By Mary Ellen Lloyd of DOW JONES NEWSWIRES
(c) 2009 Dow Jones & Company, Inc.
It’s still too early to buy home-improvement retailing stocks, even though shares of the biggest players have built up some nice gains since hitting five-year lows in October.
The U.S. housing market troubles and recession are likely to pressure sales and earnings growth at Home Depot Inc. (HD) and Lowe’s Cos. (LOW) at least through 2009 and probably through 2010, say some money managers and industry analysts. They argue home-improvement sales have lost wallet share as Americans cope with concerns about falling home values, shrinking retirement accounts and job security. Home equity withdrawals have fallen to an all-time low, and other credit for big renovation projects is harder to secure.
“Even though the valuations on those stocks probably look really, really attractive, we can’t see any earnings growth” anytime soon, said Thomas Nyheim, a large-cap growth manager at Christiana Bank & Trust Co. “It’s probably too early.”
“I don’t think the stocks are outperformers in either the short term or the long term,” said Jon Fisher, a portfolio manager at Fifth Third Asset Management.
Nevertheless, as they did in late 2007 and early 2008, shares of Home Depot and Lowe’s from late October (in which both hit 52-week lows) to earlier this month moved higher as investors anticipated the companies’ eventual return to growth once housing woes hit bottom. Sanford C. Bernstein and Goldman Sachs boosted 12-month price targets on Lowe’s in recent days, and Morgan Stanley joined the firms in boosting targets on Home Depot, too.
Bulls cite the companies’ solid balance sheets, their ongoing efforts to trim expenses and take market share from weaker players, and their leadership positions in one of the few retailing segments not dominated by Wal-Mart Stores Inc. (WMT). They also say you’re better off buying the stocks early rather than waiting too long and missing outsized gains.
Indeed, the strong finish to 2008 helped both stocks outperform the broader market and other retailers. Home Depot, a component of the Dow Jones Industrial Average and recently trading at $22.85, fell 14.6% in 2008, better than the Dow’s 33.8% decline and the 31.9% drop in the S&P Retail Index.
Lowe’s shares recently traded at $20.52 and fell 4.9% in 2008.
But others say the future is still too unclear to buy into the group.
“We do not get a turnaround in the economy until the housing market turns around, and we’re a long way from that,” said William Rutherford, Oregon’s former state treasurer and president of Portland investment firm Rutherford Investment Management. “Until that happens, you’re just trying to catch the proverbial falling knife.”
Officials with both companies declined to comment for this article.
Wait To Buy?
Home Depot and smaller rival Lowe’s together represent almost 40% of the $354 billion in annual U.S. retail sales at building materials, garden equipment and supply stores and are the top two players.
But Home Depot in 2007 posted the first full-year revenue drop in its 30-year history as it fought the effects of the weakening housing market and made major operational and management changes. The Atlanta retailer faces two more years of declining revenue and net income, based on current consensus forecasts that bears call overly optimistic.
Shares of Home Depot trade at 15.7 times the Thomson Reuters mean forecast of $1.45 a share in earnings for the January 2010-ending fiscal year.
Lowe’s, which grew more slowly than Home Depot over the years and has had a more technologically sophisticated supply-chain recently, could eke out a sales increase in the current fiscal year but is also expected to post weaker earnings for fiscal 2008 and 2009. Shares of the Mooresville, N.C., company, which were added last month to the S&P 100, trade at 15.3-times the 2009 consensus earnings forecast of $1.34.
Even analysts who like the stocks longer term have been cutting estimates. Goldman Sachs raised price targets on Home Depot and Lowe’s on Jan. 5 but cut 2009 and 2010 earnings forecasts that were already below consensus estimates.
JPMorgan analyst Christopher Horvers, who rates both stocks at overweight, on Jan. 9 warned there may be an emerging third leg down in the housing market if existing home sales don’t respond to the significant reduction in mortgage rates. So far, the benefit has only been seen in refinancing applications. “If (home) sales do not respond, our view of ‘achievable 2009 estimates’ for HD and LOW would need to change,” Horvers wrote.
And Citigroup recently advised clients to wait to buy the stocks until there’s more compelling evidence that housing turnover will turn positive.
“We believe housing turnover will remain negative until early 2010,” said analyst Deborah Weinswig, who maintained hold ratings.
Sales of foreclosed homes have driven recent housing sales activity, but sales to investors or speculators probably generate lower home-improvement spending than sales to homebuyers, she said. Lowe’s has said it believes both groups spend about the same amount at its stores.
Morgan Stanley estimates the average homebuyer spends $2,000 to $3,000 on home improvements in the first 18 months after a move.
And while some industry watchers expect Home Depot and Lowe’s to benefit from “cocooning,” or people staying home more and deciding to fix things up as a result, others are skeptical. “I’m not so sure that is going to happen this time around, given the state of the economy and the state of the housing market and consumer sentiment and the job losses,” Rutherford said.
“There’s not a lot of discretionary income around,” Fisher said.
Projects that homeowners are undertaking are generally smaller – painting or changing light fixtures. The boom days of many $30,000 kitchen renovations are unlikely to return anytime soon – if ever, some money managers say.
“These stocks may be good two or three years out, but I don’t see it happening in the near term,” Rutherford said.
He and other industry watchers also worry that industry profit margins won’t rebound to housing-boom levels, even once the housing market recovers.
Both Home Depot and Lowe’s are pulling back on store growth, which means they may increasingly find it harder to leverage expenses even as their stores mature. Citi expects Home Depot to slow store growth in 2009 even more than the company has outlined. The firm recently cut its new store estimates, saying it expects 15 new stores in 2009 and in 2010, rather than the 30 to 50 estimated earlier based on Home Depot’s long-term guidance.
Cutting back on expansions may not be enough, given the low customer traffic at both chains, Fisher said. “It may not be to the magnitude that other retailing chains have, but they need to go further in reducing their stores,” he said.
(Mary Ellen Lloyd covers home-related retailers from Charlotte for Dow Jones Newswires. She can be reached at 704-371-4033 or by email at maryellen.lloyd@dowjones.com.)