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Home Improvement Retail Still Looking for Support of the Acceleration in Estimates; Remain Neutral; Updating Indicators
August 13, 2019
Equity Research Americas
Seth Sigman Research Analyst (212) 538-8043 seth.sigman@credit-suisse.com Kieran McGrath (212) 325-5158
kieran.mcgrath@credit- suisse.com Lavesh Hemnani (212) 325-5302
lavesh.hemnani@credit- suisse.com
DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Investment Highlights Still looking for that acceleration; We don’t expect Q2 results to look dramatically different than current expectations, based on updates to our indicators in this report (incl. our leading macro indicator, seasonal tracker, supplier index, custom home price index, web-search analysis). But, we expect that results will continue to reflect moderating underlying trends, coinciding with the housing trends observed YTD. And, with risk to full year headline comps guidance (HD specifically) based on YTD trends, commodity deflation and tariffs, along with uncertainty around the 2H acceleration, we are still not in a rush to own this group. While valuation is not unreasonable as there are fewer places to hide in retail (HD’s 20% premium to market is similar to prior periods of falling rates/ general retail unease, and LOW is trading at a discount to HD and their comps gap), there remain a number of debates about the demand backdrop. Our key considerations; 1)
2H acceleration still uncertain; We continue to expect some level of improvement in 2H, consistent with our macro indicator shown later, supported by lower interest rates. And, accelerating comps for high quality large cap retailers is likely to be a key part of the bull case. But, consensus estimates already embed that, and we are not convinced that lower rates will spur as much of an acceleration in turnover and related spending activity absent further reductions in home prices. Our updated custom home price indices continue to moderate, which we see as a risk for big ticket demand. 2)
Pricing and tariffs; We expect price increases to ramp in 2H, potentially a positive for comp ticket, but we are concerned about elasticity. Further, HD guidance didn’t have a clear impact embedded from list 3 moving to 25% as it was working through it, and list 4 seems to bring incremental exposure for both. We show later some evidence of elasticity in recent periods. Net/net, it’s difficult to assume pricing is a net positive to comps in 2H. 3)
Market share needs to remain an offset; Q4 was first time that HD and LOW both outperformed our industry benchmark in years. HD’s comps outperformed the industry in Q1 by a similar magnitude as prior periods despite LOW’s improvement. We look for signs that LOW’s progress, helped in the near-term by improved in-stock levels, is not zero sum, while HD’s elevated investments can support stronger comps in 2H as guidance reflects.
Our estimates/key bogies; For HD, we model US comps 3.5%, in line with Street, and indicators pointing to a 3.0-3.5% range. We consider a slightly easier comparison than appreciated because of the shifted comps period. But we expect weaker total comps, due to Canada (we est. 3.2% total vs. 3.5% US; note Street models them the same). Despite that, we are slightly higher on revenue growth based on the week shift (we incl. -110 bps non-comp impact vs. Street - 160 bps, based on past). We model EPS $3.09, in line with Street, with lower GM offset by lower SG&A. Tax could help like last quarter while we see less upside from buybacks vs. consensus in Q2. Key for the stock : guidance and gaining comfort in the bridge to the new numbers; we expect no change to EPS, as tariffs are offset by buybacks, while headline comps are revised 50-100 bps from the 5.0% based on our bridge (CS/street already there: CS 4.4%, consensus 4.2%), justified by net deflation -40 bps based on current commodity prices and 10 bps from Canada (FX/weaker trends).
For LOW, we model US comps 2.1% vs Street 2.3%, with indicators pointing to 2.0-2.5%. Similar relative performance vs. industry as in Q1 would suggest 3%+. We also consider that LOW’s spring comparison was not as difficult, as they didn’t seem to recoup all of that missed business from 1Q18
in 2Q18. We model weak GM, down 133 bps off the 32.9% rebased/reclassified GM last year vs. consensus -90 bps, similar to the Q1 trend (down 160 bps) per management’s comments, while we expect slightly better SG&A leverage based on tight controls during the quarter (detailed SG&A bogies later). We model EPS $2.00 vs. Street $2.01. Key for the stock; Hitting comps (particularly as it started addressing the price issue), narrowing the comps gap vs. HD which the stock arguably is not getting credit for at a ~4x turn discount on FY20 numbers, improving GM performance (i.e. in line or down less than last quarter should help instill confidence in 2H and prospects for recovery in 2020). Risk would be a more Q4-weighted improvement. We expect no change in guidance at this point incl. 3% comps (CS and consensus 2.9%) and EBIT margin down 20-50 bps off rebased 9.2% last year.
