Lowe's (LOW) a Top Pick at Morgan Stanley; PT Lifted to $87

Morgan Stanley analyst Simeon Gutman raised his price target on Overweight-rated Lowe's (NYSE: LOW) earlier to $87.00 (from $84.00), calling it the one of their top investment ideas.

"We think LOW offers a compelling mix of top-line and margin visibility in an increasingly choppy retail backdrop," Gutman said. We advocate sticking with playbooks that are working in this environment and continue to see positive earnings revision potential for LOW. We are raising our price target to $87, reflecting modestly higher 2H '16 EPS estimates on stronger flow through (30% vs. prior high 20% range)."

The analyst said there are three primary areas of investor focus during meetings with management last week:

1. Industry drivers solid. The home improvement retail industry is healthy as demand continues to recover from below average levels. Private fixed residential investment (PFRI) is 55 basis points below its 15 year average. LOW indicated that its higher ticket discretionary business is only halfway recovered from the prior peak. The US housing stock is aging (33 years) while affordability has never been better. We estimate there is a $12-15 billion sales opportunity as industry demand normalizes. This does not include any upside potential from Sears, which continues to cede market share (~13% of HI market).

2. Progress with the pro. LOW has a meaningful market share opportunity within the segment, especially on the pro side of the business. Though pro is just 30% of sales for LOW, it has recently driven a disproportionate amount of comp growth. Newly launched professional brands along with a pro only website and more targeted services are helping drive gains with the Pro. There was a step change in pro sales momentum in Q1, a clear signal that this strategy is resonating. Adding one more item to each Pro Basket (currently at $100) could boost comps by an incremental 200 bps.

3. Improving flow through. The margin side of the LOW story is intriguing as the business is able to convert sales into profits at a higher rate. Incremental margins are around 25% and we see a pathway for them to climb to 30%. There is heightened internal focus on reducing indirect costs such as store fixtures, telecom, and utilities. There is also a medium to longer-term cost focus as LOW looks to centralize various corporate and store level functions. We forecast stronger flow through as 2016 progresses both from these efforts and from expanding gross margin. Related to flow-through, LOW's omni-channel growth is not holding back margin expansion, an exception across retail. Tied to our omni-channel ROIC framework (Why Retailers Are Stuck in the Omni-Channel Maze), LOW is able to deliver positive store-only comp growth while simultaneously growing its online mix, which is driving stronger returns.

For an analyst ratings summary and ratings history on Lowe's click here. For more ratings news on Lowe's click here.

Shares of Lowe's closed at $80.01 yesterday.

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