stable for 2013 and then begin to taper down to a long term buyback rate of -.1%. Year Common Share -9.3% -8% -6% -4% -2% -.1% Growth Dividend Growth: LOW has declared a dividend since 1961 when they first became a publicly traded company. Over the past 5 years LOW has an average dividend growth rate of 24.1%. This is skewed from 2008 growth rate of 61.1%. Therefore we decreased the forecasted growth rates as follows. Year Dividend Growth 20% 15% 10% 5% 3% This allows for a margin of safety as well as tapering down to what we believe as the perpetual dividend growth.

5 Financial Analysis Return on Equity (ROE) and Return on Assets (ROA) Return on Assets decreased from 11% in 2007 to 5.5% in From 2010 to 2012, ROA has stabilized. ROE decreased from 20% in 2007 to 9% in 2010 and then began recovery in 2011 and These levels are low and have not shown signs of full recovery. Earnings Yield and Dividend Yield The earnings yield decreased from 7.9% in 2008 to less than 5% in EPS has not shown signs of recovering. The dividends yield is gradually increasing over the past six years; however, the dividend yield has not exceeded 1.9%. The dividend yield has not reached the desired level for the Washburn University Student Investment Fund. Value Creation Metrics Net Operating Profit After Tax and Free Cash Flow NOPAT shows a decrease from year 2008 to While free cash flow has high volatility with a decreasing trend over the past three years.

6 Economic Value Added and Market Value Added EVA and MVA have sharp decreases from 2007 to The Market seemed to over appreciate Lowes stock since the positive trend for MVA began a year before the positive EVA trend. The difference from the two variables has been consistently similar over the past three years showing the growing over evaluation. Value Spread: ROIC to WACC One of the major contributions to evaluating value creation is determining the ROIC to WACC Spread. Return on Invested Capital (ROIC) and ROIC to WACC spread. ROIC decreased from 15% in 2007 to about 7% in In 2011 and 2012 ROIC has stabilized to around 9.3%. With a WASS of 8.3, ROIC-WACC Spread is 1%. This spread is very small and does not contribute a great deal to the value creation process.

7 Weighted Average Cost of Capital (WACC) Assumptions A WACC of 8.3% was calculated using. Short term debt cost of 2.27% Long term growth rate of 2.0% Cost of Equity of 9.3% was calculated using: o Risk Free Rate of 2.27% o Market risk premium of 7.0% o Beta of 1.0 Other Analyst Recommendation These results were derived from the performance risk valuation investment theory which is provided by EVA Dimensions LLC. The PRVit Scores are used to further strengthen our understanding of the Lowes stock prices, versus their value potential. We conclude that this method also matches our finding that Lowes stock is significantly over valued.

8 When comparing LOW s stock versus the industry average we conclude the actual valuation is within the 80 th percentile. This indicates significant overvaluation. On the vertical axis the intrinsic value of LOW s stock is compared to the industry s average intrinsic value. LOW s stock is in the 54 th percentile showing it has average intrinsic value for the industry. After intersecting the values we can see it is below the line indicating a sell recommendation. Financial Stability Since 2009, LOW stock has become increasingly overvalued.

9 Looking at the Dividend Discount Model, the Intrinsic Value of the Dividends account for $12.15 of the $31.09 of the stock. This impact on the valuation will be shown on the recommendation summary of the report. If the stock was purchased today at $31.09 the expected return on the stock, based on the dividend stream alone, would be -14.8%. Recommendation Summary Due to LOW s over evaluation in all of our models, decreasing net income, EBIT and EPS we rate LOW as a SELL stock for the Student Investment Fund.

10 Over evaluation for the dividend discount model shows this stock is not performing above average in dividends and we can see this confirmed by noting the 1.7% dividend yield. The dividend yield has never increased above 1.9% since This is not ideal for the student investment fund. LOW is over evaluated for the present value of free cash flows model which concludes the expected income is less than what is needed to support the stock price. When LOW stock price is compared to earnings, free cash flow, sales and to book value it is consistently over-valued. The Macroeconomic call the Applied Portfolio Management class developed calls for an economic slow-down which would decrease the value of this stock.