Why Home Depot is the go-to home improvement stock: Strategist

On today's Good Buy or Goodbye segment, Yahoo Finance's Julie Hyman is joined by Zacks Investment Management Client Portfolio Manager Brian Mulberry to dissect his stock picks in the home improvement sector.

Mulberry names Home Depot (HD) as a stock to buy, highlighting the company's integrated retail strategy, which he believes "enhances their digital footprint." This approach allows Home Depot to gather more data on consumer trends and increase "wallet share." Additionally, Mulberry notes that the company connects consumers with contractors, enabling them to "maintain better margins" and boost cost control. Lastly, he emphasizes that Home Depot has maintained its professional market share by offering a "wider selection of products that help contractors," thereby increasing margins.

On the other hand, Mulberry identifies Lowe's (LOW) as a stock to avoid. He points out that the company is experiencing a consumer spending pullback on big-ticket discretionary items, which he expects to be reflected in their upcoming earnings report as "it's already a measurable change to the downside." Furthermore, Mulberry notes that Lowe's is grappling with "inventory control problems," leading to a loss of margins. Lastly, he highlights the company's substantial debt on its balance sheet, which he says has to be "repriced at a much higher interest rate" under the current rate environment.

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This post was written by Angel Smith

Video transcript

It's a big, noisy universe of stocks out there.

Welcome to goodbye or goodbye.

Our goal.

To help cut through that noise to navigate the best moves for your portfolio.

Today we're examining the foundation of two giants in the home improvement sector, joining me here to discuss Brian Mulberry, that investment management client portfolio manager.

Good to see you again.

Thanks for coming back to goodbye.

Goodbye.

Absolutely.

And we're talking about the home retail home improvement retail market specifically here.

And let's start with the stock that you like, one that we just heard from and that is Home Depot.

The shares have done pretty well over the past year or so, so let's get to the reasons why you like it.

First of all, there's what you call their integrated retail strategy that they deployed after covid.

What does that entail, and how is it helping them?

What they really did is enhance their digital footprint, so it's increased a lot of Web traffic from consumers, and the return on that investment is data.

And so what that does is it allows Home Depot to actually capture more wallet share from consumers because they know more about what consumers are interested in so that investment has proven to be very profitable, help them control costs and stay ahead of trends.

And then also, perhaps it's helped them.

If they're better understanding what customers need.

One of the things that customers need is contractors to do the projects that they want to do and hopefully buy the stuff at Home Depot.

Precisely so inventory management has been a critical part of their cost controls.

And so knowing where consumers are what projects are popular has helped them maintain better margins by having the right inventory in stock to, you know, complete projects.

So also joining customers with contractors to get that work done has proven to be a very valuable strategy for the stock as well.

Yeah, and that kind of brings us to the third part of what you're looking at, which is the pro market right, and that has been a really interesting, uh, growth driver for them.

It really has, and they've made a couple of key acquisitions recently where they actually now have access to very customizable finishing products.

Whether it's landscaping or interior design, they now have a wider selection of products that help contractors that not just get the nuts and bolts done, but also complete design.

And that has increased margins and and a backlog of projects.

Now that shows durability in the earnings for the next couple of quarters.

A quick step backwards here as we're talking about Home Depot and we're going to get to your other one in a second.

There's really only one other big one.

So but we don't wanna give away, you know?

How does, Uh, Home Depot and what's happening right now kind of fit in with what's going on in the hou housing market right where we are seeing kind of a freeze in some areas because of where we're seeing rates?

Well, no question.

I mean, a few years ago, a lot of people were able to refinance their mortgage at 3% or maybe even a little bit less.

That's anchoring those homeowners to those properties.

They're gonna stay there a lot longer because they have such a low rate on their mortgage at this point.

So they're looking to really spruce up, take advantage of some of the equity increases that they've had in that house and then make it more livable, or maybe even completely new, because they know they're gonna be there for a lot longer than they may have already originally planned.

So let's talk about the risk, then potentially for Home Depot.

And that's what we're seeing.

