Austerity And Fewer Home Buyers Could Hurt Home Depot’s Outlook

Home Depot’s (NYSE:HD) third quarter results announced in October this year was met with widespread cheer from investors. The company posted revenues of $18.3 billion for the quarter, beating Wall Street estimates by about $400 million and delivering a 4% top line increase over the same quarter last year. The results bring additional cheer since Home Depot is the largest retailer of home improvement products in the U.S., and its numbers are associated with the overall performance of the housing market.

The housing bust of 2008-09 was also a period of diminishing earnings for the company. As new home sales fell from 1 million in 2006 to 375,000 in 2009, the company’s top line shrank steadily by nearly 15%. The trend reversed in 2010 as permits for new constructions picked up, and the company earned around $70 billion in 2011, an increase of around 6% over 2009. But keeping in mind the strong correlation between Home Depot’s top line performance and the state of the overall housing market in the U.S., let’s evaluate if the company will continue its positive run.

Our complete analysis for Home Depot’s stock

Renting Americans To Steer Clear Of Home Improvements

The recent growth in construction activity has also been accompanied by a steady drop in homeowner rates. More than ever before, Americans are now renting and this trend has failed to turn itself around despite the improving market scenario. As of 2012, home ownership rates stood at 65%, a steady decline from 69% in 2006. Even in 2008, the home ownership rate was higher at around 67%. This spells bad news for home improvement companies as people living in rented houses typically spend much less on home improvement than those who own their homes.

The best explanation for this phenomenon can be the unemployment rate in the country. National unemployment rose from 4.7% in 2006 to 9.7% in 2008. The younger generation was the hardest hit, unemployment in the 21-25 year age group are currently well into double digit figures (around 13-14%). This caused what is termed as ‘doubling-up’ of households, where children are living in their parents’ homes due to economic hardship. It is estimated that nearly 60% of doubled-up households are a result of children being unable to find the right economic conditions to move into their own homes. Showing a slight improvement, the unemployment rate in 2012 is hovering around the 7.5% mark. This has freed some of the young adults, allowing them to move in to their own places. However, the turbulent economic scenario also means that such people are more likely to rent their homes than purchase them. ^[1]

Unemployment To Effect Home Depot Prospects

Unemployment in the U.S. makes the long-term scenario for the housing market (and Home Depot) rather murky. Most of the recent improvements for Home Depot could be undone if the policies related to the looming fiscal cliff are not implemented properly. According to the Congressional Budget Office’s (CBO) estimates, severe fiscal tightening in 2013 could potentially push the unemployment rate to just above the 9% mark. Considering the nation’s population hits the 317 million mark the same year, this would imply that the pool of employed people could shrink by as much as 1.5 million. Meanwhile, higher taxes would spell decreased per capita spend on home improvement products. This could result in a  drop in demand for new homes and could also mean more people giving up on home ownership and move to rented premises. Hence, they will spend less on home improvement.

Of course, in contrast to the scenario described above, lies another possibility. A conservative set of fiscal tightening policies could also help the U.S. limit its unemployment to around the 8% mark. In such a situation, there would actually be an increase of around 2 million in the total pool of employed people – raising the demand for new homes and new home improvement products.

The actual set of policies implemented will probably create a scenario somewhere between the two described, and therefore the fortunes of home improvement companies could swing either way.

We will be covering the latest developments on fiscal cliff policies and what they mean for Home Depot and close competitor Lowe’s in the coming weeks.

We have a Trefis price estimate of $59 for Home Depot’s stock, which is 10% below market price.

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1. “The Shifting Nature of U.S. Housing Demand“, The Demand Institute [↩]