There has been an ongoing debate on the US housing sector, its economic performance, and how consumers and builders translated this information into their forward sentiments. The sector performance seems to be weakening again as a result of various factors. Let us take a look at each of them and see what the future holds for the leading companies operating in the sector.
How is Home Depot Doing?
The Home Depot Inc. (NYSE:HD) is a leading home improvement specialty retailer. The company owns 2,260 stores as of its third quarter report, majorly distributed (approximately 88% stores) across the 50 states of United States. Net earnings of the company have fluctuated over the past three quarters due to the ups and downs faced by the topline of the company. As of the third quarter, its net profit margin (NPM) stood at approximately 7% which is lower than the previous quarter but higher than last year's NPM.
Source: Quarterly Statements
To gauge the financial strength of the company I compared the various metrics of the company to the industry. The debt to equity ratio of Home Depot (112.63) is substantially higher than the industry (56.42). At first glance it appears as though the company's balance sheet is weaker than its peers. However, Home Depot's rising CFO and enhanced capacity to pay off debts rejects the notion of weak performance. Home Depot's CFO/debt ratio performance over the past three quarters is shown in the graph below.
Source: Quarterly Statements
In terms of rewarding investors, the company has maintained a strong history of dividend increases. As of the third quarter of 2013, Home Depot paid $0.39 per share of dividends which is 34% higher than the DPS figure last year ($0.29).
Further per share returns are distributed among shareholders through its share repurchase program. As of this year, the company repurchased shares worth $6.4 billion and has not yet stopped its repurchase spree. The practice has increased per share earnings for investors by a stellar 51%. With regards to ROE the return is majorly driven by the company's higher profit margin and better asset management. As far as the financial policy of the company is concerned, it is not a worrying aspect since the company has a significant level of cash flows in its balance sheet that may be used to pay off debt. The breakdown of the Return on Equity (ROE) of the company in comparison to the industry is indicated in the table below.
Now with regards to the industry, both residential and commercial construction growth is expected to show an increasing trend through 2015.The American Institute of Architects (NYSEARCA:AIA) projects the construction industry will show double digit growth through 2015 with 28% growth expected in 2014 and 29% expected growth in 2015. The following graph represents the historical performance of the industry and projected performance based on consensus forecasts. The graph further segregates the expected growth in each component.
Source: For Construction Pros
However, contrary to the estimated growth forecasts, recent home buying activity is declining and this will have a direct hit on home construction and related companies. The numbers gathered in February 2014 indicate that the seasonally adjusted index that assesses the activity of mortgage applications has slipped by 200 basis points to settle at 397.2 as reported by Mortgage Bankers Association. The 30 year mortgage rates are showing a decelerating performance, refinancing applications dropped by 0.20% and home sales fell by 5%. This significantly shook builders' confidence. The National Association of Home Builders (NAHB) revealed the data for its Housing Index, depicting per month drop of 10 points which was the biggest monthly plunge in history. The index settled at 46 as of February.
Source: Wall Street Cheat Sheet
The US economy is weakening again which is evident in the faltering business conditions index coupled with its rising unemployment rate. The general business conditions index published by the New York Federal Reserve Bank's Empire State slumped by 64% settling at 4.48 compared to the estimated figure of 9. Furthermore, student loans have made it difficult for young people to buy a house. As a rough estimate, about 70% graduates today are buried in heavy debt which hampers them from filing a mortgage loan; mortgage loans today have stricter lending policies than ever before. The total student loan figure already amounts to $1.1 trillion as of recent data. Due to the exceptionally high unemployment rate over the years, 11.50% of the student loans are either in default or 90 days past due.
The weakening economy translates into a bleak industry outlook. Even though the company's credentials are strong, how far can a company grow if the industry begins to shrink? However, look at the bright side; where North America shows slowing growth, South America paints a brighter picture. Right now Mexico seems to be an ideal growth region for home construction companies and Home Depot is already expanding its operations in the region. In addition to that the company favorably rewards its investors and maintains a strong balance sheet. It doesn't seem likely that the company will incur losses any time soon. Minus some short term ups and downs, the company is a long term buy.