When it comes to steady dividend growth, dividend kings, 22 companies that have raised payouts for 50+ consecutive years, are standouts that generally mark a great place to start shopping for long-term income investments.

However, a problem that many dividend growth investors have is that most dividend kings are very slow growing companies with equally slow rising payouts.

Lowe’s Companies (LOW) is an exception with not only an impressive record of 54 straight years of increasing payouts, but also one of this group’s fastest dividend growth rates, 17.6% per year over the last three decades.

Better yet, Lowe’s appears to be well-positioned to continue growing strongly in the coming years, which would result in healthy total returns from this dividend king.

While Lowe’s yield isn’t great enough to consider the company in our best high dividend stocks list here, learn if Lowe’s might be a reasonable core holding for a long-term dividend growth portfolio, especially at today’s valuation.

Business Overview
Founded in 1946 in North Wilkesboro, North Carolina, Lowe’s is America’s second largest home improvement retailer, behind Home Depot (HD). It operates 2,365 stores in the US, Canada, and Mexico.

The company’s stores are famous for being a one-stop shop for both do-it-yourself (DIY) customers, as well as professional contractors, generally offering more than 35,000 products, including both well known national and exclusive brands.

Source: Lowe’s Investor Presentation

Business Analysis
The key to Lowe’s steady growth has been its strong long-term focus on strong customer service, which combined with its extensive base of conveniently located stores, economies of scale, brand recognition, and massive distribution channels creates a wide moat in an otherwise highly commoditized retail sector.

Smaller competitors are unable to match the broad assortment of inventory and in-store product presentations that Lowe’s can afford. They also have much less bargaining power with suppliers, making their products less price-competitive. Consumers have few reasons not to head to Lowe’s or Home Depot for their home improvement needs.

Lowe’s has also been improving its competitive positioning by investing more in technology and product presentation. Through the use of technology and helpful in-store displays and service, customers have even fewer reasons to try out competitors’ stores.

Combined with a relatively Amazon (AMZN) proof niche, Lowe’s has been able to avoid the kind of disruption that many traditional retailers are facing.

And thanks to the company’s aggressive investments into its online omni-channel sales platform (nearly half of company-wide capital expenditures going forward), this will likely continue being the case going forward.

Lowe’s largely Amazon-proof nature can be seen in the company’s impressive sales, earnings, and free cash flow (FCF) growth over the years.

Source: Simply Safe Dividends

Of course, that doesn’t mean that Lowe’s business isn’t cyclical, since home improvements generally track closely with the economy and thus resulted in flat or negative growth during the financial crisis.

However, the good news is that the economic recovery since the Great Recession has, though slow, been highly consistent and shows no signs of ending anytime soon.

And with the US housing market now having mostly recovered from its 2008-2009 collapse, this has resulted in steady sales improvements that have allowed management to focus on its long-term growth plans, which include steadily increasing economies of scale and rising margins and returns on shareholder capital.

Further good news is that, despite steadily improving profitability over the years, Lowe’s has a long way to go before its margins and returns on capital match its industry peers, especially Home Depot.

Sources: Morningstar, Gurufocus

In other words, management believes that it has plenty of room to grow its profitability going forward. In fact over the next three years Lowe’s hopes to grow its operating margin by nearly 30%, thanks to increased emphasis on automation in its distribution centers, as well as other cost reduction initiatives.

Part of that plan involves further growth to achieve maximum economies of scale through a gradual increase in US store count, more aggressive expansion into Canada and Mexico, and further improvements to its brand portfolio.

For example, in 2016 the company spent $2.4 billion to acquire RONA, Canada’s largest home improvement chain, with 539 national stores and $4.6 billion in annual revenue.

In addition, Lowe’s has recently been investing heavily into the maintenance, repair and operation (MRO) market so it can better serve professional contractors.

That involved purchasing Central Wholesalers in 2016 and more recently Maintenance Supply Headquarters for $512 million. This last purchase added 14 distribution centers and $400 million in annual revenue and is expected to be immediately accretive to EPS and FCF per share.

