As interest rates stay higher for longer, these home improvement stocks can navigate consumer trends

Published Fri, Jun 9 20231:00 PM EDTUpdated Fri, Jun 9 20233:21 PM EDT

Investors are hoping that next week's Federal Reserve meeting offers more clarity about the path interest rates could take. But even if the Fed pauses its streak of 10 consecutive rate hikes, most investors expect the higher rates we are living with won't be unwound overnight. The increases are having their intended impact on consumer behavior, particularly in the home improvement space, where consumers grapple with pricey projects that often need to be financed over time. "Depending on what market they're in," businesses "might be rethinking expansionary plans or investment decisions, and taking that waiting approach," said Christopher Herrington, an associate professor of economics at Virginia Commonwealth University with an expertise in macroeconomics and growth. Rising interest rates squeeze consumers, while a cut to follow should help boost economic activity. A higher-for-longer interest rate environment, on the other hand, can have consumers pinching pocketbooks and businesses waiting for what seems an ever-distant light at the end of the tunnel. And when those companies struggle, their stocks can, too. Herrington said it can be hard to truly understand the impact of rising interest rates, especially coming out of a period of such low rates that he said makes this moment "unprecedented." He noted the 30-year housing mortgage rate rose from about 3% in late 2021 to around 6.5% last month: in other words, a $2,000 monthly payment a few years ago is now more than $3,000 today. Consumers are already responding, Herrington said. Some are delaying buying a home or making big-ticket purchases, such as adding a new deck or installing solar panels. These pricey purchases are often financed, and higher rates mean higher costs. To offset this expense, some consumers are trading down to cheaper alternatives to keep loan payments manageable. Others stretch out payments over a longer term — which Herrington noted is popular in the auto industry — despite the higher costs, not to mention the increased chance of going underwater on a longer-term plan. "It's important we think about these things from the perspective of a consumer, and how it affects their decision-making," he added. "Even if the sticker price of the thing doesn't change, the interest rate still matters a lot for their monthly budget." Wall Street is left trying to gauge how companies that rely on financing will fare, with some analysts already watching for consumer trends and others wondering what lies ahead for the companies they cover as these businesses try to contend with changes in behavior. "I don't see any of my companies that are particularly well positioned to benefit from a higher interest rate environment," said Kurt Yinger, an analyst at DA Davidson who covers residential-building product makers. "It's really just the degree of softness or challenge that they're going to face is dependent upon their different end market exposures." Building and improving the home In a higher-for-longer rate environment, companies with more exposure to the construction side of the market will get hit harder, while the residential and repair side may not feel it as much, he said. Companies that sell some sort of premium offering, like engineered wood siding from Louisiana-Pacific or fiber-cement siding from James Hardie , may also be somewhat spared because these products might not see as much price downside despite volumes falling, he said. Still, Yinger said, the whiplash is notable. The companies he covered were at least "content" in the 2010s due in part to the low-rate environment. Then, 2020 and 2021 marked what he called some of the best years many companies ever saw. The "brakes were hit very hard in 2022," largely due to higher rates on the new-home construction side, he said. There's also another unwinding happening. The robust demand and supply chain issues during 2020 and 2021 gave a boost to smaller brands. Bank of America analyst Rafe Jadrosich said companies such as Fortune Brands ' Fiberon and UFP Industries ' Deckorators were able to take market share from Trex and Azek during this period with the major players' capacity constrained and demand surging. But the market leaders have regained their share losses through product availability and breadth, innovation and offering better terms, Jadrosich said. The result is some are seeing modest improvements within the quarter even though growth is still lower on an annualized basis. A Barclays analysis of Home Depot and Lowe's transactions by price point using credit card data showed big-ticket sales, deemed greater than $900, declined less in May compared with the same month a year ago than they did comparatively in March and April. Analyst Seth Sigman, who kept his equal weight rating on both stocks, said improvements in commodity deflation may have helped get consumers back into more expensive purchases. Upscale furniture seller RH could beat expectations on revenue growth as the company laps two years of negative comparable trends, according to Bank of America's Curtis Nagle, who reiterated his buy rating late last month. That rating puts him in the minority of Wall Street, with the average analyst having a hold rating, according to Refintiiv. But Nagle said the company's revenue should be helped by "an improvement in high-end spending and housing post banking/interest rate/possible recession headwinds in 2023." In Loop Capital's Eye on the Consumer report published in April, the firm also noted positive advancements in closely followed indicators that can foreshadow performance for retailers tied to the housing market. The report said RH and Williams-Sonoma , as well as eye care stock National Vision , can all benefit from falling inflation and improvements in the housing market. "Nearly all of the measures we monitor appear to be heading in the right direction, with the inflation and housing market data particularly encouraging," Loop's Anthony Chukumba said. "With all of our covered companies having reported F4Q 2022 results and provided F2023 guidance, we believe the backdrop is particularly favorable for stock pickers seeking new long ideas." Another survey from Loop on pools found that the 2023 fiscal year should be better than expected, prompting managing director Garik Shmois to upgrade industry leaders Pool Corp. and Leslie's to buy from hold. Shmois noted first-quarter numbers may be down due to weather-related issues, though unaffected markets appear to have reached goals and full-year expectations look solid. Bank of America was even more specific in a note last month, calling Leslie's "the #1 retailer in a strong sector." Crosscurrents in the green space Of course, these trends don't exist in a vacuum. For solar companies, many on Wall Street are focused on regulations around the Inflation Reduction Act, whose tax credits for solar panels and electric vehicles could be a boon for companies whose products meet the requirements. "The more recessionary the backdrop, the more the IRA subsidies should shine and make these companies more attractive," said Bank of America analyst Julien Dumoulin-Smith in a note to clients last month. Dumoulin-Smith said SunRun and Sunnova have upside potential in the residential market and are a way to play the dip in the stocks. Investors wanting to lean into the prediction of solar simply accelerating, which is in part tied to the IRA, should buy tracker stocks Array Technologies , Nextracker and FTC Solar , he said. Others are hoping a squeeze on residential is short-lived or can be mitigated elsewhere. Deutsche Bank analyst Corinne Blanchard said when upgrading SolarEdge last month that the U.S. residential market was a weakness as management has mentioned the higher interest rate environment. But she said another challenge, lower battery sales, could turn around with the new metering proposals in California and upgraded the stock to buy. Meanwhile, Citi's Pierre Lau named SolarEdge, Enphase and Shoals Technologies as top U.S. picks with the hope of the residential market recovering from the higher rates. Multiple analysts have noted concerns over the rate environment could be offset by rising electricity costs. "Policy and interest rate-driven weakness in residential solar is a headwind but will likely prove to be temporary," Lau said. "Our analysis indicates that there is still a healthy runway for growth given low adoption rates and projected increases in electricity rates." Generators can also be impacted, though the major producers, which include public companies such as Generac , Caterpillar and Cummins , typically have larger business areas elsewhere. Ultimately, this all leaves investors still guessing as to how the Fed will move — and how to position themselves ahead of the pivotal decision. "While rate cuts are expected this year, the Fed [is] guiding rates to be higher for longer, and there is no expectation that interest rates will make an abrupt return to pre-pandemic levels," said John Bailer, deputy head of equity income and portfolio manager at Newton Investment Management. "As such, 'fighting the Fed' is not a opportunistic strategy at the moment." — CNBC's Michael Bloom contributed to this report.