Americans are finally getting around to renovating their kitchens, upgrading their bathrooms and building the garages they've always wanted.
Canada's southern neighbours spent $130-billion (U.S.) last year on home renovation – the most since the start of the economic downturn in 2007, and up 3.1 per cent from 2012, according to the U.S. Census Bureau.
As housing prices climb and consumer confidence grows, Americans are getting a taste for discretionary spending again, and that's giving them an appetite for home renovation. That's opening up opportunities for Canadian investors, who can buy into the upswing through companies such as retailers and lumber suppliers.
The U.S. is coming out of a "lost decade" of renovation spending, says Keith Hughes, managing director of equity research with SunTrust Robinson Humphrey investment bank, based in Atlanta.
From 2002 to 2006, he says, the U.S. home renovation market was in a "typical upcycle" – strong, but nothing for the record books. The subprime mortgage crisis followed, pushing the economy into recession; Americans who kept their homes were wary of investing money into an asset that was declining in price. Mr. Hughes estimates home-reno companies contracted anywhere between 20 and 40 per cent.
Mr. Hughes, who specializes in building products and consumer durable goods, says that, while home renovation spending saw some recovery in 2012, it wasn't until 2013 that the market saw its first full up-year. "It was a long time coming," he says.
With the caveat that poor weather has affected renovation spending in January, Mr. Hughes says that, "You look toward 2014 and all signs [indicate] we're going to have a good year in home renovations."
A full two-thirds of American mortgage holders had at least 20 per cent equity in their homes in the third quarter of last year, up from 55 per cent in the same quarter in 2012, according to CoreLogic, a real-estate data firm.
And while U.S. home prices dipped last November, the S&P/Case-Shiller Home Price Indices show that prices still increased year-over-year by nearly 14 per cent, with their best November performance since 2005.
"If home prices go up, people are going to then feel more confident reinvesting in their home," says Joseph Lavorgna, managing director and chief U.S. economist with Deutsche Bank AG in New York.
"Prices may not continue to rise at the rate they are, but as long as people believe they are sustainable, that they're not going to correct, that's likely to mean they're more confident buying housing and doing all the things that are more associated with buying housing," Mr. Lavorgna says, including remodelling.
(Canadians, for what it's worth, never really stopped renovating: according to TD Bank economist Diana Petramala, home-reno spending rose an average of 7 per cent annually over the past decade in Canada, but spending growth is expected to slow down this year.)
Investors can buy into American home renovation from a few different angles. One obvious route is to pick up shares of prominent U.S. retailers like Home Depot Inc. and Lowe's Cos. Inc., whose stock values have risen 15 per cent and 20 per cent, respectively, over the past year as of Friday's market close.
Mr. Hughes sees the two companies achieving same-store sales growth – an important metric for retailers – above U.S. GDP in 2014, in about the 5-per-cent range.
"If the economy co-operates, we could see several years of growth for these players in the U.S, " he says. "They've got a while to go."
That sentiment is echoed by other analysts, including the Royal Bank's Scot Ciccarelli, a managing director and analyst at RBC Capital Markets, who wrote in a research note in November that Home Depot, in particular, will continue to benefit from the recovery, and that its stock could appreciate at 15 to 20 per cent annually for the next few years.
Retail isn't the only way to play the renovation upswing. Tapping into the lumber market is a strategy favoured by Mark Schmehl, a portfolio manager with Pyramis Global Advisors who oversees Fidelity Investments' Canadian Growth Company Fund and its Special Situations Fund.
"The best way to play any housing story right now is to own lumber," Mr. Schmehl says, pointing out that the material is still used in both renovation and new construction, with additional new demand coming from China. "The Canadian dollar, as it weakens ... that's really good for the lumber producers."
He recommends looking at companies like Quesnel, B.C.'s West Fraser Timber Co. Ltd. (up 32 per cent year-over-year), an integrated wood-products company that pays out a dividend. Canfor Corp., also based in British Columbia, is a global forest-products company whose shares are up nearly 58 per cent year-over-year.
Mr. Schmehl is less interested in retail stocks such as Home Depot and Lowes right now – he believes they're at a point in their cycle that makes it difficult for retailers to outperform. "Their cost of wages starts to go up, competition gets tougher because all of their peers are doing better, marketing budgets are higher," he says.
Mr. Hughes, in contrast, believes that these retail stocks are in a strong point in their cycle, in large part because of the recent uptick in U.S. home renovations. As long as the economy holds up, he says, Home Depot and Lowe's will be "kings" of the home-reno market.
Some analysts who cover the stocks, Mr. Hughes says, "spend a lot of time comparing and contrasting them with other retailers, which is understandable. But they don't spend enough time looking at what's gone on in the renovation markets. They usually don't get past the [new housing construction] number."
Earlier this month, for instance, Matthew J. Fassler of Goldman Sachs lowered his rating on Lowe's to "neutral" from "buy," partly because of moderating housing numbers, but pointed out in a note that home improvement on its own "is a well-positioned industry."
To get a bite of the U.S. home renovation upswing, look for companies peddling the kind of big-ticket purchases on which Americans can spend discretionary cash. Here are some examples that might be right for your portfolio:
Mohawk Industries, Inc.
When people decide their homes need new laminate flooring or carpet, there's a good chance they'll turn to the world's largest flooring company, based out of Georgia. JP Morgan analyst Michael Rehaut upgraded his rating on the stock to "overweight" last month, saying he saw "further solid upside" on the stock that's risen 37 per cent in the past year, as of Friday's market close.
Nothing says "cash to spend" like a new in-ground pool. Pool Corp. – aptly listed on the Nasdaq as POOL – is a Louisiana company worth watching, with a share price that's grown 20 per cent in the past year. The dividend-paying company has been buying back shares in recent months, signalling confidence in its own fundamentals.
The once-struggling insulation manufacturer is getting positive reaction in the wake of a recovering U.S. home remodelling market. It beat analyst expectations last quarter, and this week announced its first quarterly dividend payment since 2000. According to Bloomberg, 12 of the 19 analysts who cover it – including SunTrust Robinson Humphrey's Keith Hughes – rate the stock as a "buy" or equivalent, with the rest signalling it as a stock to hold.