No More Room for Improvement

11/24/2009 1:00 pm EST

Focus: STOCKS

Jocelynn Drake

Financial Analyst, Schaeffer's Investment Research

Jocellyn Drake of Schaeffer’s Investment Research says shares of home improvement retailer Lowe’s have underperformed, but investors still may be too optimistic.

[A recent article in Barrons.com]—"High Hopes for Lowe's" (November 16th—subscription required) on Lowe's Companies (NYSE: LOW) takes an optimistic look at the shares [of the] home improvement giant.

[Last week] the company posted third-quarter earnings that were largely in line with expectations, despite the fact that they were down 30% from the year-ago period. In addition, same-store sales retreated for the 13th consecutive quarter.

However, chief executive [officer] Robert Niblock said Lowe's is "beginning to see signs of improved performance in some of the hardest hit housing markets, including California, Florida, and areas of the desert Southwest."

Looking ahead, the retailer doesn't anticipate a repeat of last year's dismal holiday season, as management noted that discounting and promotion should not be as intense as 2008. Furthermore, LOW is seeing a slight up tick in interest in seasonal items, while it has ordered more modest inventory to avoid slashing prices on large amounts of merchandise.

Rochdale Securities analyst Jaison Blair notes that Lowe's "is poised to generate earnings per share beats and expense leverage as the cycle turns." Furthermore, Wall Street Strategies analyst Brian Sozzi anticipates year-over-year EPS appreciation of around 11% next year.

Technically speaking, the shares of LOW are massively underperforming the broad market. The stock has tacked on only 1.5% since the beginning of the year, while the Standard & Poor’s 500 index (SPX) has gained more than 22%.

Since reaching a February 2007 peak, the security has ground lower under its ten- and 20-month moving averages. The equity is now consolidating under resistance in the $22-$23 region. (It closed at around $22 Monday—Editor.)

Meanwhile, we're beginning to see signs of optimism among speculators. The International Securities Exchange (ISE) has seen an increase in call trading. During the past [few] trading sessions, more than three calls have been purchased to open for every one put purchased to open.

This ratio of calls to puts is higher than two-thirds of the readings taken during the past year. An unwinding of this optimism in the face of the stock's lackluster performance could increase the selling pressure on the shares.

In addition, we find that Wall Street is smitten with the shares. According to Zacks Investment Research, 15 of the 19 analysts following LOW rate it a Buy or better. Any downgrades from this group could spell trouble for the shares.

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