And these are just two of many MRO-focused acquisitions that Lowe’s has done over the years.

The reason that Lowe’s is pushing so aggressively into the MRO segment is because more Americans than ever have been renting instead of buying homes since the financial crisis.

This is because new tighter banking standards mean that home buyers generally need to save up for a 20% down payment, which is getting harder to do with home prices now rising to near their 2006 highs.

This has led to rental prices outpacing inflation (which has averaged about 1.5% annually) for many years. That’s largely because over 9 million new renters have entered the market since the financial crisis, overwhelming the existing supply of multi-family units.

The bottom line being that going forward, Lowe’s wants to diversify its business and take advantage of the strong boom in new apartments (600,000 under construction right now) which requires a larger presence in the professional contractor market.

Another benefit of greater exposure to the MRO industry is that contractors generally buy larger orders, which has helped Lowe’s to steadily improve its sales per square foot.

Management believes the company’s most recent acquisitions will help continue this positive trend, resulting in steady same-store sales growth of 3% to 3.5% a year and overall top line revenue growth of 4% through 2019.

Combined with its margin expansion plans and some of Wall Street’s most aggressive share buybacks (5.4% a year through 2019), Lowe’s believes it can achieve 15% annual EPS growth in the coming years. And thanks to management’s 35% dividend payout ratio target, this should result in very impressive 15% to 20% annual dividend growth.

Key Risks
Lowe’s ability to hit its top and bottom line growth targets is largely tied to the health of the overall economy, and specifically the construction industry.

Unfortunately, in recent years construction costs have been rising faster than inflation, resulting in recent new residential and apartment construction starts slowing considerably.

And with the Federal Reserve planning on increasing interest rates by 2% through the end of 2019, higher mortgage rates are likely to only add to the headwinds facing the construction industry.

That could mean that Lowe’s short to medium-term growth prospects will have to be shouldered by retail customers and thus driven more by rising consumer spending.

Unfortunately, given that wages haven’t been growing nearly as fast as economists would expect this late into the economic recovery (Federal Reserve’s long-term wage growth target is 3.5% compared to trailing 12 month actual wage growth of 2.5%), this means that consumer spending over the next few years could be weaker than in the recent past.

In addition, we can’t forget that Lowe’s is betting a lot of its future sales and margin growth on its many recent acquisitions. However, anytime a company acquires another there is substantial integration and execution risk. This includes the threat of both overpaying and failing to achieve the expected synergistic cost savings.

Which means that the company may fall short of management’s impressive growth targets, which rely on substantial improvements in its margins and returns on capital.

Finally, Amazon needs to be mentioned when discussing almost any brick-and-mortar retailer.

Home Depot and Lowe’s both recently sold off on news that Amazon was acquiring Sears’ Kenmore appliance line, for example.

Fortunately, Lowe’s seems resistant to Amazon’s model today because many of its products are for unique home projects.

Physically going into the store to review paint colors, cabinets, flooring options, and more is critical to getting the project right.

While some product categories are vulnerable to online competition, most are not, and Lowe’s is not resting on its laurels (remember its substantial allocation of capex to e-commerce?).

Overall, it’s hard to pinpoint a major risk that could disrupt the company’s long-term earnings power. The home improvement retail industry is slow-changing, and Lowe’s benefits from economies of scale, strong brand recognition, quality merchandise selection, and decent store locations. It’s hard to see the company being disrupted for many years to come.

Lowe’s Dividend Safety
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

Lowe’s has a Dividend Safety Score of 85, indicating it has a highly secure and dependable dividend. That’s not surprising given that Lowe’s has been raising its payout every year since 1963.

There are several keys to Lowe’s safe and steadily growing dividend.

First, management has wisely been highly conservative in how fast it grows the dividend, making sure to maintain low to moderate EPS and FCF payout ratios. In fact, management’s target EPS payout of 35% is much lower than Home Depot’s policy of paying out 55% of earnings in the form of dividends.

And given that Home Depot’s dividend is also highly secure (Dividend Safety Score of 87), this shows you just how much extra safety cushion Lowe’s shareholder enjoy.

