Home Improvement Retailers
Date February 2019
- Home improvement stores are performing solidly amidst a turbulent retail landscape
- Seasonal sales patterns affect net orderly liquidation values (NOLVs) for home improvement retailers
- The housing market maintained positive growth in 2018
Approximate Net Recovery on Cost
Housing market and industry consolidation impact retailers: The housing market has been generally positive with U.S. residential construction starts in May 2018 (unadjusted units) hitting an 11-year high; however, autumn brought some declines with October and November starts down 3.2 and 2.0 percent, respectively, over 2017. As of November 2018, Census Bureau information showed year-to-date declines in the Northeast and Midwest regions, with positive numbers holding up in the South and West. Given the overall positive numbers, do-it-yourself (DIY) consumers continued investing in homes as housing prices improved, and interest rates remained relatively low.
Mortgage applications decreased 2.7 percent for the third week in January 2019 over the prior week, according to the Mortgage Bankers Association; however, volume was still 3.3 percent higher than a year ago. Additionally, the year-to-date rate of new housing completions remained positive through November 2018, driven by double-digit increases in the West. It remains to be seen how tariffs on lumber, steel, and other building supplies may impact the housing numbers in the coming months.
Retail sales remain positive: Sales remain positive for the two biggest retailers in the home improvement market. Home Depot recorded third quarter 2018 revenue growth of 5.1 percent, as comparable store sales increased 4.8 percent. The increase was driven by big ticket items such as flooring, windows, and appliances; store traffic also improved 1.2 percent. The company added decorative home furnishings to its assortment in 2018 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 second quarter of fiscal 2018 was $20.9 billion, representing a 7.1 percent increase over 2017. The company’s top-line growth was the result of comparable store sales growth of 5.2 percent with the Building & Maintenance category, which represented 38 percent of sales, performing especially well. Despite continued positive comparable store sales for Q3 2018 (+1.5 percent); the company announced late last year that it would close 51 underperforming stores across the U.S and Canada as part of its ongoing strategic reassessment. The company also announced that by the end of its fiscal year it would close all 99 of its Orchard Supply Hardware branded stores along with the distribution facility that serves them.
Despite Lowe’s undertaking to right size its store base and manage a rebalancing of high- and low-turning inventory categories, positive industry performance and continued investment in DIY home improvement projects bodes well for 2019. For the upcoming five-year period, an increasing number of housing starts are projected to continue to drive industry growth. IBISWorld projects unemployment will remain low and per-capita disposable income will rise, and it estimates that revenue for the Home Improvement Stores industry will increase at an annualized rate of 1.0 percent over the same period.
Seasonality influences NOLV: Typical of many retailers, hardware and home improvement stores exhibit strong sales seasonality, 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. Home Depot continues to see higher volume from construction-related expenditures in states affected by hurricanes in 2018. 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 onset of 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 involvement to each appraisal analysis, which in turn assists asset-based lenders in offsetting the risks associated with low-turning inventory.