What Home Depot’s Earnings Really
Tell Us About the U.S. Housing Market

homebuilder stocksWhen looking at homebuilder stocks, you can look at two basic segments to gauge the housing market: the companies that build the homes directly, such as Toll Brothers Inc. (NYSE/TOL), and those firms that sell the supplies, such as The Home Depot Inc. (NYSE/HD) and Lowe’s Companies, Inc. (NYSE/LOW).

Home Depot just came out with earnings that beat the estimates of Wall Street handily and pushed the shares up even higher. Sales were up 5.9% for the fourth quarter in 2011 compared to the same period 2010. Net earnings were $774 million in the fourth quarter 2011 versus $587 million in the same period 2010. For the entire year 2011, sales were at $70.4 billion, up 3.5% from 2010.

 The homebuilder stocks’ selling supplies have far exceeded the S&P 500 over the last three months. Home Depot is up approximately 24% over that time period, and Lowe’s up 18%, while the S&P 500 is only up 12%.

Does this mean that the housing market is about to boom? Not necessarily. Home Depot cited the extremely warm weather as part of the reason for the increase in sales. This being one of the warmest winters on record has improved traffic and sales of early spring equipment, which offset the decline in snow removal gear. While the warm winter might have helped the sale of plants, this doesn’t mean the housing market is fixed.

What else is helping homebuilder stocks that sell supplies is the increase in foreclosures and conversion to rental properties. The housing market is now becoming more of a rental market. This means buyers of foreclosed properties need to renovate and this benefits homebuilder stocks that sell supplies, such as Home Depot and Lowe’s.

The other portion of the housing market consists of people who are stuck in their homes and can’t sell because the price has fallen too far, but they’re not underwater, so they’re not walking away from their homes. These people are turning to homebuilder stocks that sell supplies like Home Depot to buy upgrades. Since they can’t move, they might as well spruce up their homes with new plants, energy-efficient furnaces and other small-to-medium purchases.

Home Depot’s guidance for 2012 expects an estimated sales growth of four percent, 11 new stores, operating margin expansion of approximately 50 basis points, and share repurchases totaling $3.5 billion.

While these are great earnings numbers, we can’t judge the entire housing market based on the homebuilder stocks that sell supplies. We need to see the level of foreclosed homes come down for the housing market to gain some price improvement. With the housing market still expecting some price declines, it will be difficult for confidence to build up. The housing market needs prices to move up. Once we see prices increasing across the country, we can then say that the housing market is becoming “normal” once again. Until foreclosure levels come down, I’d be wary of the housing market bouncing back anytime soon.