Rise in Residential Investment May Boost Sales at Home Depot (HD) and Lowe’s (LOW)

Spending on construction of new residential housing and improvements to existing homes is at a three-year high, a trend that may boost sales at Home Depot Inc. (HD) and Lowe’s Cos. (LOW)

Private-residential fixed investment, which includes major replacements such as new roofs and improvements like finishing a basement, rose 9.1 percent from a year earlier to an annualized $360.7 billion for the three months ended March 31. This marks the fourth consecutive quarter of nominal increases and was the fastest pace of yearly growth since 2006, Bureau of Economic Analysis data show.

These expenditures may prolong a structure’s life or increase its value and are “another piece of corroborating evidence” that home-related purchases were “very good” in the first quarter, said Scot Ciccarelli, a New York-based analyst at RBC Capital Markets.

New U.S. homes sold at a 328,000 annual rate in March, beating the 319,000 median estimate of economists surveyed by Bloomberg News. The total was down from an upwardly revised 353,000 pace the prior month that was the highest in two years, based on Commerce Department data.

Residential building permits also climbed unexpectedly by 4.5 percent to a 747,000 annual rate in March, the highest since September 2008. Economists surveyed by Bloomberg predicted a 710,000 pace.

High Correlation

Private-residential spending — which accounts for about 2.3 percent of gross domestic product — is highly correlated with comparable-store sales for Home Depot and Lowe’s, the two largest U.S. home-improvement retailers, Ciccarelli said.

Same-store sales probably rose at least 5 percent in the fiscal first quarter at Home Depot and at least 2.4 percent at Lowe’s from a year earlier, he forecasts. Atlanta-based Home Depot is scheduled to release earnings on May 15, followed on May 21 by Lowe’s, based in Mooresville, North Carolina.

Home Depot reported an increase at stores opened at least a year of 5.7 percent for the three months ended Jan. 29; Lowe’s said sales rose 3.4 percent for the three months ended Feb. 3.

About 30 percent of Fortune Brands Home & Security Inc. (FBHS)’s North American sales are at Home Depot, Lowe’s and home- improvement chain Menard Inc., Chief Executive Officer Christopher Klein said in a telephone interview. The Deerfield, Illinois-based company, which owns the Moen faucet and Omega cabinet brands, is projecting a 4 percent increase in 2012 revenue for its repair and remodel business, up from a previous estimate of 2 percent, he said.

Signs of Comeback

As the housing industry shows signs of a comeback, the Standard & Poor’s 500 Home Improvement Retail Index, comprised of Home Depot and Lowe’s, has risen 73 percent since Aug. 10, 2011, compared with the S&P 500’s 21 percent gain.

Shares of the two companies have outpaced the market in the past nine months as investors try to gauge how much recent revenue increases reflect “stronger forward-looking demand” and not moderate weather, said Ciccarelli, who maintains “outperform” recommendations on these retailers.

Their valuations already may reflect improvement in housing, Ciccarelli said. Home Depot and Lowe’s are trading at multiples of about 18.1 and 17.2 times consensus 2012 earnings, compared with a five-year average of 15.9 and 15.5, he said.

“It’s really become a duration call,” he said. “Investors who think we’ll get a multiyear recovery in the housing market, particularly in home improvement, need to have exposure to these stocks.”

Warm Weather

The warmer-than-usual winter may have contributed to as much as half of the 19 percent first-quarter sequential gain in private-residential fixed investment on an annualized basis, according to estimates by Joseph LaVorgna, chief U.S. economist in New York at Deutsche Bank Securities Inc.

“We’re starting to see very faint signs of a housing recovery, and a better labor market should further increase demand for housing and related remodeling activity,” he said.

The U.S. added 115,000 jobs in April, the 19th consecutive month of increases, while unemployment fell to 8.1 percent from 8.2 percent in March, the Labor Department reported May 4.

The National Association of Home Builders/Wells Fargo Housing Market Index, a gauge of builder perceptions for single- family home sales and forecasts for the next six months, held at an almost five-year high of 28 in March, then fell to 25 last month. Readings below 50 mean more respondents said conditions were poor.

