GDP, Hurricane Sandy Could Boost Stocks
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Catastrophic bonds, through which insurance providers shift some of the risk of natural disasters to investors, lose money when disaster strikes. Investors earn generous yields from cat bonds, which are rated below investment grade, by betting correctly that financial losses from natural disasters will remain below a certain threshold. Investment declines occur when investors misplace that bet.
For the five year period leading up to 2012, cat bonds generated returns of some 8.2 percent, according to Reuters. Cat bond investors did not lose money from Hurricane Sandy despite the severity of that storm because financial losses from the catastrophe were not high enough to pull the payout lever.
Investors searching for returns that rival those earned in the cat bond market may need to look no further than home improvement stocks, where arguably there is less risk.
Raise the Roof
Retailers that sell items such as generators, products that are in such robust demand during and in the months following a hurricane, are likely to see higher tickets sales. Manufacturers of the very products that are in demand are also in a position to benefit as items generally deemed ubiquitous, such as batteries, begin selling on the black market.
Early Tuesday, Home Depot (NYSE: HD) reported 3Q EPS of $0.74 excluding items, $0.04 ahead of analyst estimates. Revenues increased 4.6% over the year ago period to $18.1 billion. Comparable store sales for the company's fiscal 3Q were 4.2% and 4.3%, the latter of which represents U.S. comp sales.
Home Depot also raised its full year earnings guidance to $3.03 per share, excluding items. The company announced a share buyback in which it will repurchase $700 million in stock in the 4Q.
Home Depot has a P/E ratio of about 20 based on the company's projected earnings for 2012. The stock is trading close to its 52-week high after receiving a little bounce following Hurricane Sandy, a storm that arose during the 4Q. Indeed, shares are on a tear as the stock has advanced 44 percent year-to-date.
In its 2Q, Home Depot noted that its business is driven more directly by economic expansion as expressed by gross domestic product (GDP) versus conditions in the housing market. In its 3Q, however, the company attributed its strong results in part to a turnaround in housing.
Either way, Home Depot appears to be in a good place. GDP could advance a better-than-expected 3% in the 3Q compared with previous, more modest projections of 2% economic expansion, according to economists cited by The Wall Street Journal.
If that's the case, Home Depot investors are in for a nice holiday season. Driving the anticipated boost to economic growth is better-than-anticipated export data coupled with wholesale inventory levels, the WSJ noted. A 3% increase in GDP would be a boon not only to the economic turnaround but also stocks.
While the sales impact from Hurricane Sandy is still unfolding, the company's same store sales improved by one point in the wake of Hurricane Irene in 2011, according to Barron's.
Home Improvement Retailers
(*Sources include a combination of FactSet, First Call and Company Estimates)
Although both Home Depot and rival Lowe's (NYSE: LOW) stand to benefit from higher sales as a result of Hurricane Sandy, Home Depot appears to be in a more competitive position. The company has 300 brick and mortar locations in close proximity to the storm's hardest hit areas, which is about 100 more stores than Lowes, according to Barron's. Home Depot's exposure to Hurricane Sandy was a blessing and a curse, however, as the company was forced to temporarily close more than 50 store locations in preparation for the storm, according to The New York Times.
Lowe's has a PE ratio of 18 based on the company's full-year earnings projections of $1.66 per share. The stock has a dividend ratio of 2% compared with Home Depot's 1.9%. Shares of Lowes are up close to 25% year-to-date.
For its part, Wal-Mart (NYSE: WMT) raised its full year earnings guidance during its 2Q to a range of $4.83 to $4.93 versus a previous estimated range of $4.72 to $4.92. In either scenario, earnings are expected to topple last year's EPS results of $4.54. Wal-Mart has set a high bar for itself, and in order for its stock to continue its rise the retailer must deliver impressive same-store sales and profit growth, according to Morgan Stanley analyst Mark Wiltamuth cited in Market Watch.
If the discount retailer continues on the path it has set over the past four quarters when domestic comparable store sales have been growing, as pointed out by Barron's, investors are likely to celebrate the stock. Wal-Mart shares have advanced 20% year-to-date.
Best Yet to Come
Third quarter GDP results will not be reported until November 29. Meanwhile, as the Northeast continues to recover from Hurricane Sandy and earnings season continues to unfold, the best for home improvement retailers may still be yet to come.
Fool blogger Gerelyn Terzo does not own shares in any of the companies mentioned in this entry.