A long-dreaded nightmare might be coming true for the housing sector.
How are home improvement retailers like Home Depot HD and Lowe’s Companies LOW being affected by a possible market correction in the housing sector?
Investors will be watching for a read-through for the housing sector when the two companies report earnings Tuesday and Wednesday, respectively.
The Pandemic Housing Boom
U.S. home prices have been on the rise since the pandemic started.
According to Zillow, the median U.S. home grew in value by $52,667 between December 2020 and December 2021.
Data from the St. Louis Fed shows that the price of houses in the country jumped by a staggering 42% between March 2020 and June 2022.
Reasons behind the boom are ample. One comes from a substantial change in the living habits of most Americans during the pandemic. The advent of remote work gave city dwellers the ability to work from anywhere, driving up prices of homes outside the main urban centers.
Real estate also became a target for large-scale institutional investors, who purchased 24% of family homes during 2021, as per a report by Pew.
The ongoing hike on interest rates by the Fed was anticipated to have a consequence on home prices: as the cost of borrowing rises, buying a house becomes increasingly difficult for the middle class.
Mortgage purchase applications are down 41% year-over-year. The effects are already visible, according to the Mortgage Bankers Association. For the first time since 2012, the St. Louis Fed recorded a drop in housing prices. The value of homes dropped on average 1.3% between June and August — which is when most recent data comes available.
Diane Swonk, chief economist at KPMG, told Fortune that “we’re easily going to see large double-digits declines. I think 15% next year is very conservative. We’re already turning.”
Can The Homebuilding Sector Shed Light On The Housing Market?
Looking at search data for keywords in the homebuilding sector, a new report by Bank of America says that “web traffic trends for homebuilders are surprisingly strong given elevated mortgage rates and a return to more normal seasonality.”
Web traffic to homebuilder websites was flat in October on an year-over-year basis, but up 20% on a two-year basis.
The firm said that interest in home ownership remains elevated and there is pent up demand, but macro concerns and affordability are weighing on sales.
In other words, people are still looking to buy homes, but the macro environment is not making it easy. Buyers could also be speculating on a future housing market crash before making a purchase.
This data gives hope for those fearing a looming crash. While the drop in sales is likely to drive a drop in prices, this one might be more modest than previous housing bubble bursts like the one seen during the Great Recession of 2008.
Another argument for a milder correction comes from housing inventory. Builders remember the 2008 recession and are not looking to make the same mistakes. Back then, one of the issues behind the 33% drop in house prices was an accumulated oversupply of properties.
Housing supply continues to be low, as builders are not building quickly enough to meet demand, according to a report by Bankrate.
Will Homebuilding Retailers Be Affected?
This week is earnings season for Home Depot HD and Lowe's Companies LOW, which will release earnings reports on Tuesday and Wednesday, respectively.
The two companies’ base operations revolve around the sale of home improvement items and building materials, as well as gardening and decoration supplies.
Analysts are concerned the struggles facing the housing sector could spill over to Home Depot and Lowe’s.
Historically, these retailers have been able to weather recessions as home improvement is a basic need in most households.
Home Depot is the largest home improvement retailer, and its shares are down 23.7% this year, underperforming the S&P 500’s 18% decline.
The company’s performance this year has been exceptional: it reported record quarterly sales in the second quarter.
Last week, Goldman Sachs issued a new report maintaining a Buy rating for Home Depot but dropping its one-year price target from $366 to $329. Jefferies also called the stock a Buy last month.
The stock was trading at $311 Monday.
According to Yahoo Finance’s Faizan Farooque, Home Depot has consistently generated positive free cash flow over the past 10 years, as well as consistent growth across the board. Still, the company could suffer from low inventory levels hitting retailers across industries due to global supply chain disruptions.
Lowe’s is the second-largest home improvement retailer. The company’s shares traded at $207 at the time of this writing.
Goldman Sachs also maintained a Buy rating for Lowe's last week and dropped its price target from $252 to $226.
Last week, the company announced it has signed a deal to sell its Canadian operations to private-equity firm Sycamore Partners for US$400-million in cash plus unspecified benefits.
In the second quarter, sales for Lowe’s showed a drop in year-over-year sale. Yet, on a long-term basis, the company has been a solid Buy. In the last 15 years, Lowe’s outperformed the market by 7.92%.
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