By Jacob Sonenshine
Hope for better times next year has boosted the home-improvement stocks Sherwin-Williams and Lowe's by double-digit percentages so far this year. One way to play them is to buy the dips.
Next year looks promising, mainly because the Federal Reserve is expected to lower short-term interest rates because inflation has dropped. The average rate on a 30-year fixed-rate mortgage has dropped to 6.3% from the multi-decade peak of 7.8% hit earlier this year.
That should boost home sales next year, which would be a positive shift for sellers of goods and services for home improvement. Many upgrades happen when people have just bought a home, or are hoping to sell one.
Sales of existing homes have fallen year over year in many months this year. They are already down by double-digit percentages from their peaks during the Covid-19 pandemic, when people were eager to move from cities to larger homes in the suburbs or rural areas.
The stocks' gains already reflect the potential recovery, which means now isn't the time to aggressively buy home-improvement shares. Those stocks are vulnerable both to near-term disappointments from data on home sales, as well as any quick jumps in mortgage rates. And mortgage rates could head higher for a few days if Fed policymakers' forecasts of where rates will be in coming months imply smaller reductions to rates than Wall Street has penciled in.
If any of these factors do send home-improvement stocks lower, it likely would represent an invitation to buy the shares.
The three-month moving average of home-improvement sales for companies that Evercore analysts cover is down by couple of percent from its level a year ago. But the analysts' leading indicator, which uses data from various home-related retailers, shows that revenue for the group should rise by more than 1% year over year in January.
Lowe's should see 1.5% sales growth in 2025 to about $84.5 billion, according to the consensus call among analysts tracked by FactSet.
This seems achievable. Sales have fallen both this year and last, and that moderate recovery wouldn't even bring revenue up to the peak of just about $97 billion in 2022. Analysts' earnings forecasts have proven to be too optimistic only once in the past 20 quarters.
Modest sales growth can go a long way for profits, especially if costs are under control, as they are at Lowe's. While profits should grow in the low single digits, per-share earnings will likely rise almost 6% to $12.59 in 2025 because the company consistently repurchases shares, forecasts from FactSet indicate.
EPS is likely to grow even after 2025. Lowe's has ramped up its capabilities in the higher-margin pro business, which centers on higher-priced products for contractors that mostly build houses for affluent home owners. The company even mentioned on its second quarter earnings call that it expects to continue to grow its pro business.
Evercore analyst Grech Melich writes that while the stock price already reflects how rate cuts might boost sales of existing homes next year, the shares would look attractive if the rally pauses in the short term.
Lowe's currently trades at $245, and sees consistent buying support at just over $210. That price represents about 16.7 times expected 2025 EPS, below the stock's current 19 times, and about in line with its three-year average.
Sherwin-Williams is forecast to grow sales just over 4% next year to roughly $24.3 billion. Part of the company's strength is that it's gaining market share in the U.S.
Kelly-Moore Paints closed its operations earlier this year and PPG Industries is exiting the North American architectural market. PPG said in a release that its sales in that business totaled almost $2 billion annually, leaving Sherwin an opportunity. The number of products sold could increase slightly, while the company should enjoy continued moderate price increases. Part of its appeal is convenience, since it has thousands of well-stocked stores across the country, Mizuho analyst John Roberts writes.
This should allow profits to grow briskly. With product costs remaining subdued, margins can rise. Given share buybacks, EPS can rise about 12% next year to $12.88.
The stock is now at $364, but it would look ripe for buying if it drops to the familiar support area of around $300.
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Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
September 10, 2024 09:29 ET (13:29 GMT)
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