Home Improvement Retailers
Date August 2018
Approximate Net Recovery on Cost
- Home improvement stores are performing solidly amidst a turbulent retail landscape
- New housing starts and completions up YTD over 2017
- Home Depot has entered the home décor space following its acquisition of online retailer The Company Store
- Seasonal sales patterns affect net orderly liquidation values (NOLVs) for home improvement retailers
Housing market and industry consolidation impact retailers: While U.S. residential construction starts (unadjusted units) in May 2018 were at their highest since July 2007, June saw a 9.9 percent decrease over May and a 4.1 percent decrease over last year. Census Bureau information showed declines in starts across the country, regardless of region. However, do-it-yourself (DIY) consumers are still investing in homes as housing prices improve, and interest rates remain relatively low for the time being. Additionally, new housing completions have maintained at positive rates, with June 2018 totals increasing 7.3 percent over May and 3.3 percent over last year. It remains to be seen how tariffs on lumber, steel, and other building supplies may impact the housing numbers in the coming months.
Consolidation, acquisitions, and mergers in the industry remain prevalent. HD Supply recently acquired A.H. Harris, and True Value sold 70 percent of its business to private equity firm ACON and is moving away from its historical co-op model and into more of a typical distributor model. Additional retailer consolidation included Patrick Industries’ purchase of Collins & Company, Ace Hardware’s acquisition of The Grommet, and Lowe’s acquisition of Maintenance Supply Headquarters (MSH).
Retail sales improving: On the heels of a positive year in 2017, for the first quarter of fiscal 2018, Home Depot’s sales increased 4.4 percent, driven by a 4.2 percent increase in comparable store sales, a 20.2 percent increase in online sales, and four new store openings. Online sales represented 7.6 percent of the company’s total volume for the quarter as compared to 6.6 percent last year, indicating continued growth for the online channel. The company has recently added decorative home furnishings including bedding, home goods, bath accessories, and wall decor in an effort to widen its appeal and establish itself as a one-stop shop for home needs. The product expansion follows the retailer’s acquisition of online home goods retailer The Company Store and allows for direct competition with major home goods retailers like Wayfair and Bed Bath & Beyond.
Also performing well, Lowe’s revenue for the same period increased 3.0 percent to $17.4 billion, reflecting 17 net new locations, comparable store sales growth of 0.6 percent, and incremental sales from the company’s acquisition of MSH. Additionally, smaller footprint retailer Ace Hardware’s revenue increased 5.8 percent to $1.31 billion for Q1 driven by a 2.2 percent increase in comparable store sales, the opening of new stores, plus a significant 34 percent increase in online sales.
Positive industry performance and continued investment in DIY home improvement projects bode well for the balance of 2018. For the upcoming five-year period, an increasing number of housing starts are projected to continue to drive industry growth. IBISWorld projects unemployment to remain low and per capita disposable income to rise and estimates that revenue for the Home Improvement Stores industry will increase at an annualized rate of 1.7 percent over the next five years.
Seasonality influences NOLV: Typical of many retailers, hardware and home improvement stores exhibit strong sales seasonality. A significant percentage of sales typically occurs between April and July, in line with weather-related home improvement and remodeling peaks.
Weather-related events can also drive geographic sales volume. Per Creditntell, the hurricanes that hit the Caribbean in September 2017 increased demand for tools and materials necessary to start rebuilding and contributed $662 million to Home Depot’s gross volume for the second half of fiscal 2017. Whether typical or atypical, seasonal sales patterns affect NOLVs, both through gross recovery values and store-level sales capacity. Moderate or significant variations may occur depending on the timing of a going-out-of-business (GOB) sale and the monthly sales volume encompassed by the corresponding sale term.
Seasonal categories such as lawn and garden products, including grass seed, chemicals and equipment; outdoor furnishings; ice melt and snow blowers recover differently (sometimes significantly so) depending upon the timing of a GOB sale. An early spring or winter can impact category sales positively or negatively, depending upon mix and assortment. As a result, high and low season gross recovery rates for identical products can vary from 5 to 15 percentage points on retail. And depending upon in-stock inventory levels, high and low seasonality ranges may have a material effect on overall gross and net recovery rates.
Appraisals must consider this seasonality. Out-of-season inventory management as well as in-season replenishment cadence can also have a material impact on recovery values. Normal course discounting to clear through seasonal product is essential. On-hand excess seasonal product during a non-peak period may require additional discounting to sell through in a GOB sale. Partnering with an appraiser to understand the implications of seasonal recovery values on NOLVs is especially important in segments like hardware and home improvement stores where over 30 percent of annual sales can occur within two to three months. A forward-looking seasonal model can provide asset-based lenders with the insight needed to adjust advance rates in order to navigate through seasonal high periods while mitigating risk during seasonal lows.
Category demand drives range of recovery rates: Many retailers are resigned to carrying a selection of low-turning inventory in order to provide customers with a range of core product options as part of the normal course of business. When faced with a bankruptcy filing and subsequent liquidation, this inventory often has low sell-through rates, due either to its extreme specificity or lack of demand because of seasonality.
Even specific categories for hardware retailers can drive significantly higher or lower gross recovery rates depending upon intended use and level of inventory availability. High recovering categories such as hand and power tools, branded household cleaners, and fuels such as propane typically require less discounting to sell through regardless of the season. Conversely, categories including hardware and fasteners (e.g., depth in quantities of a broad assortment of nuts and bolts), as well as specific project- and repair-based plumbing and electrical supplies (e.g., PVC piping, bulk wire, or electrical cable), typically are in lower demand and therefore require additional discounting to sell through quickly. The delta between high and low recovering categories in the hardware segment can be as much as 40 percentage points on retail. Even within a stronger recovering category such as premium branded paint there is the potential for a lower recovery on non-traditional base colors or less in-demand finishes.
Managing discounts on high and low recovering inventory in tandem with seasonal demand and on-hand inventory levels is therefore critical to a successful GOB event. Understanding and predicting gross recovery rates by category, brand, region, and season comes with experience. Gordon Brothers applies real-world disposition experience to each appraisal analysis, which in turn assists asset-based lenders in offsetting the risks associated with low-turning inventory.