Some weakness creep into big ticket discretionary sales, durable goods, for example, fridges and yeah, absolutely appliances, TV, S things of that nature and that has, you know, crept in a little bit into Home Depot's life, where they've seen a little bit slower sales in those big ticket discretionary areas.

If that were to continue, then it could be a worrying trend for the stock over the next couple of quarters.

Retail sales coming out this morning flat.

Not bad.

But you're definitely starting to see customers be a little bit more thrifty in what they're buying.

If there is an uptick in home sales, what does that mean for Home Depot?

I think it's good either way.

As people buy properties, they want to tend to make them their own.

And so you'll see.

I think that's pretty level set in terms of orders and order flow.

And Home Depot tends to benefit either way, even if there is greater turnover in the housing market.

Any position in Home Depot?

Yes, we have it in several different of our portfolios.

ZE, CPR, ETF.

It's one of the principal holdings in there because of the consistency of the set of returns that we see from this point going forward.

Obviously year to date, it's relatively flat.

But what we're talking about is what are you buying now and looking at the future price structures of this particular stock over the next three years?

We see earnings growth in the mid twenties.

We would expect the stock price to probably follow as well.

All right, so let's get to the flip side of that.

And that is lows for people who have not guessed.

Of course, it's the big competitor here.

Stock price uh, looks pretty.

Chart looks pretty similar, but whereas that is a potential risk, why is it this pull back a discretionary?

Spend more of a risk for Lowe's because it's already happening and W see more in their earnings report next week when they come out.

But we're already seeing in their sales estimate revisions.

Big ticket items are coming in much lower, so it's already a measurable change to the downside on lows.

And so we're seeing that change in behaviour happen there.

But it's been more durable to the good side for Home Depot.

Interesting.

And then, as we see all of that happen, high margin items in particular are taking a hit.

Yeah, absolutely.

Those bigger appliances tend to carry a lot more profit per unit for them.

But they're also having inventory control problems of their own, where their cost of inventory has not been as sharp as home depots and so they're losing margin even in some smaller items as well.

And you also pointed out to us that they've been spending on their garden centre.

What do we expect on the seasonal side with the sales of those kinds of items?

Yeah, so there's a bit of a lag because we had, you know, really, a late start to spring.

And that has lagged sales from the Garden Centre.

There's been a big investment from Lowe's to make those garden centres larger with more options, and we're seeing a delayed start to the planting season as a result of weather patterns, again just an area of weakness on the balance sheet might not be durable or long lasting, but it definitely is something that's showing up here in the Northeast.

It's raining like every weekend.

I wish it would stop.

OK, and then there's also the debt position of Lowe's versus Home Depot.

Yeah, I mean, really, what all this comes down to is if interest rates are going to be higher for longer, and they certainly are compared to what we were thinking early in the year, with maybe as much as 45 or six rate cuts.

Now only one or two.

The level of debt on the balance sheet for Lowe's has to now be serviced or repriced at a much higher interest rate.

That's going to be an immediate headwind to their profitability going forward.

So just puts them again down a peg immediately compared to the peer of Home Depot.

And then quickly.

One thing that could go right for Home Depot is that you could see the them benefiting from that contract.

Absolutely.

There's no question, again, that same demand from homeowners to get projects done is lows as well.

And to be perfectly candid, some of the backlog of orders at home Depot is benefiting lows as well, where contractors are going, where they can actually still get first priority in terms of placement and getting jobs done, it's benefiting lows as well.

And do you have any position in Lowe's or just smaller than in Home Depot?

We do not have a position in it.

All right, Brian.

Thank you.

Let's summarise what you're telling folks here you recommend buying Home Depot.

It sees benefits from its integrated retail strategy, the ability to add on to margins and making strides in capturing the professional contractor market.

On the other side, you say avoid lows because consumers are pulling back on larger discretionary items, that's hurting them more.

The loss of sales in those high margin items is then hitting earnings, and it also has a bigger debt burden on its balance sheet than does Home Depot.

Thanks so much for being here, Brian, Good to see you again and thank you for watching goodbye or goodbye.

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