Pandemic-induced 'nesting' fuels Home Depot and Lowe's sales—Why it's likely to continue

KEY POINTS

• Consumers' appetite for home improvement continued in the third quarter, as they spent money on an aspect of life that's brought comfort during the pandemic: their homes.
• Home Depot and Lowe's customers have taken on DIY projects and paid for home renovations, such as converting garages into home offices and gyms and sprucing up the yard to make it a relaxing escape during a challenging year.
• Both retailers saw a noticeable bump in sales and a shift online in the third quarter.

When the coronavirus pandemic hit, many Americans not only switched to working remotely and cooking more meals, they began checking off tasks on the to-do list, from painting walls to replacing old appliances.

Home Depot and Lowe's reported that appetite for home improvement continued in the third quarter, as consumers invested in one of the aspects of life that's brought comfort: their homes. Both companies expect this trend to outlast the pandemic.

The uptick in DIY projects and home renovations translated to a jump in sales online and in stores. Home Depot's same-store sales in the U.S., which includes sales online and at stores open at least 12 months, soared 24.6% in the quarter. Lowe's same-store sales, including online sales and those at stores open at least 13 months, jumped by about 30%.

Like other retailers, the companies have seen a shift toward online spending — with many customers picking up their purchases at curbside.

At Home Depot, digital sales rose 80% year over year — and customers picked up about 60% of those orders at its stores, the company's CEO, Craig Menear, said.

At Lowe's, digital sales more than doubled, with 106% of year over year growth.

The companies did not share revenue figures, however, which makes it hard to compare the companies' total e-commerce sales to one another. However, it should be noted that Home Depot's efforts to build its online business began earlier than Lowe's.

Despite the strong revenue gains, investors sold both stocks in the wake of their earnings releases. Home Depot shares, recently trading at about $269, have gained 23% since the start of the year, but have widened the gap with their 52-week high of $292.95 in late August. Lowe's shares hit a 52-week high of $180.67 last month but are now trading at about $150. Even with the drop, the stock is up about 25% from January.

A 'nesting instinct'

As the pandemic interrupts nearly every aspect of life, Home Depot Chief Financial Officer Richard McPhail said people have had a "nesting instinct." He compared it to Americans' frame of mind after the 9/11 terrorist attacks and the housing crisis in 2008.

Many consumers have put money toward their home so it better suits the way they live now. They have converted garages into home offices and gyms, transformed children's bedrooms into temporary classrooms and spruced up the yard to make it a relaxing escape during a challenging year.

"What we've seen is the emergence of the true project — the multi-item, more complex home improvement project that our customer decides to take on themselves," McPhail said.

The real estate market's strength has boosted spending, too, he said. U.S. homebuilding has increased, as mortgage rates remain at historic lows. As people spend more time at home, some have chosen to move out of dense urban environments and into more spacious houses in suburban or rural areas.

"A healthy housing economy leads to consumers being willing to spend more on their homes," McPhail said. "They view their homes more as an investment, rather than expense, and so they're willing to spend more."

Home inventory in the U.S. is also aging, Lowe's CEO Marvin Ellison said. As houses get older, homeowners need to replace worn-down kitchen appliances or refresh an out-of-date bathroom.

Despite the economic toll of the pandemic on millions of unemployed Americans, some consumers feel like they have more money as they skip vacations and nights out to dinner. Those customers have been more willing to splurge on big-ticket items such as riding mowers and even seasonal decor — like a 12-foot skeleton that became a breakout hit and sold out at Home Depot before October.

Pandemic boosts costs

The retail rivals, however, diverged on their third-quarter earnings — in part, because they were on different footing when the pandemic began.

Home Depot beat Wall Street's expectations on earnings and revenue. Its net sales rose 23% to $33.54 billion from $27.22 billion reported a year ago.

