Higher Lumber Prices Are Good News For Lowe’s And Home Depot

After nearly four years of uncertainty, the housing market in the United States is finally recovering, albeit slowly. Housing starts (new home constructions initiated) for 2012 are estimated at around 894,000, the highest levels seen since 2008, just before the housing bubble burst in the U.S., and the economy went haywire. Meanwhile, Standard & Poor’s Supercomposite Homebuilding Index, a benchmark for the housing industry as a whole, has risen by around 23% since June 2012.

Housing prices have been moving upwards steadily in much of the country as have permits for new construction. Estimates for new housing starts for 2013, stand at over a million. This has resulted in demand recovery for housing materials in the country, a fact evident by the rapid rise in lumber prices. ^[1]

Our complete analysis for Home Depot’s stock

Lumber prices have increased by a healthy 37% in 2012. Current prices are double than that of 2008, and has touched levels not seen since 2006. This increased demand spells good news for home improvement retailers such as Home Depot (NYSE:HD) and Lowe’s (NYSE:LOW), for whom sale of housing materials such as lumber, make up for a significant chunk of revenues.

Sales from housing materials contributed around 19% to total revenues in 2011 for Home Depot while the corresponding figure for Lowe’s stood at around 18%. We estimate that the Home Depot and Lowe’s derive around 18% of their total stock value from their building materials products. And both companies derive over 90% of their revenues from the U.S. Stronger demand in the segment is likely to benefit both companies equally.

Home Depot and Lowe’s suffered a sharp dip in their top line with the collapse of the housing market. Since 2009, the companies have increasingly focused on improving their bottom line through various cost-saving initiatives such as, reducing capital expenditure on new stores, improved inventory management and streamlining their IT systems.

Having reinvented themselves internally, both companies look well poised to cash in on the long awaited recovery. We expect Home Depot, with its wider reach and larger network of big-box stores, to leverage macro-economic trends more effectively, a fact supported by a stronger increase in same-store sales for Home Depot, when compared to Lowe’s in the latest quarter (4% for Home Depot, compared to around 2% for Lowe’s).

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

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1. “Lumber Reaches 6-Year High as Housing Rebound Erodes U.S. Supply“, Bloomberg, December 2012 [↩]