Retailers Ride Housing to Bigger Profits

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Bed Bath & Beyond (NASDAQ: BBBY) released its fiscal first-quarter earnings numbers in line with expectations. Investors sent its stock higher on the news, even though it merely matched analysts’ forecasts across the board. The numbers follow an impressive first-quarter report from fellow housing retailer Home Depot (NYSE: HD)

Can investors expect the rally to continue?

What’s behind the report

Bed Bath & Beyond earned 93 cents per share in the first-quarter, matching the consensus estimate. It narrowly beat revenue estimates of $2.60 billion at $2.61 billion.

Same-store sales are behind Wall Street’s optimism. The company reported a 3.4% increase in same-store sales compared to the year-ago period. Like many retailers, Bed Bath & Beyond is engaged in a rapid share repurchase plan. The company announced repurchases tallying 5 million shares, worth $324 million. Some $2.1 billion remains in its December 2012 repurchase authorization. If the company were to repurchase those shares at the current market price, share count would fall by more than 20%.

Bed Bath & Beyond is growing shareholder value from the inside. The company has plans to return much of its earnings to shareholders as the maturing retailer cannot find sizable growth opportunities within its network of 1,478 stores.

Home Depot is another housing-related company using buybacks, not new store openings, to drive growth. Home Depot plans to open only nine new stores against a current portfolio of 2,256 open locations. It will return some $17 billion to shareholders via buybacks by 2015, since organic growth in store count is muted by its already dominating market position.

Watch this housing statistic

An improvement in housing underpins the gains in Bed Bath & Beyond and Home Depot. As home sales pick up from an anemic, post-financial crisis pace, both companies benefit from remodel purchases and the sale of new fixtures and furniture.

A key metric for both retailers is household formation. When a 20-something moves out of mom’s house, a new household is formed, which leads to the sale of various new home essentials. Home Depot and Bed Bath & Beyond benefit from new household formation.

Household formation is very positive. Here’s a chart of households as a percentage of population:

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When this chart turns up, new households are forming. That means dollar signs for focused retailers.

Why retail is the best bet on housing

As rates rise from their lows, investors are calling for a pullback in new home construction. Home builders were targeted for their exposure to interest rates, since higher interest rates put a damper on new home sales.

Retailers aren’t tied to new home sales or sales trends. Bed Bath & Beyond customers are not just homeowners, but renters, too. New apartment leases are a boon for the business, just as a new home sale. The same is true of Home Depot, which can ride of the wave of new apartment construction as Americans begin to form new households on the back of economic recovery. Apartment building is a perpetual bright spot in the real estate industry. 

These two retailers are a diversified bet on an improving economy and household formation. Bed Bath & Beyond trades at just fourteen times forward earnings expectations for 2013. Excluding cash on the balance sheet, the company trades for a P/E multiple of 13.

Home Depot is pricier at 18 times earnings due to its levered balance sheet. However, the company continues to post record earnings, smashing through analyst expectations after it grew bottom line net income by 17% in the first quarter of 2013.

A bet on either of these names will position investors to profit from economic growth. New jobs beget home sales and new households, which lead to bigger bottom line income. When it comes to housing, your best bet may be on these two mature retail powerhouses trading at multiples near the broad stock market.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Bed Bath & Beyond and Home Depot. 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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