Low interest rates and stay-at-home trends gave home improvement and home and garden companies a big boost over the past two years. But their fortunes have changed in a climate of rising interest rates, falling house prices, and increasing economic anxiety.
The two giants of home improvement – Home Depot Inc. HD-N increase and Lowe’s Companies Inc. LOW-N increase – have both posted good earnings this year, but looking ahead they have warned of challenging conditions.
In the meantime, their shares have sold off more than broader market indexes. Even with the summer rally, Home Depot has fallen 30 per cent year-to-date, while Lowe’s is down 25 per cent.
Another player in the home and garden space, but with different fundamentals, has been hit even harder. Scotts Miracle-Gro Co. SMG-N increase, whose lawn and garden products are staples at both chains, has seen its shares fall 70 per cent this year. A cold spring in Canada and the northeastern U.S. states cut demand and the larger macro issues affecting Home Depot and Lowes have weighed on the stock.
For investors, the question is whether to take advantage of the sell-off and jump in or wait for even better prices. The consensus seems to be that until central banks signal that interest rate increases have peaked, there’s more weakness ahead.
“As a group, a lot of things are weighing on home improvement retailers,” says Brooke Thackray, research analyst with Horizons ETF Management (Canada) Inc. in Toronto. “There’s a confluence of events that make it very difficult for them – rising inflation and interest rates and a slowing economy.”
Rene Reyna, head of thematic and specialty product strategy for Invesco Inc. in Munster, Ind., adds that for this space to turn around, we have to get close to where we believe the U.S. Federal Reserve Board is done tightening.
“In the past, coming out of recessions, we have seen this space accelerate after that tightening bottom, if you will,” Mr. Reyna says.
Home Depot and Lowes make up about 10 per cent of the Invesco Dynamic Building & Construction ETF PKB-A increase. The exchange-traded fund (ETF) has three main components, which are behaving differently. One is big box retailers that sell building supplies and related products for residential and commercial renovation projects. Demand is weakening as consumers cut back.
Another is companies that build large infrastructure projects including highways and bridges. Mr. Reyna says they will be helped by the stimulus in the recently passed US$1-trillion infrastructure package in the U.S. Their prospects are better. The third is manufacturers of building materials who are muddling along.
The ETF has US$115-million in assets under management and has mirrored the sector decline, falling 31 per cent year-to-date.
The analysts say that while Home Depot and Lowes have rallied, they may fall back in the months ahead and reset.
“I think it’s more pain to come with higher interest rates,” Mr. Thackray says.
The renovation play
Even so, the big box retailers have underlying strengths. In the face of changing conditions, some would-be home sellers have opted not to list, but to do essential upgrades instead. That’s providing demand for building materials.
As the backlog of renovation projects gets underway, that demand is also providing support. Mr. Thackray says if you drive around your neighbourhood, you’ll see plenty of signs of new projects. But he cautions the momentum may not continue as they were commissioned a while ago and have been waiting to get going.
Even if interest rate increases stop and inflation eases, the betting is that it will take a while for the housing market to lift off again.
When home prices took off during the pandemic, the wealth effect kicked in. People felt good as their net worth rose on paper and spent money on improvements. They feel less wealthy now and less inclined to spend. That sentiment will take time to change.
“Homeowners are asking, ‘Do we really want to redo the kitchen, or can we get by for another year?’” Mr. Thackray says.
Scotts Miracle-Gro chief executive officer Jim Hagedorn acknowledged in a recent conference call that the two pandemic years had an extraordinary impact on its business. Scotts is one of the world’s largest marketers of lawn and garden care products including grass seeds, soils and Miracle-Gro, which is a best-selling plant food.
Mr. Hagedorn notes that Scotts saw 10 years of consumer-led growth in two pandemic years. That pace was unlikely to continue, but by any standard, Scotts sell-off has been severe. Its shares are trading at levels last seen in 2013, even though it has increased its dividend twice in the past two years as well as issuing a special cash dividend.
In its latest quarter, profit beat estimates, although sales missed. Mr. Thackray notes that Scotts has become “a show-me stock” with investors waiting for evidence of a turnaround.
So, what’s an investor to do? Both analysts point to caution. A housing market recovery is a key element and that’s not likely to happen soon.