Home Depot and Lowe's Get Hammered

It was already clear that Home Depot (HD) and Lowe's (LOW) would get pummeled by the drop in new-home construction and housing sales. But now even consumers who are resigned to staying in their existing homes are pulling in their horns, as rising oil and food prices team up with credit woes to eat into their disposable income.

The combination has proved deadly for the two giants of home improvement. Investors took one look at their dismal sales and earnings reports on May 19 and 20 and began dumping shares. Home Depot's stock price fell almost 6% over the two days, while Lowe's shares lost more than 4%.

Little matter that analysts think Home Depot and Lowe's are doing a good job managing through the tough environment, cutting costs, and slowing the opening of new stores. Their earnings numbers mostly met low expectations. Home Depot saw net income of 41 per share, excluding a one-time charge, vs. 53 a year ago. Same-store sales fell 6.5%, while total sales fell 3.4%, the company said. One day earlier, Lowe's reported an 8.4% drop in same-store sales as it earned 41 per share, vs. 48 a year ago. Thanks to an increase in store count, total sales for Lowe's rose 1.3%.

Further to Fall?

Both chains are hoping the federal stimulus checks mailed this month can slow the slide in same-store sales this quarter, but the effect is likely to be limited. "There will be some offset there from the stimulus package," said Lowe's Chairman and Chief Executive Robert Niblock, though he still predicts same-store sales will fall another 6% to 8% this quarter.

A far bigger factor: There are no signs the housing and mortgage crisis is lifting. "In fact, conditions worsened in many areas of the country," Home Depot Chairman and Chief Executive Frank Blake said in a prepared statement.

The housing downturn set off a dismal chain reaction for the home-improvement industry. New home purchases often inspire construction of a new patio, wallpapering a bedroom, or other remodeling. The pop of the real estate bubble has called a halt to much of that. But even for those homeowners who are resigned to staying put, falling home values make them feel less enthusiastic about launching home-improvement projects. And even if they're so inclined, the evaporation of home equity and tightening of credit lines makes money harder to come by.

A Pileup of Woes

Lowe's Niblock told analysts that his chain has broader troubles, as well. "We've had ongoing pressures from housing, we've had tight credit markets," he said, "but now all of a sudden you've got a couple of other variables … on top of those." Consumers are spending less because of high food and fuel prices, and because they're worried about the economy and the job market, Niblock said.

There was some good news. Lowe's was widely praised for cutting expenses. "Management buttressed investor confidence in its ability to manage costs and profitability against near gale-force market headwinds," said Budd Bugatch of Raymond James (RJF).

Customers and investors have criticized Home Depot for weak customer service, especially compared with Lowe's. Home Depot says it is making strides reorganizing operations while improving service. Some analysts praised management for cutting back on promotional activity that wasn't working. Home Depot "is taking advantage of the slowdown to reinvest in the business," said Credit Suisse (CS) analyst Gary Balter. He says the chain should be "well-positioned once the housing recovery comes," better than Lowe's.

Downturn Squashes Small Rivals

Both chains say they're gaining market share through the housing downturn, because it puts many smaller, independent competitors out of business. This points to the strength of the Home Depot-Lowe's "duopoly," said Bank of America (BAC) analyst David Strasser. "This industry should only get stronger the longer the downturn lasts, as more independents go out of business," he said.

The key to watch for is a rise in housing turnover—if Americans start buying, selling, and moving again, home-improvement stores will get busy. "Really, it's about [the duration], not depth, of the slowdown at this point," said David Schick of Stifel Nicolaus (SF). So far, there is "no macro evidence of business picking up."

A check from the government might inspire the purchase of a couple more plants or the painting of a room, but it will take a true revival of the housing market before Americans feel confident enough to redo the kitchen or finish the basement. Only then can Home Depot and Lowe's start humming again. "Many consumers remain hesitant to begin big-ticket projects," Niblock said.

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