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Why Lowe’s and Home Depot May Kill Housing Fears Despite Rising Interest Rates

Paul Ausick

Before markets opened on Wednesday, Lowe’s Companies Inc. (LOW), the country’s second largest home improvement store chain, reported second-quarter diluted earnings per share of $0.88, up from $0.64 in the second quarter a year ago, and sharply higher than the consensus estimate from Thomson Reuters of $0.79. Sales rose from $14.2 billion a year ago to $15.7 billion, again higher than the consensus estimate of $15.06 billion. Same-store sales rose 9.6% in the quarter.

If anything, Lowe’s quarter was even better than rival Home Depot Inc. (HD), which yesterday posted EPS of $1.24 on $22.5 billion in revenue, also beating estimates. Both chains reported an increase in the average ticket and more transactions, and both noted growth in virtually all departments.

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And while the home improvement stocks are posting gains, home builders’ stocks have been falling. Since late May, shares of D.R. Horton Inc. (DHI) and KB Home (KBH) are down around 30%. Toll Brothers Inc. (TOL), which matched EPS estimates and beat on revenues this morning, is off about 14% since May.

Mortgage rates are up and that has hampered refinancing, but rates remain historically low. In late May, a conforming 30-year mortgage carried an interest rate of 3.78%, almost a full point lower than the 4.68% rate reported for last week. A 30-year jumbo loan in May carried an interest rate of 3.93% compared with 4.74% last week.

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The home improvement stores are getting a boost from rising home prices. As home values increase, it makes sense for homeowners to update and remodel their homes, whether to sell or to add value for potential sale in the future. Add in the number of existing homes being sold, which new owners often choose to “fix up,” and the rise in Home Depot’s and Lowe’s stocks is no surprise.

Toll Brothers' CEO noted that the company's sales contract numbers are about where they were in 1998. Over the next seven years, mortgage rates averaged between 5.8% and 8.1%, and sales contracts eventually peaked at double the 1998 pace. The difference between then and now, of course, is that in 2005 virtually everyone believed housing prices would never fall. We know better today.

For the new home builders to share in the prosperity, they need to remind buyers that mortgage rates are still very low and that home values continue to rise: “A new home purchased today for $250,000 might be worth 10% more next year. Where else can you get that kind of return on investment? Besides, it’s a new house and you won’t need to do anything to fix it up.” That is a narrative that could overturn resistance to rising interest rates.

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A rising tide of home values lifts all boats. The home improvement stores have figured out how to take advantage of that. The home builders likely will too.

Shares of Lowe’s are up about 4.6% in premarket trading Wednesday morning, at $46.01 in a 52-week range of $25.97 to $46.25. Shares of Toll Brothers are down fractionally, at $31.63 in a 52-week range of $28.50 to $39.25.

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