Home Improvement Stores
COVID-19 INDUSTRY BRIEF
EFFECTS OF THE CORONAVIRUS ON THE Retail Home Improvement INDUSTRY Updated May 20, 2020
- Pre-COVID-19 Market Sentiment: The home improvement industry is mature with several large players, including Home Depot, Lowe’s, and Menards, and multiple fragmented smaller competitors. Prior to the pandemic hitting, industry revenue was forecasted to grow 1.1 percent over the five years to 2025 on an expectation of continued expansion of the housing market and North American economy. The industry had been growing over the five-year period ended December 2019 at an annual growth of 3.8 percent supported by a housing market that had been expanding steadily since the recovery from the Great Recession began in 2009.
- Pandemic Impacts: In most regions, home improvement stores were deemed an essential business allowing them to remain open. Lumber product volumes were a bright spot, with companies capitalizing on project-oriented consumers at home due to the pandemic. Some distributors have continued to ship steadily to job sites where builders are trying to finish projects; however, plans were sometimes interrupted by changing regulations, as city, state, and federal officials reacted to the virus.
- Market Outlook: From an outlook perspective, the home improvement industry is driven by commercial and residential construction activity. The housing market was negatively impacted by the pandemic in March and April (refer to Building Products for additional information). While stores in this segment have been open, social distancing measures have limited foot traffic, and normal spring promotions have been limited in order to avoid driving high foot traffic to the stores. In addition, installation-related services have been limited in certain regions. Despite the restrictions, sales of lumber In April were strong throughout the United States. Random Lengths, a trade journal that tracks lumber and other building products market conditions, reported in its May 8, 2020, newsletter that “dealers in all regions across the U.S. raised their sales expectations for lumber and panels,” which still trailed year-ago levels by about 12.7 percent…Jumps in sales expectations for May were most notable in the Midwest, South Atlantic, and Northeast regions.” Treated lumber demand, particularly from home centers, was “unrelenting” according to the Random Lengths report. Garden center activity has also been reported to be strong, and one wholesaler in this space reported that sales to both Home Depot and Lowe’s were up in March on a sequential year-over-year basis by double digits.
- Housing Market Impacts: COVID-19 has reduced residential and commercial construction activity. In most jurisdictions, existing construction has been allowed to proceed, but the initiation of new projects has been limited in some regions, and the impact of complying with social distancing rules as well as the availability of inspectors and supplies has limited activity. The residential building permit rate for April 2020 fell to 20.8 percent below the March 2020 rate, 25.3 percent below the February 2020 rate, and 19.2 percent below the April 2019 rate. Privately owned housing starts fell by 30.2 percent in April 2020 following an 18.6 percent decline in March 2020 and were 29.7 percent below the April 2019 rate. On April 23, 2020, JP Morgan Chase predicted a 51.3 percent drop in housing starts by summer from pre-pandemic levels, with a quick recovery to follow.
- First Quarter Results: Home Depot and Lowe’s reported first-quarter earnings on May 19,, 2020, and May 20,, 2020, respectively. Both firms reported strong sales growth for the quarter ended April 2020, with Home Depot reporting 7.1 percent top-line sales growth and Lowe’s reporting 11.1 percent sales growth. Although incurring additional costs related to the COVID-19 impact, both companies saw organic sales growth despite cutting back on promotional activity. Lowe’s noted that it closed on Easter Sunday as a benefit to its employees and cancelled its planned “Spring Black Friday” sale yet still increased sales volume, confirming that sales growth is currently elevated. Both companies cited an increase in do-it-yourself home improvement sales activity with customers catching up on projects that they had been deferring prior to the pandemic, which they now have time to complete, and both companies noted a significant increase in online traffic, with Lowe’s reporting a 150-percent increase in online sales in April on a year-over-year basis. Additionally, although both chains recognized that this may be a temporary phenomenon, they do not expect a decline in sales in the second quarter, although sales growth is expected to taper off from first-quarter levels.
- Retail Traffic Trends: These sales trends were evident in retail foot traffic trends as well. According to data from location analytics and foot-traffic data platform Placer.ai, trends for the big three home improvement companies were very strong in the second half of April and into May with average store traffic for Home Depot, Lowe’s, and Menards increasing by 12.0, 26.9, and 17.2 percent, respectively, for the trailing 30-day period ended May 14, 2020. Some of this may be due to the limited number of stores open in most markets, as well as strength in home improvement and renewed interest in gardening due to the stay-at-home orders, but it is clear that this industry has fared well during the pandemic period.
- Interest Rates: The interest rate adjustments made by the Federal Reserve Board in early March have had a positive impact on the housing market. The average 30-year fixed-rate mortgage dropped from 3.72 percent as reported by the Federal Home Loan Mortgage Corporation, known as Freddie Mac, for the week of January 2, 2020, to 3.28 percent for the week ended May 14, 2020. This should have a positive impact on housing longer term; however, availability of credit both in the primary mortgage market and the secondary home equity market has been curtailed due to the pandemic. Total residential real estate loan volume has fallen since early April by about 1.0 percent likely reflecting the impact of weakened consumer confidence since the beginning of the year, job losses, and lower loan demand due to falling rates of housing starts and new building permit applications.
