Play the Housing Market With Home Improvement Stores

Play the Housing Market With Home Improvement Stores

It looks like the recovery in the US housing market is really starting to pick up steam, as not only the macro numbers coming out recently have been favorable, but also the earnings from housing-related companies. Lowe's , the second-largest US home improvement retailer by market cap, recently came out with earnings that easily beat estimates. Its larger rival Home Depot likewise reported some encouraging results. With homebuilders also optimistic about the prospects of the US housing market, we may be in for another boom. Based on the macro numbers and recent earnings, home improvement stores look like a good bet for those willing to get in on the US housing market recovery.

Lowe's at a glance
Lowe's is a well-known American home improvement retailer. With a market cap of $47.1 billion, and some 1,758 retail locations, it is a large company, but not quite as large as its prime competitor Home Depot. It offers a range of DIY and DIFM products to consumers and businesses. Up an impressive 74% over the last year, the stock's performance clearly reflects resurgence in the US housing market. It offers a decent 1.60% dividend yield at a fairly low payout ratio of 37%.

Healthy demand
Americans are buying homes again. With double-digit growth in home sales as well as home prices, this is hard to dispute. However, they are also building more homes. Housing starts increased by nearly 21% compared to a year ago, with a 12.4% increase in the number of building permits for private homes. This growth is expected to continue, albeit at a slightly slower pace.

This is all good news for Lowe's, which reported a great quarter. Diluted EPS of $0.88 beat the $0.79 consensus and was up an impressive 37.5% year over year. Sales increased 10.3% to $15.7 billion for the quarter, with comp sales for the quarter up 9.6%.

Its gross margin improved 42 basis points to 34.35%. Product categories that saw especially strong demand included kitchens and appliances, lawn and garden and plumbing, while things such as hardware and flooring lagged.

Despite these strong results, management perceives a gap between intent to purchase and actual closing rates, which it intends to reduce through a more efficient offering of inventory, increasing the proportion of weekday labor, and increased product differentiation.

Taking this into account, the company expects sales growth of around 5% for full-year 2013, with a 4.5% increase in comp sales. Expected EPS of $2.10 is up from $1.75 in the previous year. However, Lowe's isn't the only company benefiting from the strong housing market.

Broader housing strength
Lowe's major competitor Home Depot also came out with some fairly strong results recently, benefiting from the same macro conditions. EPS of $1.24 beat by $0.03 and was up nearly 23% compared to the year-earlier period, with sales up around 9.5%. Perhaps more importantly, the company raised its full-year guidance again, now expecting an increase in sales of 4.5% with comp sales up 6%.

With 2,252 stores and a market cap of around $110 billion, Home Depot is considerably larger than Lowe's and as such may enjoy some scale advantages; yet, there isn't much to separate the two in terms of growth looking ahead to the full-year.

Homebuilders are the other natural beneficiaries of a stronger housing market, and their earnings reflect this as well. Toll Brothers , one of the larger American luxury homebuilders, sees a significantly improved market in 2013, with average sales contracts per community around the same level as they were in 1997-1998.

For the full-year, the company is expecting to deliver between 3,925 and 4,125 homes with revenue between $2.46 billion and $2.62 billion. This compares to a total of homes delivered 3,286 in 2012, and revenue of $1.88 billion. Citing the University of Michigan consumer sentiment survey, and the slowly improving job market, management is confident that the housing rebound will continue to take hold.

Valuations and metrics

Home improvement stores don't look cheap at the moment, but also not outrageously expensive. Lowe's trades at 26.26 times trailing earnings, and Home Depot at 23.44. Toll Brothers however looks like a steal at 10.9 times trailing earnings versus the 15.65 home construction industry average. Lowe's trades at only 0.94 to sales, compared to Home Depot's 1.43, with gross margin more or less equal. Based on these metrics, it's hard to call a clear winner between the two.

The bottom line

Clearly, the US housing market is picking up, which is reflected in home improvement retail earnings. Lowe's beat estimates easily for the quarter, and expects a solid performance throughout the year. However, so does its main competitor Home Depot. In any case, those that wish to benefit from an improving housing market might look toward home improvement stores for solid growth.

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Daniel James has no position in any stocks mentioned. The Motley Fool recommends Home Depot and Lowe's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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