Have You Missed the Opportunity to Make Money on the Housing Recovery?

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Do you blame yourself for not being smart enough to read the housing recovery in advance? Do you believe that you have missed a golden opportunity to make money since the stocks might have priced in the housing recovery? Well, in most cases, especially in building stocks, (or stocks that are directly related to first phase of home building), what you believe is absolutely right. However, there are certain sectors that still haven’t priced in the housing recovery given that they come in at the second phase of home building. One of the prime examples is home improvement retailers.

Home Depot (NYSE: HD): Despite HD’s strength and above-average valuation, the Street is bullish on this name ahead of a housing recovery. This company has proven its ability to deliver sales and margins before any signs of a housing recovery. It has done so through internal changes, stronger execution, and smart management. That points to even more upside. Late last year, for the first time in the current economic cycle, Chairman and CEO Frank Blake, who has been measured in calling a recovery, commented that housing is beginning to show some light. Although this stock has performed well in anticipation of a housing pickup, consider that: (1) Comps are already running around 4%, and (2) EBIT margins are approaching 11% with little macro support.

That implies an EBIT margin potential in the mid-teens and earnings power of nearly $7 five years from now. This is why HD remains one of the best ideas in the hard-line retail industry. We continue to believe that management is a difference maker for HD, with Blake and CFO Carol Tome laying a foundation for steady operating performance. A combination of smart strategic decisions such as distribution changes, enhanced customer service, and solid tactical execution has helped HD achieve consistently strong results. Credit Suisse has set a target price of $78, which means 18% upside from current levels.

Lowe’s (NYSE: LOW): Lowe’s is setting up as a compelling 2013 idea. The company, which faces relatively easy top-line and gross margin comparisons, should benefit from its shrinking cost structure, is beginning to see signs of a housing pickup, and has a sizable buyback that should continue to enhance EPS growth. More important, and critical in unlocking the earnings power in this model, is that the company’s business transformation appears to be taking hold with gross margin positively inflecting in Q3. The inflection and its timing are viewed as encouraging signals that internal efforts are paying off. One way to think about the stock’s story is that the company’s buyback and housing benefit represent valuation backstops, while execution from internal changes represent upside. Credit Suisse has set a target price of $44, which means 15% upside from current levels.

Lumber Liquidators (NYSE: LL): There are a number of very compelling reasons to like this story. One of the keys to the investment story is how much higher gross margins can rise, as previous management commentary has suggested a ceiling of ~40% that the market seems to accept. Given the company’s direct sourcing moves and the competitive advantages LL has over peers, the Street sees it pushing gross margins beyond the 40% range, which should put it in the select group of rapid-growth retailers with years of growth ahead. In addition, continued improvements in the housing backdrop should result in a meaningful tailwind, as LL expands rapidly into a fragmented marketplace. While expectations are high in the near term, this story has a number of drivers and is not well liked, setting up for potentially significant upside in 2013.

Foolish Bottom Line

So don’t waste time and invest in the home retailer space in order to benefit from the housing recovery.

AnalystX has no position in any stocks mentioned. The Motley Fool recommends Home Depot, Lowe's, and Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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