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Will the Worsening Lumber Shortage Derail Home Depot and Lowe's?

By Rich Duprey – Aug 8, 2020 at 7:00AM

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Building on, up, or out on your home is getting increasingly difficult.

Walk into any Home Depot (HD 2.81%) or Lowe's (LOW 3.25%) stores these days and there is a good chance you will be struck by what you don't see: merchandise. Many of the shelves lack products, and what the stores do have is displayed in a way to make the racks seem more full than they really are.

Yet there's one area where the home improvement warehouses can't disguise a lack of merchandise -- their lumber departments. A recent visit to my local Home Depot found the lumber racks virtually picked clean, with just a few stray pieces of dimensional lumber scattered about.

While sheet goods were somewhat better, pricing on even the cheapest grades of plywood were exorbitant, and it was like that at several of the area DIY centers I visited. That doesn't bode well for Home Depot or Lowe's earnings in the coming quarters.

Carpenter installing roof trusses

Image source: Getty Images.

A cascading impact

The lumber shortage is not the fault of either retailer, but yet another bit of collateral damage from the coronavirus pandemic.

Despite having been declared an essential industry, the forestry industry was impacted just like everyone else. Logging companies reduced the number of trees being harvested, lumber mills closed down, and wood did not get pressure-treated.

Yet sitting around with nothing to do, consumers began sprucing up their homes and adding on, as home builders began building again in earnest. But with logging and milling activity slowed or stopped, the home improvement centers have been hit with a lumber shortage, and their prices are soaring.

The pandemic's splintered fallout

Data from the National Association of Home Builders shows framing lumber prices have rocketed 26% higher over the past month, and are about double where they stood a year ago.

Exacerbating the situation is the ongoing trade war between the U.S. and Canada, which resulted in tariffs of 20% being imposed on Canadian imports of soft wood and caused lumber prices to rise 8% higher on average here in the U.S.

With framing lumber accounting for as much as one-fifth of the materials cost of new home construction, and sheathing at double that amount, the soaring cost of building a home, putting on an addition, or even just building a deck is going to put a damper on plans. 

And because restarting forestry production all the way down the supply chain isn't as simple as bringing everyone back to work, it could take several weeks to get production back up to speed. Producers also still face a backlog of orders, so the lumber shortage is a real threat to Home Depot and Lowe's future performance.

Building on demand

The retailers have been big beneficiaries of consumer spending during the pandemic, with Home Depot reporting a 7% increase in revenue last quarter, hitting $28.3 billion, as U.S. comps jumped 7.5% year over year. Lowe's sales were up 11% to $19.7 billion on a 12.3% increase in comps.

Because professional contractors have long been Home Depot's primary customer target, the building materials segment is its biggest contributor to revenue, accounting for $9.8 billion in revenue last quarter, and it enjoyed a 4% sales increase last quarter.

Similarly, Lowe's also saw a spike in demand, even though the contractor has been a relatively recent area of attention. But the new focus is paying off, as building products revenue was its second-best performing segment, with sales rising over 10% to $6 billion.

A mote in their eye

Both home improvement centers are scheduled to report earnings within the next two weeks, and while this period may not show the full impact of the lumber and wood products shortage that has accelerated in recent weeks, expect there to be a reckoning soon.

Shares of Home Depot are up 24% in 2020, nearly doubling from their March lows, while Lowe's stock is 28% higher year to date and has rocketed 135% higher from its nadir (as of Friday's close).

The long-term outlook for the home improvement centers is bright as consumer demand remains strong. But this may be the high point for both retailers for the time being, so investors may want to wait before building a position.

Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Home Depot. The Motley Fool recommends Lowe's and recommends the following options: long January 2021 $120 calls on Home Depot and short January 2021 $210 calls on Home Depot. The Motley Fool has a disclosure policy.

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Stocks Mentioned

The Home Depot, Inc. Stock Quote
The Home Depot, Inc.
HD
$283.70 (2.81%) $7.76
Lowe's Companies, Inc. Stock Quote
Lowe's Companies, Inc.
LOW
$193.92 (3.25%) $6.11

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