Housing Recovery? Check Out Home Depot

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

A big part of investing depends upon perspective. Currently, there are some positive signs emerging in the US economy. According to ABC News, in September the US trade deficit decreased by 5.1% month over month to $41.5 billion, and exports increased by 3.1% month over month. In addition, the US housing market is showing signs of recovery. In September, house construction starts increased by 15% from August levels, and August was already a good month. Also in August, construction starts were up 29.1% year over year, according to CNN.

Investors who believe that the housing market will continue its recovery should look into large home improvement companies. In other words, investing in Home Depot (NYSE: HD) is a good way to bet on this recovery. Home Depot is the world’s largest home improvement retail company, with 2,255 retail stores in the US, Canada, Mexico, China, and other locations. In comparison, its biggest competitor, Lowe’s (NYSE: LOW), has around 1,745 stores. In 2011, about 89% of Home Depot’s revenue came from inside the US. In addition, in its 2011 Annual Report, Home Depot estimates that its market share of the US home improvement market is around 25%.

The company’s main product groups are plumbing, electrical and kitchen; hardware and seasonal; building materials, lumber and millwork; and paint and flooring. All these segments should benefit greatly from a recovering housing market and economy. In Q2 2012, Home Depot reported an increase in diluted EPS of 17.4% year over year. In the quarter, the company generated $1.5 billion in net income, or $1.01 diluted EPS. The most important metric, comparable store sales, was up 2.1% year over year and up 2.6% for US stores in the same period. Comparable store sales is a good metric because it compares sales from stores that were already open in the previous year. It gives a clear view of a retailer’s business performance because it ignores the revenue growth from new stores. Rising comparable store sales mean business is improving.

In addition, Home Depot should see some increased business from the ongoing recovery in the Northeast region. The damage caused by Superstorm Sandy to the state of New York could total $33 billion. The total damage the storm caused to the US was previously estimated to be in the range of $30 to $50 billion, including property damage and other costs, according to the Detroit Free Press. While some Home Depot stores in the area were affected by the storm, Home Depot should see increased sales in the region as people stock up on supplies for repairs.

Looking at its competition, two of Home Depot’s biggest competitors are Lowe’s and Lumber Liquidators Holding (NYSE: LL). Lowe’s is the second largest home improvement retailer in the world. Lumber Liquidators is the largest home improvement specialty retailer focused on hardwood flooring. Home Depot’s biggest advantage is its size and broad range of products. In addition, Home Depot has been outperforming Lowe’s. In Q2 2012, Lowe’s reported a 10% decrease year over year in its net income. The company’s comparable store sales decreased 0.4% year over year and 0.2% for US stores year over year. Lowe’s CEO Robert A. Niblock bluntly stated, “Our results fell short of our overall expectations.” Lowe’s net profit margin for the last twelve months is 40% lower than Home Depot’s net profit margin.

On the other hand, Lumber Liquidators has been performing well. In Q3 2012, the company reported a net sales increase of 18.8% year over year, and comparable store (net) sales increased 12% year over year. However, Home Depot has a broader line of products.

Looking forward, one looming threat that could cause the housing market to tank, along with the rest of the economy, is the incoming fiscal cliff. Fiscal cliff is just a fancy name for about $7 trillion of incoming tax hikes and spending cuts currently set to occur in January. The fiscal cliff would reduce the yearly deficit by around $700 billion. While the reduction in deficit is very good for the future of the US, there are concerns that the fiscal cliff will lead the US back into recession. The changes are sudden and could shock the economy. Furthermore, the spending cuts would be across the board, and taxes will increase.

Due to the incoming fiscal cliff and Home Depot’s P/E ratio of 21.8, it is probably a good idea to wait for the government budget to be decided before investors jump in. Home Depot’s valuation is not cheap, and the economy could tank quickly when the fiscal cliff arrives. Regardless, for investors bullish on the housing market, Home Depot is a great investment to consider.

iamgreatness has no positions in the stocks mentioned above. The Motley Fool owns shares of Lumber Liquidators. Motley Fool newsletter services recommend The Home Depot, Lumber Liquidators, and Lowe's Companies. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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