Battle of the home improvement giants

Stocks staged a mixed close yesterday after two retail giants posted better-than-expected earnings. Retail stocks have been on the ropes, but you wouldn’t have known that if you observed the sector in yesterday's market – leaving traders wondering if this is just a dying gasp.

Dim the house lights. This is the setting. You are on a conference call and a pleasant person welcomes everyone to the call and goes through the necessary disclosures “please hold all questions until the presenter is done…blah, blah, blah will be available later today...forward looking statements blah, blah…type your comments in the box…please respect…” You may know the drill if you have ever joined an earnings conference call. I often urge my readers to attend some of these and I post all the week ahead dial-in numbers and times on Mondays during earnings season. It is certainly worth taking the time to listen to management commentary around earnings, because often, that is where you can pick up the real information that can impact your portfolio. Ok, ok I know you are busy, and you don’t have the time to sit and listen to an hour-worth of corporate, technical, gobbledygook. If you don’t, you can simply ask your advisor who has either listened for you or can refer you to someone who has. Beyond that, transcripts from most of the calls are available online. Ok, public service message over, let’s get back to our conference call.

“Testing, testing, can everyone hear me? Great, let’s get started.” Thirty seconds of welcomes and team thank yous ensued. Here we go. “In the second quarter, we delivered the highest quarterly sales and earnings in our company’s history.” My interest is peaked, I check the numbers quickly on my Bloomberg and sure enough, the numbers looked good on the surface. The company beat EPS and Sales estimates by +1.35% and +0.50% with quarterly sales of $43.793 billion. “Wow, good job,” I thought. Typically, a shock-and-awe opening like that is a setup for some bad news which a company hopes to deliver while guys like me are checking the numbers on their Bloomberg terminals. But I know this strategy, so I remained attentive. “Our performance reflects continued strength in demand for home improvement projects.” Wait, where is the bad news? Something wasn’t right. But my momentary elation was quickly eclipsed by what I know is the reality of a recently receding housing market. It was clear, yesterday’s morning numbers confirmed the already existing declining trends in Housing Starts and Building Permits. Monday’s National Association of Home Builders number agreed as well. We also know, anecdotally, that many folks spent money and lots of free time working on home projects during the earlier days of the pandemic, and more recently, have shifted spending patterns away from things and comfort projects back into experience-based endeavors: travel, entertainment, dining out, etc. So, what gives? At that point, my peaked interest morphed into that furrowed brow, for which I am well-known for.

The speaker’s voice is now just background noise and I return to the Bloomberg and look at the detailed model of the company’s earnings. It contains most of the detailed drivers which one would use to estimate earnings and revenues. By now you may have realized that I am talking about none other than Home Depot. Number of locations, changes in retail square footage, same store sales growth, sales per square foot…all look sound. But wait. I spot something. Inventories have increased by +37.97% over last year! Does that mean that customers bought less than company’s expert buyers were hoping, leaving inventories bloated? The noise in the background sharpens as the presenter flies over something about customer transactions. All at once I scroll down my screen to see that customer transactions decreased by -3% for the quarter. So, how is it that customers bought less, and the company was able to grow Revenues and Earnings? Don’t worry, I will give you the answer: PRICE HIKES. To be safe, let’s confirm with CPI data. Sure enough, Tools, Hardware, Outdoor Equipment, and Supplies prices indeed, grew by nearly +11% in the past year. So, it seems that the company is growing its top and bottom-line numbers by raising prices. We know that a strategy like that cannot persist, because at some point, consumers will simply stop buying, and the decrease in transactions is proof that the shift is already beginning. Home Depot reiterated its full year earnings guidance which is 1 penny below analysts’ estimates. The company has not given guidance for the coming quarters, but on median, analysts are expecting EPS declines for the next 2 quarters and a crawl back to current levels by the second quarter of next year. Now, to be clear. All this information is not necessarily bad for the stock, but it is information that should be carefully vetted out. Additionally, understanding how these things are playing out within well-known, well-run, companies with a history of success can help us better understand what we can expect in a broader sense with other portfolio holdings and macro economy.

Home Depot Inc (HD) finished 7^th on yesterday’s S&P500 leaderboard, climbing by +4.06% in the session. This morning, Home Depot is trading off by -0.24% in the premarket. But wait, Lowe’s Cos Inc (LOW) just announced that it missed Q2 Revenues by -2.31% but managed to beat EPS estimates by +1.27%. The stock is up by +1.13% in the premarket while equity index futures are down. Will the gains persist? Lowe’s will be holding its earnings call at 9:00 AM Wall Street time, but I am not going to wait, I am already checking the model. I want to know if Lowe’s expected 12-month PE of 15.12 makes it a better choice than the more expensive Home Depot, trading at 19.2 times expected earnings. It is going to be a long morning. Pay attention to your investments.

YESTERDAY’S MARKETS

Stocks had a mixed close yesterday as retail led rallies on the S&P and Dow ultimately causing inflation fears to reemerge, challenging growth stocks. The S&P500 gains +0.19%, the Dow Jones Industrial Average climbed by +0.71%, the Nasdaq Composite declined by -0.19%, and the Russell 2000 Index pulled back by -0.04%. Bonds traded lower and 10-Year Treasury Note yields gained +1 basis point to 2.80%. Cryptos declined by -0.51% and Bitcoin gave up -0.37%.

NXT UP

1. Retail Sales (July) may have grown by +0.1% for a second straight month.
2. FOMC Meeting Minutes from July 27^th meeting in which the Fed raised the key lending rate by +75 basis points will be released at 2:00 PM Wall Street time. This has the potential to move markets…heads up.
3. Ps. Lowe’s customer transactions decreased by -2% compared to Home Depot’s -3% decline.