The U.S. housing market has staged a remarkable recovery since the credit crisis over the last 10 years. After falling 27% from its 2006 peak, U.S. home prices have risen 32% since they bottomed in late 2011 and early 2012 as measured by the S&P/Case-Shiller U.S. National Home Price Index.

How sustainable is this recovery and what implications does it have for investors seeking exposure to the U.S. housing sector? Read further to find out more and discover why AtlasTrend’s Splurging Baby Boomers Fund invests in NYSE listed Lowe’s Companies (“Lowes”), one of the leading home improvements companies in the U.S..

The following information does not take into account your personal objectives, financial situation or needs. You should consider if the relevant investment is appropriate having regard to your own objectives, financial situation and needs. 

The S&P/Case-Shiller U.S. National Home Price Index

In the late 1980s, economists Karl Case and Robert Shiller collaborated to create an index to track changes in residential real estate valuations based on existing housing sales prices in an effort to anticipate pricing trends.  The S&P/Case-Shiller U.S. National Home Price Index highlights the peaks of the U.S. housing market in early 2006 before the dramatic decline through to December 2008, where the index reported its largest historical price drop.  The resulting credit crisis of 2007 to 2009 plunged the U.S. economy into recession with the U.S. housing market bottoming out in 2012.

With home prices in the U.S. almost back to their all-time highs in nominal terms (in real terms, adjusted for inflation, the Index remains about 20% below its 2006 peak), it begs the question of how sustainable this recovery is?

Source: Bloomberg

Housing starts & building permits

If one looks to the amount of construction and sales volumes, the picture is not as clear.  Construction starts and sales volumes remain below the pre-financial crisis peaks with some evidence pointing to an uneven recovery across the broader U.S. market.

According to the National Association of Realtors, sales of existing homes, which account for the majority of the total market, reached 5.57 million in June 2016 on a seasonally adjusted annual rate. This represented the fourth consecutive monthly increase but below the peak seen in February 2007 of 5.79 million.  Total housing inventory at the end of June fell 0.9% percent to 2.12 million existing homes available for sale or 5.8% lower than a year ago (2.25 million) suggesting the lack of supply remains an issue for the market.

In terms of housing starts, they have reached 1.19 million in June 2016 – compared to consensus estimates of 1.17 million and up from 1.14 million in May 2016, according to the U.S. Commerce Department (“USCD”) with building permits rising marginally to 1.15 million.  However, in July 2016, the Wall Street Journal reported on delays in U.S. building permits, negatively impacting the ability for developers to respond to demand for new housing.

As such, U.S. is in a situation where lower interest rates and employment and wage growth is driving the housing market in terms of sales volumes and prices.  However, the lack of supply remains another key underlying driver and is contributing to lowering the affordability of housing with the National Association of Realtors’ Housing Affordability Index falling more than 10% since 2013.

Home improvements segment

The one sector that has been benefitting from the U.S. housing recovery has been the home improvement segment.  As employment and wage growth have improved, homeowners have demonstrated a willingness to spend to renovate and upgrade their homes.  Investors have also driven the home improvement segment as they seek to capture value in their underlying property investments.

The beneficiaries of this trend have been Lowes and Home Depot who have both seen their businesses perform strongly, but in some segments still not returned to their pre-recession levels.  Home Depot Chairman and CEO, Craig Menear noted in a February 2016 update that special order kitchens, countertops and millwork remain below the 2006 peak.   He also stated that “the customer is clearly investing in our space so we’re in a good asset class as it relates to housing.”  Both companies have suggested that consumer sentiment remains strong in the segment with home improvement sales having reached 8.5% of consumer spending in early 2016 but still well below the 10.5% reached in 2006.

Lowes has delivered at least 4% same store sales growth since the beginning of 2014 and Home Depot has also reported similar figures.  Specifically, areas of growth have been professional builder areas such as lumber, building materials, millwork, paint and tools as well as the services segment.

Home services departments have become a focus of Lowe’s and Home Depot as they look to increase the basket spend for the do-it-yourself (“DIY”) customers.  For example, kitchen and bathroom remodelling design assistance and referrals to preferred third-party installation contractors aid the customer to complete the home improvement project from start to finish.

Lowe’s and Home Depot are confident of continued strength in the home improvement market and this view is reinforced by Harvard University’s Leading Indicator of Remodelling Activity (“LIRA”).  The LIRA recently projected nominal annual home improvement spending to increase from 4.3% in the 1Q of 2016 to a projected 7.6% in the 3Q of 2016.  Furthermore, the LIRA has suggested projected 4Q 2016 nominal spending in home improvements may exceed the peak levels of 2006.

The case for Lowe’s

Both Lowe’s and Home Depot provide investors with an opportunity for continued exposure to the U.S. housing and home improvements market.

In the current market, our preference is for Lowe’s, which trades on a 2017 P/E multiple of 17.2x and is projected to have earnings per share growth of 22.5% for 2017.  Home Depot is more expensive, which trades on a 2017 P/E multiple of 19.1x and projected earnings per share growth of 18.1%.

We can also take look to an Australian company with its own exposure to the U.S. housing market, James Hardie Industries (“JHX”).  JHX is a dominant player in the U.S. fibre cement building materials market and generates approximately 80% of its revenue from the U.S. market.  Being a leading supplier with a significant market share warrants JHX some healthy margins and certainly it has almost double the margins of both Lowe’s and Home Depot, who are retailers required to focus on growing sales volume to improve their profitability.  However, JHX trades on a 2017 P/E multiple of 27.2x and is projected to have earnings per share growth of 13.0% for 2017.

For more detail on why Lowe’s is a top pick for AtlasTrend’s Splurging Baby Boomers Fund and other international investing ideas, join AtlasTrend for free.