Real-Estate Activity

The Federal Reserve noted progress in its April 11 Beige Book: Residential real estate improved in “most districts,” with contacts in Boston, Philadelphia and Kansas City saying mild weather boosted activity.

The higher-than-normal temperatures in January and February probably helped spur outdoor projects in the Midwest and Northeast, as Fortune Brands saw increased demand in these regions, Klein said. Still, the “positive momentum is widespread,” with sales up in the Western and Southern states. This suggests that even if demand for projects began earlier in the season, “it was more than just weather,” he said.

Other companies also reported sales increases. Sherwin- Williams Co. (SHW), the Cleveland, Ohio-based maker and retailer of paints and coatings, saw demand strengthen “in virtually every product category, every customer segment, in every geographic region,” as first-quarter revenue grew 15 percent from a year earlier, Chairman and Chief Executive Officer Christopher Connor said on an April 19 conference call.

Market Firming

Stanley Black & Decker Inc. (SWK) Chief Operating Officer James Loree said the market for housing and home improvement “clearly appears to be firming,” and if that continues, it “bodes very well” for the New Britain, Connecticut-based company. Point-of- sales data for its power tools and outdoor products have been “very strong,” so “it would be foolish” to assume the gains were entirely because of weather, he said on an April 19 conference call.

MasterCard Inc. (MA), the world’s second-largest payments network, also saw recent increases. After “languishing in pretty negative territory” about six months ago, sales of hardware, electronics and home-improvement products were “actually the growth areas” in the last two months, President and Chief Executive Officer Ajaypal Banga said on a May 2 conference call.

Even so, consumer confidence still is “not back to where we’d like to see it,” which hurts expensive projects such as kitchen remodeling, Klein said. This business is lagging behind the overall market, as consumers remain “a little cautious.”

Consumer Confidence

Sentiment slipped to minus 40.4 in the week ended May 6, the lowest in three months, from minus 37.6 the prior week, based on the Bloomberg Consumer Comfort Index. That’s still more than 12 points above the minus 53.2 October 2011 reading.

Residential real estate also continues to show signs of weakness, as sales of previously owned homes unexpectedly fell 2.6 percent to a 4.48 million annual rate in March from 4.6 million the prior month, according to data from the National Association of Realtors. This was the second month of declines; the median forecast of economists surveyed by Bloomberg called for an increase to 4.61 million.

Even though housing may have bottomed, it “won’t be a big driver of performance” this year for Home Depot, Ted Decker, senior vice president of retail finance, said at a March 6 conference hosted by Raymond James & Associates Inc. The company forecasts its 2012 revenue growth will be consistent with economic expansion between 2 percent and 3 percent, he said.

‘Roughly Flat’

Industry shipments for household appliances fell 10 percent during the first quarter, Benton Harbor, Michigan-based Whirlpool Corp. (WHR) said April 26. The total for the year will be “roughly flat, which is at the low end of our previous guidance,” Marc Bitzer, president of Whirlpool North America, predicted on a conference call that day.

Though the housing recovery remains uneven, it tends to move in “very long” cycles, with the six-year market slump that began in 2006 following an eight-year boom, Ciccarelli said. Further, Home Depot and Lowe’s are large components of portfolio benchmarks such as the S&P 500, so it can be “very painful” for investors to be short or underweight if they believe the recovery is sustainable, he said.

Shares of Fortune Brands rose 9 percent on April 27 — the most since September — a day after it released first-quarter earnings of 8 cents a share, beating the analyst consensus of 3 cents. Revenue gains have been driven by pent-up demand from Americans who have decided to remodel in lieu of selling their homes or moving, as well as increased foreclosure activity that is spurring rehab projects, Klein said.

What’s even more encouraging is that the revenue gain isn’t coming from the cheapest cabinets and faucets, he said. Rather, the company’s “fashion products” have had strong sales as buyers balance value with an often long-delayed purchase.

“Our customers are saying, ‘If I’m going to spend my hard- earned money, boy, I want to feel good about it.’”

By Anna-Louise Jackson and Anthony Feld

Courtesy of Bloomberg News

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