- Valuation Outlook: Other than temporary impacts and commodity pricing issues due to the typical turnover profile, Gordon Brothers would not expect to see large declines in valuations. Special orders may be impacted especially if construction or housing projects are delayed.
Date February 2020
- Home improvement stores are performing solidly amidst a turbulent retail landscape; however, ongoing trade negotiations and the growing impact of coronavirus may negatively impact sales for 2020.
- Seasonal sales patterns affect net orderly liquidation values (NOLV) for home improvement retailers.
- The housing market maintained positive growth in 2019, with both new construction starts and completions up over 2018.
Approximate Net Recovery on Cost
Major Retailer’s Sales Remain Strong: With a combined 85 percent share of the U.S. market, Home Depot and Lowe’s continue to dominate the retail home improvement landscape. Sales for 2019 were positive for both chains, despite some challenges including significant lumber price deflation for the bulk of the year.
For the quarter ended November 3, 2019, Home Depot recorded revenue growth of 3.5 percent, with comparable store sales increasing 3.6 percent on top of positive revenue and comp sales for the corresponding period in 2018. Although the company’s gross margin for the quarter was down slightly (negative 0.3 percent), overall revenue benefited from sales of big ticket items (over $1,000), which comprised 20 percent of sales and increased 4.8 percent during the quarter. Lowe’s third-quarter revenue was down slightly at negative 0.2 percent; however, comparable store sales increased 2.2 percent and gross margins increased 1.5 percent for the quarter. In November 2019, the company announced that it would close 34 under-performing Canadian stores as part of its ongoing strategic reassessment of its Canadian operations.
January 2020 sales for home improvement retailers increased 2.1 percent over December driven by promotional activity, milder weather, and December revisions. January momentum bodes well for home improvement retailers as they head into spring, which is one of the industry’s busiest seasons.
Ongoing tariffs and coronavirus cause concerns: Optimism has surrounded the Phase One Economic and Trade Agreement with China that was signed on January 15, 2020. Although the deal suspends some List 4B tariffs and reduces some from List 4A, it does not alleviate tariffs on many items tied to new home construction. A 25 percent tariff on List 3 items remains in place for a range of construction materials, in particular a wide range of cement types including blocks, wall and floor tiles, and a long list of cement additives. As a result, Creditntell anticipates that tariffs will continue to affect gross margins and create uncertainty around supply chains, potentially causing a falloff in business investment for the home improvement and building materials space.
Strong economic trends including 2.1 percent GDP growth for the fourth quarter of 2019 and continued low unemployment through February 2020 (3.5 percent) boosted new, single-family home sales for the month of January to a seasonally adjusted annual rate of 764,000, which was up 7.9 percent over December and 18.6 percent above January 2019.
Nevertheless, as of mid-March 2020, ongoing trade negotiations and the recent global escalation of the Coronavirus outbreak have set markets into a holding pattern as consumers attempt to assess how potential travel bans, school closures, and quarantine mandates will affect spending patterns. To the extent that consumer confidence decreases and Americans postpone major purchases and home repairs, the segment could experience a considerable setback. Regarding the home improvement sector, the Joint Center for Housing Studies at Harvard recently projected a slowdown in remodeling activity, with growth projected at just 1.5 percent for 2020 as compared to 4.8 percent in 2019.
Looking further ahead, IBISWorld projects unemployment will remain low and per-capita disposable income will increase, estimating that industry revenue will increase at an annualized rate of 1.1 percent through 2024. It should be noted that this forecast pre-dated the global expansion of coronavirus and may be negatively impacted in the near term.
Seasonality influences NOLV: Typical of many retailers, hardware and home improvement stores exhibit strong sales seasonally, with a significant percentage of sales typically occurring between April and July in line with weather-related home improvement and remodeling peaks. Weather-related events can also drive geographic sales volume. 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 on the timing of a GOB sale. An early onset of spring or winter can impact category sales positively or negatively, depending on 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 on 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, either because of 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 on 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 involvement to each appraisal analysis, which in turn assists asset-based lenders in offsetting the risks associated with low-turning inventory.
Note: This publication is provided for informational marketing purposes only. The material contained herein should not be regarded as advice, nor relied upon to make financial, operational or other decisions; nor should it be used as a substitute for an asset appraisal. Actual recovery values may vary from transaction to transaction and the recovery values referenced herein are for representative transactions without regard to specific key factors. This material may be redistributed only in its entirety, including notice of copyright. All rights reserved. ©2020 Gordon Brothers, LLC.
Reference sources: U.S. census bureau, home depot, lowes, creditntell, Sandler, Travis & Rosenberg, P.A. (STR) trade