Home Depot, which has nearly 2,300 stores across North America, has a market cap of nearly $290 billion — more than 2½ times greater than Lowe's. Home Depot draws more of its business from home professionals, such as plumbers, electricians and contractors. About 45% of its sales come from pros, with the rest coming from do-it-yourself customers.

Even before online shopping's sharp rise during the pandemic, Home Depot had stepped up its investments in e-commerce to make its website easier to search and its supply chain faster and more cost-efficient.

Lowe's, on the other hand, was in the middle of a turnaround effort led by Ellison when Covid-19 began to spread across the country. Its nearly 1,970 home improvement and hardware stores in the U.S. have relied more on business from DIY customers. About 20% to 25% of its sales have historically come from pros.

As the pandemic began, Lowe's was redesigning a company website that its own CEO described as "really clunky." It was adding key features such as "one-click shopping" and changing the way prices were listed online, by breaking out the cost of the item and the cost of shipping.

Lowe's has had to juggle the costs of long-term business improvements with higher labor costs. It invested $245 million in Covid-related support for its hourly employees in the third quarter. That added up to more than $1.1 billion in the first nine months of the year.

It also spent $100 million on store improvements in the third quarter, rearranging merchandise to put supplies for particular projects together so that all customers — but especially home professionals — can more easily find what they need.

"That is an example of us not running this business quarter-to-quarter," Ellison told investors on an earnings call. "We want to make sure that we're making the right investments that will have long-term benefits and create long-term productivity gains, and we believe that we're doing that, and that's going to be our focus."

Lowe's said those investments have already started to pay off, with more than 20% of growth in the pro business in the third quarter. In March, it rolled out a nationwide loyalty program for home pros to try to woo them with perks, such as personalized offers.

Home Depot has had higher labor costs, too. Menear said on a conference call with investors that the company has spent about $1.7 billion on temporary pay and benefits so far this year. He said some of the pandemic-related temporary employee compensation programs will become permanent wage increases.

The company declined to specify the employee pay increase, but said it will total $1 billion of additional expenses per year.

Chasing future growth

As companies such as Pfizer and Moderna announce progress with development of a Covid-19 vaccine, investors have a new question about the retailers: Is the home improvement trend sustainable or will it fade when Americans can go on vacation again? This question was a key factor in why the stocks fell on their earnings news.

Home Depot declined to provide an outlook, citing economic uncertainty. Lowe's issued a forecast for the fourth quarter but disappointed with projected profits lower than Wall Street expected.

Lowe's said it expects to earn between $1.10 and $1.20 per share, lower than the $1.17 a share that analysts had called for. It forecast same-store sales growth of 15% to 20%.

Despite the many unknowns, Home Depot's McPhail said he expects home improvement demand to remain strong because of the many people who have moved and established a DIY habit.

"We do think that we will see a long-lasting change in the consumer's mindset with respect to what they get out of home improvement," he said. "Our customers today tell us the home has never been more important and that they intend to spend more on the home."

Both companies have pushed ahead with growth opportunities. Home Depot said earlier this week that it will buy back industrial goods wholesaler HD Supply, one of the largest distributors of appliances, plumbing and electrical equipment in North America, in an $8 billion deal.

Lowe's is wading into new home merchandise categories. This holiday season, for example, it's selling small kitchen appliances such as air fryers, recreational items such as kids' scooters and trampolines, and exercise equipment. Early next year, Lowe's plans to set up exercise equipment displays in select stores as part of a test.

Ellison said that wear-and-tear will continue to drive purchases, too. About two-thirds of the retailer's sales are nondiscretionary, such as replacing a broken water heater, he said.

For now, the companies are focused on delivering fresh Christmas trees, selling strings of lights and other merchandise during the holiday season. Spring is peak season for home improvement retailers, but stay-at-home trends could make the holidays another bright spot.

And, McPhail added, as more people tackle home projects, more may want to see power tools under the tree.

— CNBC's Lauren Thomas and Will Feuer contributed this report.