Home Depot, Lowe's, and Restoration Hardware Investors: Should You Care About Lumber Liquidators’ Problem?

Lumber Liquidators is blaming macro-environment trends for its sudden fundamental collapse, but if correct could other large home-improvement companies experience similar problems?

Jul 13, 2014 at 1:00PM

A 22% stock collapse in shares of Lumber Liquidators (NYSE:LL) was the talk of the market on Thursday, as a second-quarter warning created industrywide fear. Nonetheless, other large home-improvement companies like Home Depot (NYSE:HD), Lowe's (NYSE:LOW), and Restoration Hardware (NYSE:RH) all saw their valuations drop following the news from Lumber Liquidators. However, how relevant is Lumber Liquidators' warning to each of these three noted companies?

The most alarming statement
Lumber Liquidators' second-quarter and full-year warnings were without warning and surprising, to say the least. But perhaps even more alarming than its guided 7.1% decline in same-store sales for the second quarter and its revised downward full-year revenue and profit guidance were the words spoken by CEO Robert Lynch.

Lynch admitted that customer traffic to the stores was weaker than expected, which was evident by the 5.3% decline in customers invoiced. However, he attributed this sudden decline to weak macroeconomic trends, basically saying that consumers are no longer remodeling their homes and that existing home sales have been weaker than expected.

Lynch called this period of hardships a "prolonged purchase cycle" that is expected to continue into the fall flooring season and perhaps through spring of 2015. In other words, it's hard to predict when large-ticket home-improvement orders in this space will return to normal, or show strength, which is an alarming observation in the space.

What does this mean?
Lumber Liquidators' CEO did not evoke confidence on his conference call, with all signs indicating that this is a real macro-related problem and the timetable for a turnaround is uncertain. Albeit, if slowdowns in existing home sales and remodelings are to blame, then investors must be a little worried about Home Depot and Lowe's.

Just last month Home Depot presented at Oppenheimer's Consumer Conference and reiterated full-year comparable sales growth of 4.6% and a 70 basis point improvement in the operating margin to 12%. However, it's worth noting that Home Depot did in fact miss both revenue and earnings-per-share expectations during the first quarter.

Lumber Liquidators had a rough first quarter as well with a 0.6% decline in comparable sales but was banking on a strong second half of the year following strong demand in May. Conveniently, Home Depot also expected increased demand in the back half of 2014 and noted strong May sales on its first-quarter conference call.

As for Lowe's, it too has followed the same path as its home-improvement peers, including a weak first quarter and mention of strong May sales. Albeit, it's very possible that Home Depot and Lowe's are both seeing the weakness mentioned by Lumber Liquidators' CEO Robert Lynch or that we could soon hear similar tones of caution in upcoming earning reports.

A glimmer of hope
In retrospect, Lumber Liquidators is a billion dollar company, hardly comparable to the enormous presence of either Home Depot or Lowe's. Therefore, investors should keep in mind that while Lumber Liquidators' business revolves around flooring, both Lowe's and Home Depot are far more diverse and benefit from other areas of strength -- like a 4.6% increase in building materials and garden sales reported in last month's retail-sales report.

The problem is that Home Depot and Lowe's have high expectations, and if a large industry like flooring is underperforming, it could be just enough to cause both companies to miss expectations; or it could flow into other segments of home improvement as a sign of future weakness.

With that said, the only real exception to flooring weakness and fears of declining demand in home improvement is Restoration Hardware. This is a company that caters to the wealthy, or a high-end clientele, with gallerias filled with sofas, rugs, bedroom sets, etc. all individually created from hundreds of vendors with the finest materials.

Restoration Hardware has grown its comparable-store sales by 57% over the last two years with 69 stores and has guided for peak sales in excess of $5 billion as it expands throughout the U.S. In other words, demand remains high for Restoration Hardware, as the company's not exposed to the broader demand of home improvement.

Foolish thoughts
Lumber Liquidators' guidance may seem insignificant for the sector, but the sudden warning and mention of macro events should create at least some concern among Home Depot and Lowe's investors. These are stocks that have had great multi-year runs, but if in fact we're approaching a rough period in the cycle, investors should expect lower days ahead.

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Brian Nichols owns shares of Restoration Hardware. The Motley Fool recommends Home Depot and Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators. 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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