Specifically, this means that the dividend is extremely well covered by earnings and cash flow, providing a nice safety buffer in case an unexpected economic or industry downturn results in a short-term decrease in growth and profitability.

The other big safety factor protecting Lowe’s dividend is the fact that, despite taking on a lot of debt in recent years to finance acquisitions and a faster pace of buybacks, Lowe’s continues to have a strong balance sheet.

You may not think so, given the large amount of absolute debt, but it’s important to remember this is a highly capital intensive industry and so what matters is relative debt metrics.

And when we compare Lowe’s debt metrics against its peers, we can see that, while its debt burden is higher than most, especially Home Depot’s, its cash flow is still very easily covering its debt obligations.

Similarly, the current ratio (short-term assets/short-term liabilities) is above one, and combined with management’s stated stated long-term goal of a leverage ratio (Debt/EBITDA) of 2.25 or lower, the company continues to have a very strong investment-grade credit rating.

Sources: Morningstar, Fast Graphs

The bottom line being that Lowe’s strong cash flow and continued access to very low cost debt mean that the company can continue investing in future growth while still rewarding long-term dividend investors with both a highly secure dividend and the kind of impressive payout growth they have come to expect.

Lowe’s Dividend Growth
Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

Lowe’s Dividend Growth Score of 95 indicates that dividend investors can expect much stronger than average payout growth in the coming years. This isn’t surprising given that Lowe’s has one of the most impressive long-term payout growth records of any company in America, especially among its fellow dividend kings.

You can see that Lowe’s dividend has grown by more than 20% annually over each time period measured during the past two decades.

Of course such impressive growth rates can’t go on forever. However, if management can successfully execute on its margin expansion plans, than the company’s 15% EPS and FCF per share growth should allow it to achieve its short-term goal of 15% to 20% annual dividend growth through 2019.

More importantly, the company’s low payout ratio, combined with Lowe’s getting close to US market saturation (its US store count nearly matches that of Home Depot, which is no longer expanding its store count), means that in the future it will likely spend less on new store openings.

That would allow it to potentially raise its payout ratio and continue growing the dividend at a double-digit clip for many years to come.

Valuation
Over the past year Lowe’s has underperformed the S&P 500 by about 20%, making it one of the more interesting dividend kings to review today.

LOW’s forward P/E ratio of 16.6 is now lower than the S&P 500’s 17.8, for example. More importantly its forward P/E is well below both the industry median of 20.3, as well as its historical norm of 19.3.

Meanwhile, its dividend yield of 2.2% is both greater than the market’s 1.9% payout, as well as slightly higher than the industry median of 2.1%. Keep in mind that over the past 13 years, Lowe’s median yield has been 1.5% as well.

Given the company’s reasonable valuation multiples relative to history and continued outlook for double-digit earnings growth, Lowe’s could be worth a closer look today for long-term dividend growth investors.

Conclusion
When it comes to low risk and steady dividend growers, certain dividend kings can be appealing choices.

While Lowe’s somewhat low yield means it may not be for everyone, such as retirees looking to live off dividends, Lowe’s does boast the fastest dividend growth record of the dividend king group.

And when combined with a highly secure payout and strong long-term dividend growth prospects, Lowe’s seems like a reasonable holding for a diversified dividend growth portfolio.

Brian Bollinger
Simply Safe Dividends

Simply Safe Dividends provides a monthly newsletter and a comprehensive, easy-to-use suite of online research tools to help dividend investors increase current income, make better investment decisions, and avoid risk. Whether you are looking to find safe dividend stocks for retirement, track your dividend portfolio’s income, or receive guidance on potential stocks to buy, Simply Safe Dividends has you covered. Our service is rooted in integrity and filled with objective analysis. We are your one-stop shop for safe dividend investing. Brian Bollinger, CPA, runs Simply Safe Dividends and previously worked as an equity research analyst at a multibillion-dollar investment firm. Check us out today, with your free 10-day trial (no credit card required).

Source: Simply Safe Dividends