Housing Double Dip Can Eliminate Home Depot Stock Upside

Home Depot (NYSE:HD) is the world’s largest retailer of home improvement products, primarily competing with Lowe’s (NYSE:LOW) in this business. Home Depot boasts 2,244 stores, of which 1,976 (88%) are in the US. The company offers a wide range of products and installation services to both individual home owners and professional builders.

We estimate that the plumbing, electrical & kitchen segment, part of the company’s broader home improvement products, is the single largest driver of the company’s value, generating close to 31% of our estimated stock value for Home Depot. Our price estimate of $36.65 is about 6% ahead of market price, although this implied premium could be eliminated by continued stagnation in the US housing market.

Home Depot’s Share of the Plumbing, Electrical & Kitchen Market in North America

Home Depot’s North American plumbing, electrical & kitchen market share decreased from an estimated 23% in 2005 to 21% in 2007 due to increasing competition, as competitor Lowe’s successfully grabbed market share. However, Home Depot’s share rebounded towards 22% in 2008 and remained flat in 2009 as high penetration levels in the US market enabled Home Depot to partially offset its losses from the hard-hit housing markets such as Southern California and Florida.

We anticipate that Home Depot will be able to maintain its lead position in the plumbing, electrical & kitchen market going forward, gradually increasing market share alongside a widespread housing market recovery. We project that Home Depot can return to 2005 market share levels of 23% in this segment by the end of our forecast period.

Size of the North American Plumbing, Electrical & Kitchen Market

The size of the North American plumbing, electrical & kitchen market decreased from an estimated $110 billion in 2007 to $90 billion in 2009, driven by a weak housing market and reduced consumer spending during the economic recession.

We estimate that the North American plumbing, electrical & kitchen market will reach $125 billion by 2017 (an increase of nearly 40% off of 2009 levels), with near-term growth driven by maintenance and repair projects. A projection from Fitch Ratings in mid-2010 suggested a 3.5% annual increase in US home improvement spending during the year. ^[1] Long-term growth will likely stem from a broader housing market recovery.

However, recent data shows that construction spending in the US has been a bit sluggish. The US Census Bureau of the Department of Commerce estimates total construction spending during November 2010 at $810 billion, about flat with October 2010, but down 6% from November 2009. Similarly, total residential construction spending for November 2010 is about flat with October 2010, but down 4% from November 2009. ^[2]

Further, data released from Standard & Poor’s for its S&P/Case-Shiller Home Price Indices for October 2010 supports a double dip theory. According to the report, home prices have continued recent declines, with home sales down year-over-year and the supply of unsold homes up from October 2009. ^[3] While home prices are not expected to fall much further over the coming year, current expectations do not indicate much confidence in growth prospects. ((Bloomberg: Home Prices in US Will ‘Bounce Along the Bottom’))

These trends could spark downside to our current forecasts for the North American plumbing, electrical & kitchen product segment, as profitability is largely driven by construction activity and the overall housing market. We currently project that the aggregate size of this market will increase at an annual growth rate of 4.3%. However, if more moderate growth limits this number to 2% (meaning the market reaches $105 billion by the end of our forecast period) it would imply 5% downside to our $36.65 price estimate for Home Depot’s stock, bringing our number in line with market price.

1. BusinessWire: Fitch: Modest Upswing Likely for U.S. Home Improvement Spending [↩]
2. US Census Bureau News: November 2010 Construction at $810.2 Billion Annual Rate [↩]
3. S&P Indices: US Home Prices Weaken Further as Six Cities Make New Lows According to S&P/Case-Shiller Home Price Indices [↩]