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 (
). 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
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
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
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.