Can the Buildup in Home Improvement Stocks Continue?

As the U.S. economy heads down recovery road, some industries like hospitality and leisure continue to struggle while others like grocery stores and home improvement retail continue to do well. The Commerce Department's June 16^th retail report showed that while overall May retail sales bounced back 17.7%, the weak got weaker and the strong got stronger.

Home improvement retailers Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) are among a shortlist of companies that have performed well during the coronavirus pandemic. Stay-at-home orders translated to improve-your-home orders for many Americans who chose to use the increased time at home to remodel kitchens and bathrooms.

Following an initial drop in customer traffic, a resurgent army of busy beavers eager to spend their stimulus-padded bank accounts on landscaping and bathroom tiles led to strong performances for Home Depot and Lowes. For the week ending June 6^th spending at home improvement stores rose 32% compared to a year ago.

Throw in historically low-interest rates on home equity loans and the onset of warmer summer weather and customer traffic at these warehouse stores can only get better.

But with these dynamics largely priced into the stocks, and the market concerned about an uptick in COVID-19 cases, have Home Depot and Lowes reached the top floor?

Omni-channel Approach to Changing Consumer Trends

Lowe's has more than doubled from its March 19^th low of $60 and is up 13% year-to-date. Home Depot has surged over 70% from its recent bottom to regain positive territory for 2020. Strong first-quarter results and optimism towards a sharp economic recovery have sent both stocks on remarkable runs to fresh record highs.

Both retailers have reduced their operating hours and placed limitations on the number of in-store customers, yet sales figures have been resilient. The success of expanded delivery options for online orders including curbside pick-up has outweighed these measures. Home Depot raked in $28.3 billion in sales in the first quarter of 2020 which marked a 7.1% increase from the prior year. Lowe's quarterly sales figure jumped 10.9% to $19.7 billion. Its 12.3% comparative store sales growth was not solely driven by consumers stockpiling emergency supplies, but rather broad-based growth in 14 of the company's 15 merchandising departments.

With the so-called "easy money" having been made on these stocks some investors are wondering where they go from here. Both will need to deliver solid performance figures in the months ahead to convince investors they are worth their price tags.

But despite the heightened expectations and rally in the stocks, they are not trading at high multiples. In fact, with Home Depot trading at 25x forward earnings and Lowes trading around 20x forward earnings both are within reach of the S&P 500's current forward P/E ratio of 24x.

Aside from the reasonable if not inexpensive valuations given the home improvement giants' respective growth rates, both have potential catalysts on the horizon.

A structural shift that may be emerging from the pandemic is increased consumer interest in obtaining goods and services through digital channels. Home Depot and Lowe's are responding.

Through its One Home Depot strategy, Home Depot is focused on creating an interconnected customer experience. The company's $11 billion multi-year investment program includes a $2.5 billion investment in technology to enhance its digital capabilities. With contractors and do-it-yourselfers getting comfortable with online sales and delivery processes this will likely be money well spent.

Lowe's has adopted a similar omni-channel strategy that should also continue to drive sales and earnings growth. Not unlike other retail environments, today's home improvement shoppers want multiple shopping options and fast, flexible delivery. In addition to investing in its online experience, Lowe's is focused on the transformation of its supply chain through fulfillment, delivery, and order management optimization.

And while much attention and capital are going towards online platforms, there is still plenty of room for growth at Lowe's and Home Depot's physical stores. Home Depot is pouring $5 billion into the improvement and enhancement of its store footprint. Lowe's has initiatives in place to drive in-store productivity and better connect with its broad retail and professional customer base.

Large, Fragmented Market Opportunity

The home improvement market remains large and fragmented. As such there are still opportunities for consolidation. The combined market share of the two industry leaders is around 22%. This leaves plenty of room for both companies to grow into the $650 billion U.S. home improvement products market and the $35 billion Canadian home improvement market.

It remains to be seen, however, if the recent surge in home improvement spending was a one-hit wonder born out of boredom and pent-up shopping demand. With restaurants and other retailers starting to open their doors, consumers may be more likely to spread their dollars to other areas.

Regardless, the economic backdrop appears to be supportive of a healthy rebound in housing that should serve as a solid foundation for continued growth at both Home Depot and Lowe's. The U.S. consumer drove the recent decade long economic expansion and will likely be the backbone for the new post-pandemic economy. The U.S. housing market was in stable condition leading up to the COVID-19 outbreak. There have been recent signs of a housing market recovery including a 14% increase in May 2020 new home construction permits.

Home Depot and Lowe's are covering all the bases to meet the demands of its evolving customers. Both are well-positioned to capitalize on a sizeable addressable market opportunity. Investors that construct a position in the stocks are likely to witness steady long-term growth.