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Lowe's Home Improvement Feels Economic Sting

Lowe's Cos., the nation's second-largest home improvement retailer, said Monday that it will buy back almost $5 billion of its common stock.

The AP reports: "While the repurchase program has no expiration date, the Mooresville, N.C., company said it plans to use the full amount over the next two to three years."

This signals that the retail giant, like many others, has been wrestling with the infecundity of the current U.S. economy. Normally, a company only buys back its common stock to reduce the amount of outstanding stock on the open market (including insiders' holdings).

Stock repurchases are often used as a tax-efficient method to hold onto existing assets rather than being obliged to pay dividends. Sometimes, as in the case of Lowe’s, a company will repurchase their stock because they believe that it is undervalued on the open market.

Of course, a company will also sometimes repurchase its stock to provide a "bonus" to incentive compensation plans for employees (rather than receive cash, recipients receive an asset that might appreciate faster than cash in the bank). However, this is most likely not the case with Lowe’s.

Last week an official report from the home improvement giant revealed that its second-quarter net income was nearly flat due in part to bad weather but mostly because of shoppers' worries about the economy. Consequently, the company had to lower its sales forecast for the second half of its fiscal year due to this “consumer uncertainty.”

After Q1, Lowe’s had projected revenue guidance of 4 percent for 2011. According to Forbes, Q2 sales declined 1.5 percent and Lowe’s has now revised its revenue guidance to 2 percent as the consumer sentiment especially as sentiment in the homebuilder and home improvement segments dipped further.

Lowe’s will have to figure out a way to somehow pay for the buyback with only $850 million in cash on the balance sheet and steadily declining cash flows. They will either have to generate substantial capital in the coming years to fund the buyback (and cover investments needed to run the business) or they will have to take out more debt (or a combination of both).

If they are unable to come up with answers or solutions to these aforementioned concerns, they may very well become a fixer-upper themselves.

One last thing…
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