Trader Talk

Housing remodeling boom may be falling apart

In Summerville, S.C., 84 Lumber workers load a container of US-manufactured building materials bound for Mongolia.
Source: 84 Lumber

Is the housing remodeling boom over? A fairly grim report from Lumber Liquidator is acting as a possible canary in the coal mine.

After the bell yesterday, Lumber, which specializes in flooring and has been a mainstay of the remodeling boom, cut second quarter guidance practically in half: to 59—61 cents versus consensus of 90 cents. Estimated revenue of $263.1 million was also well below expectations of $302.8 million. Same store sales are now expected to be down 7.1 percent, against expectations of a gain of 6.7 percent.

Wow. Those are big misses. What happened?

Here's a hint: this time, the weather wasn't to blame. In management's own words: "The improvement in customer demand we experienced beginning in mid-March did not carry into May, and June weakened further."

Pisani: June retail looks good
Pisani: June retail looks good

Two issues stick out here:

1) Home Depot remodeled their floor segment, and that is likely posing a stiff competitive challenge to LL; and

2) Overall, housing and remodeling, after seeing significant gains last year, are not seeing big follow-through.

Remember, last year was the year of the big cyclical asset recovery: everyone was buying home builders, remodelers, and building material companies. This year? Not so much. Why not? Because housing prices are not up as much, which means the supply/demand equation is more in balance. All those numbers peaked a year ago. The hope was that they would take off again, but so far gains have been modest.

On a smaller scale, we are seeing the same issue play out with Tractor Supply, which sells farm and ranch products to retail customers. After the close yesterday, they reported second quarter same store sales up 1.9 percent, well below expectations of a gain of 3.3 percent. They still believe weather may be an issue, yet full year guidance, is at the low end of the consensus of $2.61.

You can see this concern over the fizzling of the remodeling boom. Last year, LL's earnings were up 65 percent from the year before. Was that sustainable? The jury's still out but right now, they are saying earnings will be flat with last year, which was $2.65—$3.00.

Last year, Tractor Supply grew earnings by 22 percent. Now they're saying earnings will fall short of 2013. That's still growth, but it's only roughly 10 percent.

This has big implications for the larger companies like Lowes and Home Depot. Last year, Lowe's grew earnings 23 percent. This year, the consensus is for another gain of 21 percent. Think they can do that? Maybe. They do have an active buyback program, and are expected to spend something like $3.4 billion it. Despite all this, Lowe's stock is down this morning.

What retailers need now are the following:

1) an improvement in household formations;

2) wage gains;

3) continuing increases in home prices, and

4) fewer stores and a less competitive environment.

Companies don't have control over the first three issues, but they can control store numbers. Since 2008, when a lot of companies swore off opening new outlets and increasing inventories, they all got lazy again. They're at peak margins and getting whacked.

Take Tractor Supply. There were 855 stores at the end of 2007now there's 1,351, up 60 percent.

Lumber Liquidator had 150 stores at the end of 2008, but now there's roughly 340 stores. That's a whopping 200 percent increase.

Bed Bath and Beyond had 971 at the end of 2008, now they have roughly 1,500 (including Cost Plus acquisitions).

Some have been more restrained. Lowe's had 1,651 stores at the end of 2008. Now they have 1,840, which is a relatively modest 10 percent increase. Williams Sonoma had 600 stores in 2008, now they have 589. That's a decline!

And Pier One, which nearly went bankrupt in the 2008 downturn, has gone from 1,200 to 1,100 stores. But they are in the minority.


1) European peripheral bonds, the momentum stocks of Europe, are under pressure once more, and it's about time. These are the momentum stocks of Europe, where valuations skyrocketed last year, until someone finally noticed that economic growth has been fairly anemic and said, "Gee fellas, you think we might be paying too much for this stuff?"

Just like biotech or internet/social media names that have 70, 95, or even 150 times forward earnings (YELP, LinkedIn, Pandora), bonds can get stupid valuations as well. Yes, these companies are beneficiaries and victims of central bank support and investors have been driven by the desire for yield. And investors seem to believe that there is an implicit guarantee for the debt.

That's finally getting shaken a bit today, because you have a Portugese bank, Espirito Santo, that is being ring-fenced by central bank authorities due to liquidity concerns. This is good news, but only if it leads to real reform. Debtholders need to have real risk, and that needs to be made more explicitly.

2) Monthly retail same store sales data wasn't bad. L Brands did two percent, roughly in line. Costco is up 6 percent, after the company beat by one percentage point. CATO is rising three percent. Drug stores also did well last week. Teen retailer Zumiez did guide higher versus prior guidance. Separately, Family Dollar reported a 1.8 percent gain, a half-percent better, but guidance was in line with estimates. Now, we await Gap after the close.

3) Potbelly also said second quarter earnings would be half expectations.