Rising Home Prices Are Good for Home Improvement Retailers

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Home prices continued their year-long advance, according to the S&P/Case Schiller Home Price Indices. The latest data released on Sept. 24 showed that prices continued to rise through July. This is good news for both home-improvement retailers and long-term investors.

A brief look at home prices
The S&P/Case Schiller Indices are the leading measure of U.S. home prices. The outfit reported that prices rose 12.3% and 12.4% in the 10- and 20-city composites, respectively, year-over year. Furthermore, prices rose 1.9% and 1.1%, respectively, from June.

Moreover, the advance in home prices in July is part of a four-month trend for all 20 cities. The real bright spot is in Phoenix, where home prices have risen for 22 consecutive months (the housing market in Arizona suffered greatly when the housing market collapsed at the start of the financial crisis).

 "Home prices gains are holding their 12% annual rate of gain established by the two composite indices in April," said David M. Blitzer, chairman of the index committee at S&P Dow Jones Indices.

But these rosy numbers also present some mixed signals. While home prices in all cities have increased, the monthly rates moderated in July compared to the increases from April to June. In sum, the composite shows the Southwest region is leading the housing market recovery, but all cities there remain far below peak levels.

Mr. Blitzer also noted the 1% spike in mortgage interest rates over the summer caused mortgage applications to fall -- an indication that the rate increase affected the housing recovery. The downward trend in mortgage applications continued in September and may be a sign that the housing market is retreating.

Home-improvement retailers' performance
What do these home-price reports and mortgage-application figures mean for investors?

Home Depot (NYSE: HD  ) head honcho Frank Blake recently said that rising home prices this year will boost spending on renovations, despite the spike in mortgage rates and downward pressure on the housing market.

Home Depot is the leader of the big-box home-improvement retailers. The company's main rival, Lowe's (NYSE: LOW  ) , also has its strengths when it comes to lawn care and furnishings. Both outfits have a history of solid earnings and revenue growth. 

For the second quarter of fiscal 2013,  Home Deport reported net earnings of $1.8 billion and diluted earnings per share of $1.24. Moreover, net sales increased 8.5% to $41.6 billion in the first half of this year, compared to net sales of $38.4 billion in the first 6 months of 2012.

Meanwhile Lowe's also posted solid second quarter results as the company pivoted from lawn care products to lawn furniture, as well as indoor items like kitchen appliances. Net earnings for the second quarter of 2013 increased 26% to $941 million, while net sales grew 10.3% to $15.7 billion compared to the same time frame in 2012.

"As home prices go up, people start going, 'OK, my house is now back to being a significant source of value for me'," Blake said.

In a related development, Lumber Liquidators (NYSE: LL  ) hit a rough patch after feds recently swarmed the company's headquarters looking for clues connected to potential problems about hardwood sourcing. The company is a rival of Home Depot and Lowe's, but it has a niche in the hardwood-flooring game.

The outfit acknowledged in late September sealed search warrants were executed at its corporate offices in Toano, VA and Richmond, VA by the Department of Homeland Security's immigration and customs enforcement and the U.S. Fish and Wildlife Service.

Of course this caused some lumberjacks (er, traders) to head for the hills, and the uncertainty over how this will play out may throw a wet blanket on Lumber Liquidators' share price for the time being. Meanwhile, Home Depot may be able to take advantage of this situation, because the company is a self-proclaimed leader in using sustainable wood products. Home Depot's "EcoOptions" website claims more than 94% of its wood comes from responsibly-managed domestic forests; and only a small fraction -- less than 0.15% -- comes from South American rain forests. Finally, the retailer is the first to carry wood certified by the Forest Stewardship Council.

The bottom line
While investors and analysts may argue over which outfit is a better buy, Home Depot and Lowe's peg their gains to the housing market. If the home-price and mortgage-application data does in fact indicate the housing market is slowing down, traders may be inclined to take some money off the table. But for investors with a long-term view, these home-improvement big-box retailers will gain as the housing market gains strength.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

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9/27/2016 4:01 PM
HD $126.82 Up +1.37 +1.09%
Home Depot CAPS Rating: ****
LL $18.01 Up +0.22 +1.24%
Lumber Liquidators CAPS Rating: ***
LOW $71.50 Up +0.69 +0.97%
Lowe's CAPS Rating: ****