Nov. 30 (Bloomberg) -- Shares of Home Depot Inc. and Lowe’s Cos. -- the two largest U.S. home-improvement retailers -- are outperforming other consumer discretionary stocks as the worst of the declines in the housing market may be over.
Americans are on pace to spend $337.3 billion on their homes, with annualized private-residential fixed investment rising 3 percent from 2010 for the three months ended Sept. 30, Bureau of Economic Analysis data show. This is only the second such increase since 2006 and unlike 2010, wasn’t boosted by government tax-credit stimulus programs including one for appliances, said Scot Ciccarelli, a New York-based analyst at RBC Capital Markets.
Same-store sales for the two retailers -- which track residential investment -- have started to improve and may pick up even more because “there’s been some industry stabilization,” said Ciccarelli, who upgraded Home Depot to “outperform” earlier this month and maintains the same recommendation on Lowe’s.
Comparable-store sales rose 4.2 percent at Atlanta-based Home Depot and 0.7 percent at Mooresville, North Carolina-based Lowe’s in the three months ended Oct. 30 and Oct. 28, respectively, the companies said earlier this month.
Homeowners likely deferred repair projects for several years and now are spending on “necessary upkeep” so their residences remain livable, Ciccarelli said. As a result, “upside earnings revisions are more likely,” and shares of Home Depot and Lowe’s may rally more than the market, he said.
The Standard & Poor’s 500 Home Improvement Retail Index, comprised of the two retailers, hit a peak on Nov. 25, 2008, on a relative basis and then underperformed the Consumer Discretionary Select Sector Index by 68 percent through Aug. 10, 2011. Since then, the home-improvement index has risen 37 percent as of 10:30 a.m. in New York, compared with a 13 percent increase for the consumer-discretionary index, which includes Macy’s Inc. and Kohl’s Corp.
The underperformance was “very severe” amid persistent negative news about housing, said Michael A. Gayed, chief investment strategist at Pension Partners LLC. Now, “even a small amount of positive news is a big surprise” to investors, which is why these retailers may lead the consumer sector, said Gayed, whose New York firm oversees $140 million in assets.
While the industry has been “bouncing along a bottom” this year, there are “solid signs of stabilization” in home prices and the number of mortgages entering delinquency, said Russell Price, a senior economist at Ameriprise Financial Inc. in Detroit.
The combined rate of mortgages 30 and 60 days past-due dropped to 4.5 percent in the quarter ended Sept. 30 after peaking at a seven-year high of 5.6 percent in 2009, data from the Mortgage Bankers Association in Washington show. Loans in delinquency eventually determine the number of foreclosures, so this suggests a moderating foreclosure rate, which has averaged 4.5 percent since the recession ended in 2009, Price said. From 2005 through 2007, when the recession began, the foreclosure rate averaged 1.2 percent, according to the bankers association.
Meanwhile, sentiment about home prices is moderating, said David A. Schick, a retail analyst for Stifel Nicolaus & Co. in Baltimore, who recommends buying Home Depot and Lowe’s. This is “potentially a good sign” because people are more likely to spend if they think their asset is appreciating, he said.
Home Price Sentiment
The number of consumers who said home prices are “going up” dropped 2 percent from a year ago to 15 percent in late November, according to a survey conducted twice a month by Stifel Nicolaus. While the difference between this and the 30 percent who reported “falling” prices remained at minus 15 percent -- the same as earlier in the month -- it was an improvement from late September’s minus 21 percent reading, the most negative since April 2009, Schick said.
Residential real-estate prices still are struggling, as the S&P/Case-Shiller index of property values in 20 cities fell 3.6 percent in September from the same month a year ago, the group said yesterday. While this was the smallest decrease since February, it was more than the estimated 3 percent decline in a Bloomberg News survey.
Lowe’s introduced an advertising campaign in mid-September -- “Never Stop Improving” -- to “inspire” customers “to innovate and improve their homes,” Chairman and Chief Executive Officer Robert Niblock said on a Nov. 14 conference call.
‘Above Average’ Sales
The company experienced “above average” sales in building materials, tools and hardware during its fiscal third quarter, Chief Financial Officer Robert Hull said the same day.
Similarly, Home Depot’s electrical and plumbing sales outpaced comparable-store results during its third quarter, Craig Menear, executive vice president of merchandising, said on a Nov. 15 conference call. “The maintenance and repair categories that make up the core of our store continued to perform well,” he said.
Masco Corp., a Taylor, Michigan-based maker of Delta faucets and KraftMaid cabinets, said its third-quarter sales to “key retail customers,” excluding the impact of exiting some businesses, “would’ve been up low single digit,” President and Chief Executive Officer Tim Wadhams said on an Oct. 25 conference call. Sales to these customers -- which include Home Depot and Lowe’s -- rose from the prior quarter, indicating business is improving sequentially, Ciccarelli said.
The outperformance of housing-related stocks may be short-lived if the economy weakens and interest rates go even lower, Gayed said. The yield on 10-year government bonds has hovered around 2 percent since the beginning of November, Bloomberg data show.
Another sharp decline in home prices also “would severely disrupt” recent improvements in residential investment and put strain on these retailers, he said. Lowe’s has announced it is closing 27 stores this year, while its competitor doesn’t “expect to see in the near term any meaningful tailwind from the housing market,” Home Depot Chairman and Chief Executive Officer Frank Blake said Nov. 15.
Activity has “remained very weak, held down by the large overhang of foreclosed and distressed properties, along with limited demand in an environment of uncertainty about future home prices,” Federal Reserve policy makers said at their November meeting, according to the minutes.
Signs of Life
There are some signs of life: The number of Americans signing contracts to buy previously owned homes rose 10.4 percent in October from the prior month, the biggest gain since November 2010, the National Association of Realtors said today. This beat the median forecast of 2 percent in a Bloomberg News survey and followed three consecutive months of declines.
Consumer confidence also rose this month by the most since April 2003, as the Conference Board’s index increased to 56 from a revised 40.9 reading in October, the New York-based private research group said yesterday.
Investors are taking a more sanguine outlook on home-improvement spending as owners have pushed off repair projects for as long as possible, Gayed said.
Recent government initiatives “could be useful steps toward stabilizing the housing market,” Fed policy makers said in November. Expanding the Federal Housing Finance Agency’s Home Affordable Refinance Program -- announced in October -- is one approach that may get this industry “back on its feet,” Price said.
“Allowing many of the people with high loan-to-value mortgages to refinance not only increases the likelihood that they stay in their home, but it also provides them with some additional monthly savings,” he said.
Even amid a negative macroeconomic backdrop, Americans may feel more comfortable renovating their homes than spending on other discretionary items, Ciccarelli said, adding that the most-recent increase in private-residential fixed investment suggests “a bottoming process is occurring” in housing.
“We’re seeing the early signs of positive inflection,” he said. “It’s not big, but it’s still moving up.”
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