As the COVID-19 pandemic began to sweep through the United States early last year, state governments imposed restrictions regarding which businesses could remain open. The goal was to reduce the spread of the virus, but keep essential services open. Home Depot (HD 0.74%) was one of the retailers allowed to continue operations. That proved to be a major tailwind for the home improvement store as it could remain in business at a time when consumers had limited options to spend money.
Fast forward to the present. With over 150 million doses of the vaccine already administered across the country, many of the restrictions on businesses are being removed. This could potentially be a headwind for Home Depot in 2021. Let's see why.
Image source: Home Depot.
Consumers will have more choices on how to spend their money
As states announced stay-at-home orders and people realized they would be working, learning, and entertaining themselves at home for the foreseeable future, spending on home projects surged. And given that Home Depot is the largest home-improvement retailer by annual sales, it stood ready to gain from the rise in spending. This partly explains why revenue increased 19.9% for Home Depot in its fiscal year 2020.
That rate of revenue growth is far above Home Depot's average growth rate over the last 10 years, which was just 6.9%. Shareholders should not expect the elevated level of growth to continue much longer. As lockdown restrictions ease across America, consumers will be eager to get out of their homes and spend on travel, leisure, and other outdoor entertainment -- areas with virtually non-existent spending last year. That, in turn, could leave a much smaller share of income available for home improvement services in 2021, versus last year.
In fact, it wouldn't be surprising if spending on outdoor activities this year races past pre-pandemic levels. Pent up demand from folks desperate to get out of their homes could further hurt home improvement budgets, and unfortunately, Home Depot could bear the brunt in the near term.
Home Depot is increasing its operating profit margins. Image source: Home Depot.
What this could mean for shareholders
That being said, management isn't probably expecting higher levels of spending to continue indefinitely. The boost in business, however, was a nice injection of revenue and allowed the retailer to deepen its relationship with customers while introducing itself to new consumers. Further, if there's a drop in sales this year as consumers make up for lost traveling, going to ball games, and other outdoor activities, it'd likely be short-lived. Eventually, weeds will grow out, pipes will burst, water heaters will need replacing, and the seemingly never ending list of home maintenance activities will scream for attention.
Additionally, homeownership is on the rise. Since 2016, the share of households that own rather than rent a home has increased from 63.1% to 65.6%. Why does that help Home Dept? Home owners are more likely to spend $20,000 upgrading a kitchen, or $5,000 upgrading a bathroom than renters. An increasing homeownership rate means more spending on upgrading and maintaining homes, which points to more sales for Home Depot.
For these reasons, investors interested in the home improvement retailer should not be scared away because of short-term volatility in business conditions. Home Depot is a top-tier retailer with a history of excellent business performance, and has proven that it can withstand headwinds.
