Is Home Depot Stock the Best Housing Play?

HD stock price - Is Home Depot Stock the Best Housing Play?

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Housing worries finally have hit Home Depot (NYSE:HD). The HD stock price touched an all-time high in September, even as housing-related stocks already were crumbling. Since then, however, Home Depot stock has fallen nearly 20% as investors worry that even the industry’s leader isn’t immune to the slowdown.

With HD stock at the lows, there’s an obvious bull case here. Housing worries look potentially overdone — particularly in terms of renovation spend. Consumer confidence remains strong. The houses in the U.S. continue to get older and thus to need more repairs.

Home Depot, meanwhile, is the easiest and potentially best play on renovation spend. It long has outperformed rival Lowe’s (NYSE:LOW), as a company and as a stock. And though the HD stock price has suffered from cyclical weakness in the past, over the long haul it has been a notable outperformer.

I’m sympathetic to that bull case — and forced to choose, I’d bet Home Depot stock moves higher from here. But I can’t help but wonder, given how poorly HD suppliers and competitors have fared, if other stocks might be a better play on the HD thesis.

Home Depot Stock Looks Familiar

Housing stocks started turning south earlier this year and the selling hasn’t yet abated. Homebuilders Lennar (NYSE:LEN) and D.R. Horton (NYSE:DHI) both peaked in January, for instance, and have fallen 42% and 32% from the highs. Suppliers Mohawk Industries (NYSE:MHK) and American Woodmark (NASDAQ:AMWD), the latter of which counts Home Depot and Lowe’s as its two biggest customers, are down by more than half.

Home Depot stock shook off those worries for some time, but they’ve come back with a vengeance. Starting in early September, the HD stock price plunged 20% in less than two months — a huge move. Two subsequent rallies have stalled out, and Home Depot stock is threatening a 52-week low.

At the moment, it appears investors simply don’t believe that even Home Deport will be able to avoid the impact of higher input costs and slowing construction demand. In short, they’re treating HD stock like every other stock in the sector, as proven by the reaction to Home Depot’s Q3 earnings report.

Indeed, one of the notable aspects of the selloff in housing stocks is that earning results actually have been reasonably solid. AMWD, for instance, has seen repeated jumps after earnings reports — only to give back the gains, and then some, relatively quickly. For its part, Home Depot posted a monster Q3. EPS crushed analyst estimates, U.S. same-store sales rose a sizzling 5.4% and the company raised full-year guidance. Investors dumped HD stock anyway — like they have so many similar plays over the past eleven months.

Where the HD Stock Price Goes From Here

That reaction raises some near-term alarms. As I pointed out in July, HD stock needs the economy to cooperate. As long as macro fears persist, it’s going to be tough for the HD stock price to move higher. Backwards-looking earnings reports are not going to assuage fears of a recession in 2019 or 2020.

So one of the problems with Home Depot stock at the moment is that it’s difficult to see a catalyst. There’s little, if anything, Home Depot can do to change investors’ minds about the economy as a whole. (To be fair, Home Depot, given its size, probably has a better chance than most.)

As long as investors are worried about — or convinced of — a looming recession, the HD stock price is going to be flat at best. While I like the valuation here — ~17x FY20 EPS estimates — I’m not sure there’s much of a need to rush in.

Can Investors Do Better?

There’s another catch. If sector worries have to reverse for HD to move higher — as I believe is the case — then HD doesn’t move until investors get more confident about the broad market and macroeconomic situation. But in that scenario, Home Depot stock probably isn’t the best play.

LEN and DHI, for instance, are trading at 6x and 8x forward earnings. Even if an investor believes that new construction will struggle, but renovation will stay strong — an argument Home Depot management itself made this week to analysts — there are better and cheaper options.

Distributors like GMS (NYSE:GMS), which I own, or Beacon Roofing Supply (NASDAQ:BECN), have been hammered. Suppliers like AMWD, MHK, JELD-WEN (NYSE:JELD), and Masonite International (NYSE:DOOR) have performed just as poorly.

And there’s the issue with Home Depot stock. The thesis for buying HD stock after the sellf is that the market is overreacting to housing concerns. If that thesis is correct, though, there are many stocks — some of them suppliers to Home Depot itself — with much higher rewards.

To be sure, for various reasons, those stocks offer higher risk, too, even after larger selloffs of their own. Still, personally, I see a bigger opportunity in smaller housing stocks. HD stock at $170 offers a chance to buy a wonderful company at a reasonable, if not cheap, price. But if the price truly is that cheap, investors should at least consider the possibility that other housing-related plays are even cheaper.

As of this writing, Vince Martin is long shares of GMS Inc., and has no positions in any other securities mentioned.

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