In his most recent earnings call, Home Depot Chief Financial Officer Richard McPhail couldn’t ignore the harsh reality that rising interest rates are causing customers to shy away from big projects. “Every time you read about it, you see this sarcastic phrase, ‘interest rates are coming down,'” McPhail said of the prospect of future interest rate declines while speaking with investors on the company’s May 14 earnings call. “Customers are saying, ‘we’ve got to keep that in mind and it’s on the way, so we’ve just got to wait.’ So, from a revenue standpoint, that’s the most important trend.” Lowe’s echoed that sentiment on its first-quarter earnings call on May 21. Despite beating analysts’ expectations, the company is seeing signs that shoppers are avoiding big projects, especially those that require hiring contractors. “Uncertainty around interest rate cuts, persistent inflationary pressures, and consumers’ continued preference for spending on discretionary services and experiences continue to weigh on DIY home improvement demand,” Lowe’s CEO Marvin Ellison told investors. Home Depot said sales tickets over $1,000 in the first quarter fell 6.5% year over year, with discretionary projects being postponed further. At Lowe’s, tickets over $500 fell 7.6% year over year. Both companies are seeing customers take on much smaller DIY projects. It’s unclear how long this trend will last, but it certainly depends on the direction of interest rates. The Federal Reserve has signaled a possible rate cut this year, but with inflation remaining elevated, the market expects no rate cuts for several months. Analysts say that will keep pressure on both Lowe’s and Home Depot stocks. Still, some believe that if the Fed eases monetary policy and consumers exercise some pent-up demand, there will be an opportunity for patient investors. HD LOW YTD mountain Home Depot and Lowe’s have underperformed the overall market this year. “We still believe there is limited near-term (6-12 months) equity upside potential given valuations and ‘high for longer’ interest rate trends,” KeyBanc analyst Bradley Thomas wrote in a research note on Tuesday, reiterating his sector-specific weightings. “However, [we] “We see Lowe’s as a long-term beneficiary if the weak housing market recovers.” Both stocks have underperformed the broader market. Lowe’s shares are down more than 2% this year, while Home Depot’s are down more than 5%, while the S&P 500 is up more than 11%. Projects on hold “Project demand is important for both Home Depot and Lowe’s,” Greg Melich, consumer and retail analyst at Evercore ISI, said in an interview with CNBC. “You put all of that together and Home Depot’s [same-store sales growth] “We expect the third quarter to be negative as well, but the negative margin will be smaller,” he said. The trend is not surprising given the high-interest rate environment that is putting pressure on consumers. For example, the average interest rate on credit cards has reached a record high this year. But it’s not all bad. Homeowners have more equity in their homes than they did before the pandemic, according to a May 8 report from real estate data firm ATTOM. That could make them feel wealthier and more confident to use that cushion to trade up to a bigger home or borrow against it when interest rates fall to fund projects like a new deck or bathroom renovations. The share of so-called equity-rich mortgages rose in 23 states from the fourth quarter of 2023 to the first quarter of this year, though by less than a percentage point, according to the firm. Homeowners’ equity levels remain high compared to before the pandemic. Lower interest rates could be a boon for Home Depot and Lowe’s, as rising home equity levels combined with a willingness to take on postponed projects. “Rising interest rates are causing customers to postpone large discretionary projects,” said Michael Lasser, an analyst at UBS. “That means the recovery should be robust as interest rates fall.” The analyst maintains a buy rating on the stock but lowered his price target to $400 from $411 following Home Depot’s earnings report. Lasser’s forecast suggests a 23% upside ahead. For the time being, consumers are being forced to only make repairs that are absolutely necessary, Merrick said. Some are “down-trading,” or looking for cheaper alternatives in terms of materials or the overall scale of the project, he said. “Life happens and homes are formed,” Merrick said. “At some point, [people] You have to accept that that’s the price to pay [and] That’s interest rates,” Melich said. A surprise in Home Depot’s first-quarter results was the strong consumer interest in its products, even as the company marked down prices on larger projects. That could bode well for Home Depot in the long run, and Melich thinks investors have an opportunity to buy the stock “at market multiples relative to its sluggish earnings.” His base case of $390 a share suggests a 20% upside from Friday’s closing price of $325.10. Wolf Research analyst Greg Badishkanian also expects homeowners to renovate their homes if interest rates fall, supporting his outperform rating and $401 a share price target on Home Depot. Badishkanian’s forecast is for an upside of more than 23% going forward. “As long as interest rates remain relatively high, sales of existing homes will also remain a major headwind for remodeling activity,” Badishkanian said. Turning to the ProsFor burst pipes and leaky roofs, homeowners are likely to turn to professional contractors.That piece of business, pros, is a top priority for both retailers. Home Depot leads Lowe’s in the pros category, with about half of its business coming from pros, compared with 20-25% for Lowe’s. Lowe’s stock has languished so far this year. Home Depot is making a push into the sector with its planned acquisition of specialty retailer SRS, its biggest move yet to grab a bigger share of what Home Depot CEO Edward Decker calls a $250 billion market. Still, Lowe’s efforts to grab pro market share appear to be gaining momentum. In the first quarter, the company revealed a small profit in its pros segment, helping to offset troubling losses in its DIY business. KeyBanc’s Thomas said the positive shift comes as Home Depot’s pros same-store sales are trending negative. Under Ellison, Lowe’s has also been working to improve customer engagement and e-commerce. “Beyond the private brands, management will continue to build out its pro initiatives and undertake several new pro-related activities, including converting Lowe’s Pro Cardholders to the company’s new pro loyalty and credit program and launching new online tools that allow pros to create and update online quotes from anywhere,” Thomas said. Analysts surveyed by FactSet, on average, expect Lowe’s shares to rise about 17% from Friday’s closing price. “While the near-term outlook remains difficult to read, we remain confident in the industry’s medium- and long-term outlook as our core demand drivers are all driving growth,” Lowe’s Ellison said recently.
Rising home equity levels could stimulate underlying demand for these two stocks.
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