Robust Spring Sales Expected For Home Depot As U.S. Economy Recovers

America’s largest home improvement retailer Home Depot (NYSE:HD) is scheduled to announce Q2 results on August 19. As the U.S. economy recovered in the second quarter, improved consumer spending should boost the retailer’s sales. While harsh winter conditions in the early part of the year stalled home improvement purchases, especially in the outdoor project categories, pent-up demand, and repair and retrofitting activities are expected to drive top line growth in the quarter ended July. This is why Home Depot expects full-year comparable sales to expand by 4.6%, despite only a 2.6% growth in comparable sales in the first quarter. New and existing home sales also improved in the last three months, following tepid activity in the first quarter. Higher home sales should also create demand for home improvement products, thereby boosting Home Depot’s sales revenue this quarter. While the company expects 4.8% growth in its top line this year, margins are expected to remain flat. After remaining weak in the first quarter, sales of lower margin products pertaining to lumber and garden categories should improve this quarter, thus dragging down overall profitability for the company.

We have a Trefis price estimate of $81.48 for Home Depot’s stock, which is roughly 2% below the current market price.

Our complete analysis for Home Depot’s stock

Home Improvement Sales Could Grow as Home Sales Rise

Home Depot’s business is impacted by the number of house sales, as new occupants spend on home improvement supplies and construction products and services. Macroeconomic factors are starting to favor growth in this market, as seen by the increases in home sales in the second quarter. Hurt by the overall slowdown in economic activity, along with high lending rates, sales of existing homes declined from a seasonally adjusted annual rate (SAAR) of 4.87 million in December to 4.62 million in January, 4.6 million in February and 4.59 million in March. ^[1] In fact, sales in March represented a year-over-year decline of 7.5%. New home sales also remained low, and fell to a SAAR of 384,000 in March from 449,000 in February. However, following the first quarter, house sales have picked up in the U.S. Existing homes sales improved in April, May and June to reach a SAAR of 5.04 million, which is the highest sales figure since seen in October last year, although 2% lower than June 2013 levels.

Following tepid growth in the first quarter of the year, the domestic housing market seems to be regaining momentum, supported by declining lending rates and unemployment rate, and improving consumer affordability.

• Following a negative 2.1% contraction in the U.S. GDP in Q1, the country’s GDP returned to positive growth in the second quarter, increasing by 4%. ^[2] In particular, personal consumption expenses rose 2.5%, with spending on durable goods increasing 14% percent, compared with only a 3.2% growth in Q1. This growth can act as a reference, reflecting how Home Depot’s sales might also have grown in line with the increase in consumer spending.

• According to Freddie Mac, the average rate for a 30-year fixed-rate mortgage declined to 4.13% in July from 4.43% in January and 4.37% in July last year. ^[3] Potential home buyers have looked to take advantage of the lowered borrowing costs, boosting home sales. Lending rates had previously been on a rise since the first half of last year, fueled by the Federal Reserve’s announcement of reduction in bond purchases, which had kept the long-term interest rates low. ^[4]

• Home sales are also impacted by the general business environment that affects job creation and incomes. The U.S. unemployment rate fell to 6.1% in June, the lowest rate since recession started in September 2008. ^[5] Although the unemployment rate rose slightly to 6.2% in July, the figure is still much lower than the 7.6% rate in July last year. This bodes well for the housing industry as job creation would facilitate income growth and consequently also support home sales. In addition, with job stability, consumers might also look to increase spending on home improvement products.

• Rising house prices are closely associated with consumer affordability. After decreasing by more than 30% during the recession, home prices picked up momentum in 2012-2013, rising to within 20% of the peak 2006 levels. ^[6] Home Depot expects home prices to grow by 6% in 2014, which although lower than the rise in 2013, reflects steadily growing incomes, affordability and consumer demand. While during their peak in 2006, home prices were almost 40% overvalued, as compared to metrics such as cost-to-rent and incomes, the domestic housing industry remained 4% undervalued based on the same fundamentals at the end of last year.

According to the Home Improvement Research Institute, home improvement product sales in the U.S. are expected to rise to $309 billion this year, up 6.5% year-over-year, after rising 4.2% in 2013. ^[7] Home Depot leads this market with around 27.2% market share, followed by Lowe’s, which has a 18.4% value share. With economic activity and consumer spending picking up, home improvement sales and consequently Home Depot’s sales are also expected to grow this quarter, given the company’s strong positioning in this market and vast reach. With over 2,260 store locations, Home Depot beats its closest competitor Lowe’s by a big margin of more than 400 stores (total 24% more stores than Lowe’s) spread across the U.S., Canada and Mexico.

Margins To Remain Flat To Slightly Negative In The Second Quarter

Due to the unusually cold weather conditions in the early part of the year, sales of outdoor product categories such as lumber and garden remained low. On the other hand, high margin product categories such as electrical appliances saw growth. With around 78% of Home Depot’s stores within 10 miles of a Sears location, Home Depot has also been taking away share from the leading U.S. appliance retailer. However, sales of outdoor product categories are expected to rebound in the second quarter, as consumers will engaged in repair and retrofitting activities during the spring and summer seasons. This will make the product mix slightly unfavorable for Home Depot and is expected to drag down the overall margins in Q2, sequentially as well as year-over-year. The company’s gross margins stood at 34.97% in Q1 and 34.28% in Q2 last year.

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1. “New and existing home sales, U.S.“, National Association of Home Builders [↩]
2. U.S. GDP growth rate [↩]
3. 30-year fixed-rate mortgages since 1971 [↩]
4. historical 30-year fixed-rate [↩]
5. U.S. unemployment data [↩]
6. What’s ahead for 2014 housing market [↩]
7. Home improvement research institute forecasts [↩]