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Housing downturn to hit building retailers
Home improvement stocks' valuations stretched: analyst
Jason Chow
Financial Post
We won't be needing as many nails, hammers, screwdrivers, or lumber this year and that means trouble for home improvement stocks, according to Montreal-based firm BCA Research.
After a stellar year, shares in retailing companies like Home Depot Inc. are about to slow. The culprit is predictable: increased mortgage rates.
With government bond yields rising and with expectations the U.S. Federal Reserve is about to begin a major round of interest rate hikes, Montreal-based firm BCA Research sees rising mortgage rates stalling the homebuilding boom. It all adds up to an end to rich valuations in home building retailing stocks.
"I don't think the housing sector is going to tank, but the bulk of the bull market is definitely over," said Mathew Pugsley, U.S. equity strategist at BCA Research.
It won't be long before mortgage rates rise again. Yesterday, the Bank of Canada raised its overnight lending rate by 25 basis points to 2%. Mortgage rates tied to the prime lending rate immediately rose in step and mortgage rates are expected to trend higher across the board in the months ahead in Canada and the U.S.
Over the past year, investors have inflated the price-earnings multiples of building material stocks in anticipation of strong growth in earnings.
But the way Mr. Pugsley sees it, the sector's price/earnings ratios will fall.
"Higher mortgage rates in the second half of the year would slow the record-breaking pace of housing activity.
"This would trigger a compression in relative forward price/earnings multiples for the home improvement retail group." The strategist said he expects the multiples for stocks in the Standard & Poor's home improvement index to fall from its current levels of 36 times earnings to somewhere in the low 20s. He added he's maintaining an "underweight" rating on the sector.
Last year, housing starts were at record levels as consumers scrambled to buy houses, trying to take advantage of low mortgage rates. Investors looking for quick profits also took to the sector, sending stocks shooting upwards.
The S&P home improvement index rose 29% over the past 12 months, with its largest member stock Home Depot (HD/NYSE) rising 20%. Over the same period, the S&P 500 index lost 5%.
Already, the housing market is showing signs of cooling down. The U.S. Commerce Department said yesterday U.S. housing starts plunged 7.8% in March, their biggest drop in two years.
Mr. Pugsley said it was necessary to differentiate between the building retailers and the building suppliers. While the retailing sector have built in expectations of high earnings growth, the suppliers remain cheap, with the S&P home building index trading at a multiple of eight times earnings.
But Mr. Pugsley added his prediction for the home improvement retailers could unfold for the companies that make and sell household appliances. The S&P household appliance index, which includes major brands such as Whirlpool Corp. and Maytag Corp., is also highly leveraged to housing activity and has made 43% gains over the past year.
The effects won't be as dramatic, given that the sector is trading at 16 times next year's earnings. Also, inventory levels are low as the housing boom has increased demand, suggesting that manufacturing output will hold steady to replenish empty warehouses.
jchow@nationalpost.com
Home improvement stocks' valuations stretched: analyst
Jason Chow
Financial Post
We won't be needing as many nails, hammers, screwdrivers, or lumber this year and that means trouble for home improvement stocks, according to Montreal-based firm BCA Research.
After a stellar year, shares in retailing companies like Home Depot Inc. are about to slow. The culprit is predictable: increased mortgage rates.
With government bond yields rising and with expectations the U.S. Federal Reserve is about to begin a major round of interest rate hikes, Montreal-based firm BCA Research sees rising mortgage rates stalling the homebuilding boom. It all adds up to an end to rich valuations in home building retailing stocks.
"I don't think the housing sector is going to tank, but the bulk of the bull market is definitely over," said Mathew Pugsley, U.S. equity strategist at BCA Research.
It won't be long before mortgage rates rise again. Yesterday, the Bank of Canada raised its overnight lending rate by 25 basis points to 2%. Mortgage rates tied to the prime lending rate immediately rose in step and mortgage rates are expected to trend higher across the board in the months ahead in Canada and the U.S.
Over the past year, investors have inflated the price-earnings multiples of building material stocks in anticipation of strong growth in earnings.
But the way Mr. Pugsley sees it, the sector's price/earnings ratios will fall.
"Higher mortgage rates in the second half of the year would slow the record-breaking pace of housing activity.
"This would trigger a compression in relative forward price/earnings multiples for the home improvement retail group." The strategist said he expects the multiples for stocks in the Standard & Poor's home improvement index to fall from its current levels of 36 times earnings to somewhere in the low 20s. He added he's maintaining an "underweight" rating on the sector.
Last year, housing starts were at record levels as consumers scrambled to buy houses, trying to take advantage of low mortgage rates. Investors looking for quick profits also took to the sector, sending stocks shooting upwards.
The S&P home improvement index rose 29% over the past 12 months, with its largest member stock Home Depot (HD/NYSE) rising 20%. Over the same period, the S&P 500 index lost 5%.
Already, the housing market is showing signs of cooling down. The U.S. Commerce Department said yesterday U.S. housing starts plunged 7.8% in March, their biggest drop in two years.
Mr. Pugsley said it was necessary to differentiate between the building retailers and the building suppliers. While the retailing sector have built in expectations of high earnings growth, the suppliers remain cheap, with the S&P home building index trading at a multiple of eight times earnings.
But Mr. Pugsley added his prediction for the home improvement retailers could unfold for the companies that make and sell household appliances. The S&P household appliance index, which includes major brands such as Whirlpool Corp. and Maytag Corp., is also highly leveraged to housing activity and has made 43% gains over the past year.
The effects won't be as dramatic, given that the sector is trading at 16 times next year's earnings. Also, inventory levels are low as the housing boom has increased demand, suggesting that manufacturing output will hold steady to replenish empty warehouses.
jchow@nationalpost.com
