A Rocky Recovery for Home Depot

Wall Street is hoping for a strong economic recovery, but again and again investors are disappointed by signs that American consumers remain cautious and careful about opening their wallets. The latest evidence arrived Nov. 17, when Home Depot (HD) reported earnings.

Home Depot’s profits actually beat expectations, but what worried Wall Street was the picture executives painted of their customers’ moods. “There is still a great deal of pressure in the housing and home improvement markets, though there are some positive signs of stabilization,” Frank Blake, Home Depot’s chairman and chief executive said in a statement.

There are at least a few reasons for Home Depot to be upbeat. Many sales measures did improve from the second quarter to the third.

According to comments to analysts by Blake and other executives, Home Depot customers are happy to spend on simple home remodeling projects. Basic maintenance — plumbing repairs, for example — is still being done. Customers are also launching do-it-yourself projects, including boosting the energy efficiency of their homes. Finally, customers are updating the decor with new coats of paint or new carpet, or sprucing up their yards with better gardens.

What Americans aren’t doing, however, is launching major remodeling or expansion projects. Executives said lumber, hardware, electrical and mill work sales all underformed. The average customer’s sales ticket was down, a sign contractors are still spending a lot less at Home Depot, the world’s largest home improvement chain.

The caution from Home Depot on the consumer environment echoed comments from rival Lowe’s (LOW) when it reported earnings on Nov. 16. Lowe’s chairman and chief executive Robert Niblock said in a statement:

The broad-based pressures of the macro environment are clearly evident in our sales as consumers continue to delay large purchases until they feel better about the economic outlook.

Home Depot’s gloomy outlook sent share tumbling more than 3% lower by midday on Nov. 17. Lowe’s shares also slipped.

But focusing on one day’s stock performance might overstate the significance of current pessimism about the U.S. consumer. Home Depot shares are still up 7% in November, while Lowe’s shares have risen almost 10%. Third quarter results may discourage unrealistic investor expectations, but they don’t mean the U.S. consumer is hopeless in 2010 and beyond.

And, analysts praised Home Depot’s ability to cut costs. Morgan Stanley (MS) analyst Matthew McGinley wrote:

To the extent that it is sustainable, this [cost-cutting] reflects the potential to expand margins dramatically in a sales upturn. … [Home Depot] management deserves an award for cost control in 2009, but the stock may pause unless we see confirming evidence that 2010 [sales trends] will be positive.

“While the stock should give back some of its recent gains,” JPMorgan (JPM) analyst Christopher Horvers noted, sales and profit margins should improve. “We believe a longer view is appropriate.”

Robert W. Baird analyst Peter S. Benedict also saw the glass as half full. “Bottom line,” he wrote: “More signs of stabilization here, and we see improved trends going forward.”

The big question for Lowe’s and Home Depot is how long the U.S. consumer continues to put off major home improvement projects. Many Americans may be contemplating major addition to their houses or the construction of a new deck or garage. But they can’t be expected to make such major expenditures until their confidence — in their jobs and in their investments — truly returns.

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