Home Run: Real Estate's 2020 Surge Could Give Home Depot, Lowe's A Boost

Real estate firm Zillow Group Inc Z recently reported a great quarter, exceeding the company’s own outlook and sending its shares up by double digits. “Homes are flying off the shelves,” CEO Richard Barton told CNBC in an interview.

Which could be great news for Home Depot Inc HD and Lowe’s Companies Inc LOW as those two home improvement retailers prepare to issue earnings reports of their own next Tuesday and Wednesday, respectively. What’s good for the goose is good for the gander, the old saying goes, and the booming real estate market has investors optimistic that the home improvement sector can continue to benefit. Home sales rose 5.6% last year to the highest pace since 2006, according to the National Association of Realtors (NAR).

If 2020 was the year it felt like everyone was moving to larger homes for more space where they could hunker down with their families, then 2021 might be the year when those same home buyers look around at the four surrounding walls and start thinking about what they don’t like and how to change it. If that’s the case, HD and LOW are perfectly positioned thanks to all they’ve been doing.

However, both companies will soon be comparing earnings with their 2020 results, which benefited from the pandemic. That means some analysts think further earnings gains might be a bit more limited as 2021 proceeds, a possible reason why shares of both companies are about as flat lately as that kitchen counter you’re planning to install.

Comeback Kid And The Old Veteran

LOW has been on the comeback trail as the momentum player the last few quarters, posting several strong earnings results in a row. HD has been more of the rock-solid old hand (see chart below).

FIGURE 1: LOW SHARES WAY AHEAD OF HD. This one-year chart of Lowe’s (LOW—blue line) vs. Home Depot (HD—purple line) shows LOW running way ahead of the S&P 500 Index (SPX—candlestick), while HD has lagged vs. the SPX. Shares of both HD and LOW have been a bit on the flat side over the last three months as some investors wonder if the best pandemic sales might be behind the companies and worry about tough comparisons ahead. Data sources: S&P Dow Jones Indices, NYSE. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Where they both compete heavily is for business from small contractors, the people you hire to build a new bathroom or kitchen. Recognizing that, both stores—HD in particular—have reached out to the on-the-go retail shopper and small contractor with more pick-up and delivery options during the pandemic. For instance, HD recently made it easier for small contractors to park near the stores to ease logistics.

With both companies’ earnings reports, the makeup of sales growth and projections will likely matter to investors. They may tolerate weakness in the “do-it-yourself” category as long as there’s positive news from the professional segment.

Stocks Diverge As Lowe’s Gains Ground

The two companies may be benefitting from the same tailwinds, but their stocks haven’t flocked together. LOW is up 43% over the last year, more than double the S&P 500 Index (SPX). HD, however, is up just 14%, trailing the SPX. Of course, it’s not totally an apples-to-apples comparison. HD, with a market-cap of nearly $300 billion, is more than twice the size of LOW. Also, HD has twice the dividend yield of LOW, meaning investors have benefitted in other ways from owning it besides direct market gains. (Though it’s important to note that dividend continuance is never guaranteed).

Last month, HD got an upgrade from a Guggenheim analyst, who said company spending should slow later this year and help margins. Guggenheim also thinks HD might begin to repurchase shares at some point this year. That, along with higher margins, a healthy housing market, and success with consumers it attracted during the pandemic, leaves the analyst confident about Home Depot “re-establishing the path to high-single-digit EPS growth,” Barron’s reported.

HD hasn’t stood still. Last November, it announced an agreement to acquire HD Supply Holdings, Inc., a leading national distributor of maintenance, repair and operations (MRO) products in the multifamily and hospitality end markets. At the time, HD said it expected the $8 billion acquisition to accelerate sales growth and be accretive to earnings in fiscal 2021. Analysts say this positions HD well in a $55 billion market. Listen for potential updates on this deal during HD’s call.

It’s also potentially a shot across the bow at LOW, which is also trying to position itself in the so-called “professionals” market, meaning those small contractors we talked about earlier, not just do-it-yourselfers.

Lowe’s And Home Depot Earnings And Options Activity

When Lowe’s releases results ahead of the bell on Feb 24, it’s expected to report adjusted EPS of $1.20, vs. $0.94 the prior-year quarter, on revenue of $19.33 billion according to third-party consensus analyst estimates. Revenue is expected to be up 20.6% year-over-year. 

Options traders have priced in about a 4.4% stock move in either direction around the upcoming earnings release Implied volatility was at the 18th percentile as of Thursday morning.  Looking at the Feb. 26 options expiration, calls have seen activity at the 180 strike, while put activity has been light, with a concentration at the 172.5 strike.

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Home Depot—which reports ahead of the open on Tuesday, Feb 23—is expected to report adjusted EPS of $2.59 vs. $2.28 in the prior-year quarter, on revenue of $30.56 billion, according to third-party consensus analyst estimates. Revenue is expected to be up 18.5% year-over-year.

Options traders have priced in about a 2.8% stock move in either direction around the coming earnings release. Implied volatility has been muted—at the 9th percentile as of Thursday morning.

Looking at the Feb 26 options expiration, put activity has been relatively quiet, with small concentrations at the 250 and 265 strikes. Calls have seen a bit more activity, particularly at the 290 strike.

Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation to sell the underlying security at a predetermined price over a set period of time.

Can Q4 Sales Growth Match A Sizzling Q3?

HD had an amazing Q3, with sales up 24%, but the stock sagged lately. Some analysts worry that HD (and, to some extent, LOW) won’t be able to sustain 2020 levels of growth once the pandemic recedes. One thing investors may want to listen for on the calls is what executives have to say about the rest of the year. HD has shied away from providing a full-year outlook, at least so far. Will that change?

Another thing HD investors are watching is expenses. The company charged ahead as a good corporate citizen last time out, announcing that some of the temporary employee compensation programs it started during the pandemic will become permanent wage increases. That means around $1 billion in additional expenses per year. It’s hard to fault a company for supporting its employees during these tough times—in fact, it’s worth a salute. But in dollars and cents terms, that might be one factor taking a small bite out of earnings growth.

Last time out, LOW delivered a slight disappointment with Q3 earnings. Its outlook came in a little short of Wall Street analysts’ expectations, hurt by higher costs and rising expenses in its e-commerce platform.

Same-store sales did rise 30% year-over-year for LOW in Q3, so that could be a level to watch in Q4 to see if the momentum carried over. There was no sign of a slowdown in the housing market at the end of last year, which is why some analysts remain optimistic that LOW and HD could report strong sales growth again in their Q4 results.

Another thing to listen and look for when the companies report is how their executives see things playing out if there’s another government stimulus. Political chatter in Washington is that a $1.9 trillion stimulus, which would include $1,400 checks to many Americans, is likely to pass Congress and be signed by President Biden next month. A stimulus that sent $600 checks took effect in December, and January U.S. retail sales jumped 5.3%. So evidently, those checks are getting spent. More checks to consumers could potentially wind up being more money in the bank for retailers like HD and LOW.

The equation gets even better if the economy continues to recover from Covid. One near-term worry, however, is how the frigid February weather across much of the U.S. might affect sales for big retailers. Early indications point to a bit of a slowdown, especially in states like Texas that were hard hit by the storms and not used to digging out of snow.

Of course, if the snow and ice damaged homes, that’s another potential opportunity for the home improvement business. Remember that other old saying: “’Tis an ill wind that blows no one some good.”

TD Ameritrade^® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

Photo by Annie Gray on Unsplash