Home Improvement for Your Portfolio

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

Global Insight believes the total U.S. home improvement market reached $275 billion in 2012, up from the $261 billion in 2011. The market is expected to jump to $345 billion by 2017, with rising U.S. home ownership continuing to drive the market. So what's the best way to take advantage?

The home improvement industry is highly concentrated, with the likes of Home Depot and Lowe's (NYSE: LOW) owning the U.S. market. Lowe's has 1,745 stores across fifty states, and a few stores in Canada and Mexico. Home Depot has over 2,250 stores located throughout the U.S.

Part of Lowe's strategy has been to close underperforming stores. With there being little differentiation between Lowe's and Home Depot's product offerings, Lowe's is looking to rebrand itself to get an added advantage. The company's new tag line is "Never Stop Improving," which it hopes will encourage shoppers to spend more on home improvement projects. 

Lowe's is also hoping its new online tool, MyLowes, will drive sales higher by helping consumers manage their home improvement projects. Lowe's recent acquisition of Orchard Supply Hardware Stores, should help increase the company's presence in the California market. 

The thing about Lowe's and Home Depot is that they generally trade together. Home Depot and Lowe's have historically traded in lock-step on a P/E basis…

The two also now have similar debt to equity ratios…

But, Home Depot is utilizing its assets better…

And it now has the better profit generating capabilities…

As a result, it appears Home Depot could be the best opportunity for investors in the space. However, I'm not 100% convinced. 

Is there a better way?

One of the nice aspects of the major home improvement stores is that they are inherently diverse. Home Depot gets over 30% from plumbing, electrical, and kitchen products. Meanwhile, paint and flooring account for 19%. Lowe's gets around 10% of revenue from plumbing, appliances, and tools/power equipment, each. 

However, I feel investors are better off invested directly in the top home improvement markets. Baby Boomers tend to spend more time at home, and as a result should increase their allocation of income to their homes and its general improvement. 

The other big tailwind is the rising age of homes. The majority of refurbishment and home improvement spending comes when houses reach 25 years old, and the latest Census Bureau shows that nearly 70% of house are over 25 years old. 

Thus, what I would rather do is invest in the housing-related markets that have the most exposure to the ripe-to-grow areas; these are the ones specially tied to the cosmetics of housing, such as appliances, paints, and furnishings. 

Appliances

Whirlpool (NYSE: WHR) is the world's largest manufacturer of appliances, with its main products being laundry appliances, refrigerators and dishwashers. During 2012, laundry appliances accounted for 30% of total sales, refrigerators/freezers 30% and cooking appliances 17%. 

Whirlpool calls North America its largest segment, accounting for over 50% of sales, but the company also operates in Latin America, EMEA (Europe, Middle East and Africa), and Asia. Around 25% of 2012 sales were from Latin America -- Whirlpool's fastest growing market. 

Sales are expected to be flat in fiscal 2013, but rise 3% in 2014. This should be driven by a continued recovery in the housing market. The company is the market leader in a number of its products and it pays a 2% dividend yield. 

Last week Whirlpool missed earnings estimates, posting $2.37 EPS compared to expectations of $2.42; yet, the stock jumped 4%. This comes as the company did manage to beat on revenue with $4.7 billion versus $4.67 billion. Year over year, earnings were up 75% from a year ago and Whirlpool upped its full-year outlook. The company traded at 18 times earnings but has a forward P/E that's only 11 times. 

Paint

Valspar (NYSE: VAL) is one of the leading paint companies, having been in business for over two centuries. The company is the fifth largest manufacturer of paints and coatings in the world. Its key brands include the Valspar, Cabot, and McCloskey brands. Valspar calls Lowe's its top customer, accounting for 10% of sales in fiscal 2012. 

Earlier this year Valspar acquired paint manufacturing assets from Ace Hardware Corporation to help boost its North American presence. This should also help boost revenues from the sales of Ace-branded paints. 

Valspar trades at 21 times earrings, which is a large discount to other major paint peer Sherwin-Williams, which trades near 30 times. Also worth noting is that Valspar pays a 1.4% dividend yield, compared to Sherwin-Williams 1.1%. 

Interiors and furnishings

Bed Bath & Beyond (NASDAQ: BBBY) has over 1,000 stores nationwide, selling various home furnishings. It has stores that include Bed Bath & Beyond, Christmas Tree Shops, World Market, and buybuy BABY. 

Last month, Bed Bath posted first quarter EPS of $0.93, compared to $0.89 for the same period last year, driven by 3.4% growth in same store sales and 18% sales growth, year-over-year. Sales are expected to be up nearly 7% in 2014 and will reflect a strong year of its integrated Cost Plus acquisition, not to mention the boost from the Linen Holdings acquisition. 

The company is trading, in line on a P/E basis, with its 5-year historical average of 16 times, but it boasts a solid balance sheet; no debt and nearly $4.25 per share in cash. 

One of the great things about Bed Bath & Beyond is that it's a relatively low cost way for people to "spruce" up their homes. It's relatively easy and can be fun, as opposed to painting or appliance shopping. 

Bottom line

While you might enjoy the inherent diversity that the home improvement retailers (i.e. Lowe's) provide, I think the best way to play the rebound in housing is to focus on the key areas that will see the most demand; these include the likes of Whirlpool, Valspar, and Bed Bath & Beyond. 

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Bed Bath & Beyond and Lowe's. 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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