Housing prices are no longer in the dumps. What does this mean for the home improvement retailers, and how might other trends be helping to provide a positive industrywide backdrop? Both Home Depot and Lowes may be long-term winners, but valuation considerations shouldn’t be ignored. The Valuentum analyst team digs in. ~8 mins.
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Chris Araos:
Hello, this is Chris Araos at Valuentum Securities. With me are Kris Roseman and Brian Nelson. Today, we are going to focus on Home Depot (HD) and Lowes (LOW) and why they are doing so well.
We have a strong housing market. New home sales have hit the highest level since 2008, the Great Recession. Home prices hit record highs in May of 2016, according to the National Association of Realtors. There has also been a threat of the Federal Reserve raising rates and what leads prospective buyers to act on their decisions before the next probable rate hike, leading to more purchasing in housing.
Brian Nelson, CFA
The strength in housing has continued through the end of 2016 and the outlook for 2017 also looks pretty solid in light of some of the dynamics within the housing market itself — that being that private fixed residential investment as percentage of GDP is still below the historical mean, household formation (particularly as millennials continue to go through their lives) is increasing, and then there’s the aging US stock, which plays in the hands of a lot of the home improvement retailers, Lowes and Home Depot, specifically.
More recently, what we’ve seen is that Home Depot has tended to perform a little bit better than Lowes on a comparable store basis — and what would you say might be a couple trends, a couple reasons behind that trend?
Kris Rosemann:
Yeah, well, Home Depot has a very high share of the professionals market, the professional contractors market (professional home builders and remodelers). They (Home Depot) generate 20% of their revenue from big-ticket items — big tickets being nine hundred dollars or more — and as you can imagine that aside from things like appliances the big-ticket items kind of lend themselves to more of that professional market.
The most recent quarter we saw double-digit growth from Home Depot in their big-ticket items. Now that’s not to say that Lowes doesn’t have a decent share there as well — they are competitive — more specifically to Lowes though, they are seeing strength in their online business serving professionals, where they order online and pick up from the store. Home Depot has many of those similar features as well.
Brian:
Pros typically are more fickle in terms of their demands for the product, either from Home Depot or Lowes, and I think Home Depot might be doing a little better in terms of product innovation. The pro market also demands enhanced delivery in some cases, and then also better credit offerings in terms of meeting and more-efficiently managing their business.
I think there’s another dynamic, too, at play as the geographic presence of Home Depot relative to Lowes is that Home Depot tends to be a little bit more diverse where Lowes is more heavily weighted towards the East Coast, the southeast states, where Home Depot has a stronger presence in the West. That shields it (Home Depot) from a lot of the geographical dynamics that may occur within the housing market – and I think anytime you mention housing, you always come up with the idea that this is still a very cyclical industry.
But when we look at, at least in Lowes’ case specifically, net sales performance has tended to be somewhat resilient given that when buyers may not be looking to buy a new home, they may be looking to improve their existing home and live in their home longer, or the renter’s market tends to be enhanced, and investment in remodeling to improve rental units becomes an offsetting dynamic. So while this is a very cyclical industry, there are some mitigating factors that come along with it.
An interesting stat about what this pent-up demand from the housing collapse could be a catalyst for new builds, and we’re starting to see housing prices come back very strongly, and when we look at a survey of the housing stock of the United States, 65% of it in the US is now in excess of 30 years old. That’s just a huge percentage of homes that are in need, or at least a basket of houses, that eventually are going to need maintenance and improvement, if they haven’t been (properly) maintained this whole time — so things tend to start to break on a more consistent basis as the house ages.
Kris:
We’re also expecting to see first-time home buyer activity continue to grow through 2017 as it picked up towards the back at 2016 here. You can kind of imagine the type of home that someone might be buying their first time around, where they’re at a certain point in their life, they might be buying more of a fixer-upper or something at the lower end of the price range, which is going to require more do-it-yourself (DIY) projects or things of that nature.
Also, as Chris mentioned earlier, with home prices going up, that’s just encouraging more and more people to invest in their homes, as they’re getting ready to sell, and then on the other end of that, as people are buying these homes, they’re making modifications and improvements to what someone else might have had in that home to make it their home instead of somebody else’s home — so they’re making these minor modifications to maybe the kitchen or bedroom, removing a wall, whatever you may prefer compared to what the other person had.
Then, another thing that a lot of these (home improvement) retailers are pointing to is the do-it-yourself category is kind of a hobby for a lot of people. Some people have begun spending more time remodeling their home than they might have before. A recent sentiment survey from Lowes has indicated that overall home improvement spending intentions is expected to continue to outpace overall spending intentions, which is just kind of a little interesting anecdote into the mindset of the consumer as we continue to see a changing demographic in the retail environment.
Brian:
Kris, I’m a huge fan of the home improvement industry, and I think Home Depot and Lowes are fantastic companies, but I think the bigger takeaway for the investor is the valuation dynamics of the business.
The valuations of Lowe’s and Home Depot aren’t off-the-charts; they’re call-it 15 and 18 times 2017 earnings. But when you look at Lowes, in particular, in August of 2011, for example, the stock was trading under $20 per share. Now it’s trading at over $70 per share. While certainly, the market has come to recognize the increased value for the company, can we truly say that the value of Lowes is now worth more than three, almost four times, it was just a few short years ago?
Now granted one could say that it was underpriced back in 2011, but does that then imply that this business is very cyclical if these entities aren’t being valued properly on what would be considered mid-cycle earnings — and if mid-cycle earnings are difficult to forecast, then are these truly as strong of business models that we potentially think they are. So a lot of things to think about in the home improvement retailing space — not only is the backdrop very, very strong, but I think the market is still kind of feeling out the valuations of these entities that have been around for decades, since the 1940s in the case of Lowes.
This is Brian Nelson for Valuentum Securities. Thank you for joining us.
Homebuilders: CAA, DHI, JOE, KBH, LEN, MDC, MTH, NVR, PHM, TOL