Home Depot building on the housing recovery

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Michael Haden 08/25/2014

Housing prices are well recognized as a bellwether for economic growth. While an indicator for the economy at large, housing metrics are an even more direct predictor for home-improvement stores. Increases in home prices drive new construction as well as spending on home improvement. If it is true that appreciating home prices lead people to purchase and, most importantly, invest in upgrading those homes, Home Depot stands ready to reap the benefits.

Frank Blake, CEO at Home Depot, believes that while U.S. home prices are appreciating, housing is still affordable. Blake also believes U.S. homes are aging rapidly. Aging homes will need repairs, creating more customers. Further, Blake sees an increase in home purchases by high-end and speculative buyers. These big spenders can be expected to make more big-ticket purchases. Blake sees these factors combining to provide an opportunity for growth in his industry.

The recovering housing market has proven to be a boon to both Home Depot and chief competitor Lowe's ( LOW ). Both stores topped earnings forecasts for the most-recent quarter, though Home Depot did better. While the two companies together dominate the home improvement industry, Home Depot is the clear leader with $23.8 billion in second-quarter sales compared to $16.6 billion for Lowes. Lowe's also cut its sales forecast for the year from 5% to 4.5%.

How did Home Depot achieve such an advantage over its rival? At one time Lowes was the bright and shiny store with the attentive staff, while Home Depot was seen as the more serious store for the professional contractor. Lowes made a concerted effort to attract female customers, with well lit aisles and easily accessible shelves.

As time went by, Home Depot found a way to turn this dichotomy to its advantage.

It would seem that, even in this enlightened time, home improvement is still a boy's game.  Men tend to spend an average of 35% more than women per month on home improvement. Home Depot has enjoyed the benefits of its male-focused stores while still directing efforts toward enticing female customers.

Likewise, the Home Depot focus on contractors has positioned the company to make the most of the housing recovery. In the first quarter of 2014, 35 percent of Home Depot revenue came from professionals, compared with 25 percent at Lowe's.

Home Depot has a stronger presence in the Sunbelt states, making it less susceptible to seasonal fall off in sales. Additionally, Home Depot has taken the lead in on-line ordering. Offering in-store pick-up, an option that one quarter of on-line customers choose. These customers will often purchase additional items once in the store. Lowes trails in their on-line capability.

Finally, Home Depot has made strides toward improving overall efficiency, decreasing inventory turnover to less than 80 days in comparison to Lowe's 93 days. Lowe's opted to stock up early this year on warm-weather inventory, a decision that left the company holding expensive inventory that impacted their balance sheet.


Chart courtesy of stockcharts.com

Home Depot would appear to be winning nearly every phase of the competition with Lowe's, enabling the company to take the lion's share of profit from a growing home-improvement market. With this outlook for the company in mind, and because a significant near-term drop in the price of  HD stock seems unlikely; I will pursue a bull-put credit spread. Look at the November 75/80 bull-put credit spread for at least a $0.20 credit. You will need to use limit orders to place this trade. This trade has a target return of 4.2% over 93 days, which is an annualized return of 16.48%, (for comparison purposes only). HD stock has to fall 12.4% to cause a problem. Be aware that this is an aggressive trade, best undertaken by investors with diverse portfolios and high tolerance for risk.




The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Originally published on InvestorsObserver.com



This article appears in: Investing , Options

Referenced Stocks: LOW , HD

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