Summary of Incremental Analysis Guidance/ comps bridge analysis; We dissect comp trends for HD and LOW, what needs to happen to deliver that acceleration in 2H, and for HD, what could drive the 50-100 bps change in comps guidance we are anticipating incl. deflation, weather, and Canada. Leading macro indicators confirm lower growth in Q2, but imply acceleration in 2H – both are consistent with estimates: Our indicator, which incl. EHS, home prices, interest rates, real PCE and inflation, among others, points to relatively in line Q2 comps for HD US in the 3.0-3.5% range (consensus 3.5%) and points to an acceleration in 2H to the 4.5-5.0% range – primarily driven by lower interest rates. Note consensus for HD is +5.0% in Q3, +5.8% in Q4. The macro index obviously does not bake in company specific initiatives, which are expected to be a material driver for HD’s 2H (>100 bps benefit in 2H based on original guidance), and for LOW as it improves in-stock and service levels. While leading indicator improving, still see risk of moderating home price appreciation - home price data mixed: Our HD/LOW store level home price indices (population weighted) have continued to moderate, with a higher percent of listings with price cuts as well, and HDs markets slowing more than LOWs. For HD, data shows prices tracking an average of +2.1% QTD vs.
+3.7% in Q1. For LOW prices are tracking an average
of +2.4% QTD
vs. +4.0% in
Q1. 15.2% of homes listed for sale in
HD/LOW markets had price
cuts, with more cuts in
HD’s markets. We
continue
to believe that the moderation in home price appreciation will result in lower comps growth for the space as well. Short-term, most data points confirm deceleration in comps in Q2, but better exit rate; We believe this points to HD US in the 3.0-3.5% range (vs. CS/consensus 3.5%, and 3.0% in Q1), and LOW
US
>2.5%
range
(CS
1.9%,
consensus
2.3%,
and
4.2%
in
Q1).
SpendTrend
for Home Improvement in 2Q19 (through 1H July) +1.3% vs. +1.9% in Q1, incl. including +0.3% May, +3.3% Jun, +0.3% so far in July. HD/LOW’s outperformance is key to hitting numbers; both names outperformed in Q1 for the first time. Using Google Trends for home improvement-related categories seems to confirm lackluster trends, although generally consistent with expectations, with some improvement throughout Q2. Seasonal tracker shows accelerating trends in June and July, helping lap difficult comps for HD/LOW; We observed the weakest trends in May, then an improvement in June, and further in July, with two year stacks improving. This data supports 3.0-3.5% HD US comps, and >3% for LOW US comps. HD is lapping 200 bps of seasonal upside last year, while LOW lapping 130 bps. Suppliers generally weaker Q2, but points to relatively in line Q2 comps + better end-market and cadence commentary: Most of our suppliers slowed seq. vs Q1, with the exception being our “big ticket” suppliers which seq. improved (first improvement in 5 quarters). Commodity suppliers remained the weakest, while Distributors continue to lead. End-market commentary was better, with suppliers highlighting better retail POS trends, and strong Pro project pipelines. Cadence showed better May vs April, and a solid June, while early July commentary was also positive. Deflation (specifically lumber) slightly worse than Q1; Our commodity index points to deflation of 60 to 80 bps for HD vs. 50 bps in Q1, slightly higher for LOW. Lumber prices are -37% vs. -27% in Q1. Based on current levels, we expect neutral in/deflation in Q3, slight inflation in Q4. It also would suggest a FY impact for HD of ~50 bps, or 40 bps net of some of the offsetting commodity categories where prices are increasing. Promotional analysis indicating slightly more activity from LOW y/y, similar for HD y/y: Analysis shows (1) higher email count for LOW in Q2, lower for HD. (2) Longer holiday sales periods for LOW (3) Discount levels slightly higher for LOW vs. prior year, while HD has been similar. However, we think LOW’s promotions were less broad than last year, with more brand specific SKUs, meaning y/y impact could be flat.
Macro Leading Indicator Slowed in Q2/ Points to 2H Reacceleration; Consistent with Estimates Lower rates, improving housing turnover and healthy consumer confidence are key variables for 2H, as shown below, estimates for comps seem to already embed that improvement
10% HD US Comps LTM LOW US Comps LTM Leading Indicator LTM 9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
HD/ LOW US Comps + Consensus Forecasts vs. CS Macro Leading Indicator
• Our macro indicator include...
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