By Ronda Fears
Nashville, Nov. 22 - Bear Stearns & Co. analysts recommend Lowe's Cos. for outright and hedged convertible investors, citing it is a good entry point into a high-growth retail name.
They recommend Lowe's 0% convertible senior notes due 2021.
"LOW's 0.0% debentures offer a good equity-sensitive way to play a high-growth retail name which is also a sound credit," said convertible analysts Rao Aisola, Sarah Gallagher and Matthew Hempel.
"We are recommending the Lowes 0.0% convertible senior notes due 2021 for outright as well as hedge investors on market hedge of 65%."
On the back of excellent third quarter execution for the home improvement products retailer and the subsequent stock sell-off in sympathy with Home Depot's woes, the analysts said Lowe's convertible is at an attractive entry point.
"Should Lowe's common comes under pressure given [last week's] drop in housing starts, we would be aggressive buyers of the debentures," the analysts added.
The U.S. Commerce Department reported last week that U.S. housing starts fell 11.4% in October after surging in September.
Using a spread assumption of 100 basis points and a volatility of 38%, the analysts said the Lowe's convertible is fairly valued.
"The modest conversion premium of 19.91% offers investors the ability for equity participation in today's convertible universe, which is 60% busted with a conversion premium of over 70%," the analysts said.
"For the hedge investor we are recommending a market hedge of 65% to establish a neutral stance on the common, which is rated outperform with a price target of $50. However, if LOW's common stock trades up to the $47 level, we would increase our hedge aggressively."
With cash balance of $1.3 billion, debt of $3.74 billion and 13x EBIT coverage of interest expense, the analysts do not see any significant issues with the credit.
Lowe's reported better than expected third quarter EPS of 43c versus 32c a year before and Bear Stearns' estimate of 40c. Sales increased 17.6% to $6.41billion with an in-line same store sales gain of 4.1%.
Bear Stearns retail analyst Dana Telsey believes Lowe's can gain market share, improve sales and margins as it continues to enter larger metro market. With 36% less stores than Home Depot, she thinks Lowe's has considerable room to grow and leverage its supply chain and distribution infrastructure.
Lowe's 0% convertible due 2021
| Price: | 75.5
|
| Common: | $38.438
|
| Conversion premium: | 19.91%
|
| Conversion price: | $36.99
|
| Current yield: | 0.00%
|
| Yield to maturity: | 1.92%
|
| Spread: | 100 basis points
|
| 100-day volatility: | 55%
|
| Delta: | 58%
|
| Call/put price: | 65.549%
|
| First call/put: | February 2004
|
| Credit: | A/A3
|
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