Will This Home Improvement Retailer Continue to Rally?

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The rally in the housing market in recent years has also pulled up the stocks of leading home improvement companies Home Depot (NYSE: HD) and Lumber Liquidators Holdings (NYSE: LL). Will the recovery in the housing market continue? Will these home improvement retail chain stores continue to trade up? Let’s examine the recent developments in the housing and home improvement sectors.

Housing Market Continues to Recover

The U.S economy is showing mixed signals regarding its growth, but at least in the housing market there are signs of progress: the number of new homes sold (opens pdf) during the first two months of 2013 was 842,000 compared to 705,000 in the first two months of 2012 – a 19.4% increase.

The chart below shows the progress in the number of new homes sold in the past few year

The rise in homes sold is a sign of recovery in the housing market, which could increase the major home improvement companies’ revenues in the months to follow. The FOMC’s ongoing QE3 program, in which the Fed purchases $40 billion of mortgage backed securities each month, is keeping the mortgage rates low and thus indirectly raising the demand for housing. In the recent minutes of the FOMC meeting, however, several FOMC members voiced their concern about this asset purchase program. If the Fed will end this program in the coming months, this could ease the demand for housing and thus lower the growth in new homes sold.

Let’s turn to the home improvement retail sales.

Home Improvement Retail Keeps Rising

Based on the latest retail sales report (opens pdf), in the first two months of 2013 furniture and home furniture stores sales rose by 2.5% compared to the same time in 2012; sales of building material and garden equipment and supplies dealers increased by 3.7%. These numbers show that the growth in retail related to home improvement continues to rise.

Growth and Profitability

Based on the above, it seems that not only the housing market is getting healthier but also that the home improvement market is growing. Does this mean the leading home improvement companies continue to rake in profits?

In recent years the growth rate of some companies, including Home Depot and Lumber Liquidators, has doubled: net sales at Home Depot rose by 3.5% in 2011 (y-o-y) and by 6.2% in 2012; net revenues at Lumber Liquidators grew by 9.9% in 2011 and by 19.3% in 2012. On the other hand, net revenues of Lowe's (NYSE: LOW) increased by 2.9% in 2011 and by 0.6% in 2012 - a decline in its growth rate.

If the housing market will continue to grow as it did in the first two months of the year, these companies are likely to continue growing.

In regards to profit margins, Home Depot leads the way with 10.4% operating profitability in 2012 – an increase compared to 2011. The profitability of Lumber Liquidators sharply rose from 6.2% in 2011 to 9.6% in 2012 – a 54% growth in profit margin. Lowe’s profitability slightly increased to 6.2% in 2012.

The chart below shows the developments of the yearly profit margins of all three companies in recent years.

Despite the high growth rate of Home Depot compared to its main competitor – Lowe's – the P/E of Home Depot is close to the P/E of Lowe's – around 23-24. At face value, this could suggest that Lowe’s is too expensive or Home Depot is too cheep (or maybe both). Home Depot has other attributes that put the company on top of Lowe’s: Home Depot offers a higher dividend yield (the company raised again its dividend to an annual dividend payment of $1.56 per share), has a higher profit margin and is leading this industry. These factors might suggest Home Depot’s stock has more room to grow in the near future than Lowe’s does.

Home Depot board of directors recently authorized a share repurchase program of $17 billion. This is another way the company will give back its profits to its stockholders. Lowe’s bought back nearly $4 billion worth of stocks in 2012. This means both companies are returning big portions of their respective profits to shareholders.

The P/E of Lumber Liquidators is almost double the P/E of Home Depot. The sharp growth in revenues of Lumber Liquidators is among the main reasons for the high P/E. On the other hand, Lumber Liquidators doesn’t offer any dividend, which means the main reason for holding this stock is for the appreciation of the company’s value over time.

The Foolish Bottom Line

Home Depot continues to lead the way in the home improvement retail sector. Even though the company’s revenues growth wasn’t as high as Lumber Liquidators’, Home Depot still has room for more growth. If the housing market will keep growing, these retail companies will benefit from it. Home Depot’s dividend yield and recent share repurchase program are additional benefits worth noting when considering investing in the home improvement sector.

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Lior Cohen 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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