The recent fluctuations in the housing market and subsequent adjustments in interest rates present a unique opportunity for investors. Our decision to purchase shares of Home Depot stemmed from a belief that the housing industry—and by extension, the home improvement retailer—might soon see a favorable shift. Just last week, we initiated our investment with an initial purchase of 50 shares at approximately $362, followed by another 50 shares at a slightly higher price on Wednesday. While Home Depot has recorded a modest year-to-date increase of about 7%, it still lags behind the S&P 500’s more robust growth of over 16%.
In March, expectations for a hawkish Federal Reserve caused Home Depot’s shares to soar to $395, as investors predicted possible rate cuts. However, by May, the stock fell dramatically to $325 as these projections dampened. Recently, Home Depot shares appear to be stabilizing in the wake of lower bond yields and soft inflation indicators, although they remain shy of their peak close of $415 per share in late 2021—a time when many were increasing spending on home improvement projects during the pandemic. Now, with the Fed rumored to be considering rate cuts at their next meeting, we believe that investing in established companies like Home Depot makes sense, especially as affordable borrowing becomes more accessible.
Understanding the Investment Rationale
The cornerstone of our strategy is the anticipated pickup in housing turnover, a crucial determinant of Home Depot’s sales growth. Historical data suggest that substantial housing turnover typically accelerates once mortgage rates fall within the 5% to 6.5% range. Recently, we have seen signs supporting this thesis. Home Depot’s CEO, Ted Decker, highlighted during the second-quarter earnings call that applications for mortgages surged once rates dipped below 6.5%.
Mortgage rates are gradually shifting; just last week, they decreased for the sixth consecutive week to 6.29%. This drop led to a 1.4% uptick in total mortgage demand alongside a 1% rise in refinance applications. While the current rise in activity isn’t groundbreaking, it may signal that we are on the path toward a more vibrant housing market. Forward-thinking analysts like Doug Yearley, CEO of Toll Brothers, speculate that we may soon see mortgage rates dipping below 6%, potentially catalyzing a surge in housing transactions.
It is critical to note that even if mortgage rates decline significantly, the positive effects on Home Depot’s sales won’t be immediate. There is often a lag of several months as homeowners close on properties and begin planning renovation projects. However, should Yearley’s predictions prove accurate regarding the potential for a 5% mortgage rate, we may witness an acceleration in housing activity.
Importantly, despite the broader concerns surrounding consumer sentiment, the home improvement sector operates under different dynamics. Rising home values are typically accompanied by increased sales for Home Depot. As Decker noted in a recent investor conference, the total equity value of homes has increased by nearly $18 trillion since 2019, with $11 trillion available for home equity lines of credit (HELOC). This provides a compelling backdrop for optimism regarding future sales performance.
Strategic Competitiveness in a Recovering Market
Despite current challenges, Home Depot’s investments, particularly its recent acquisition of SRS Distribution for over $18 billion, are designed to enhance its capabilities in the professional customer segment. This move not only expands its addressable market significantly but also positions Home Depot favorably against chief competitor Lowe’s.
Investors should also keep in mind the appeal of income-producing assets, particularly in a falling interest rate environment. With Home Depot boasting a dividend yield close to 2.4%, the stock becomes increasingly attractive for those seeking steady income while awaiting greater capital appreciation.
While Home Depot may currently be grappling with comparable sales declines, a strategic investment now could yield considerable benefits as the housing market rebounds. We maintain a price target of $420 per share, reflecting our commitment to positioning ourselves ahead of an inflection point in the market. Observing how closely Home Depot aligns with broader economic trends can guide our investments, as we believe this company has significant potential for recovery and growth in a post-rate-cut landscape.
As we venture forward, we remain watchful for positive shifts in the market and confident in our strategy to capitalize on the opportunities presented by Home Depot’s robust market presence and evolving industry dynamics.