Why we started a position tied to housing and where we see this stock going
5 min read
We started buying Home Depot shares last week as a play on housing and interest rates. Our initial 50-share buy was around $362. We bought 50 more shares Wednesday a few dollars higher. The Dow stock is having a mixed year — up about 7% compared to the S & P 500 ‘s more than 16% gain. After rallying to $395 in March when the market anticipated as many as six Fed rate cuts this year, Home Depot then traded as low as $325 in May as investors reset their expectations lower. Home Depot has finally started to work again over the past few months after bond yields plunged on a series of softer inflation prints with resilient economic data. Still, the stock is well below its late 2021 all-high close of $415 per share when everyone was nesting during Covid. The peak was reached only a few months before the Fed’s rate-hiking cycle began in March 2022 to combat rising inflation. With the Fed widely expected to cut rates at its upcoming September meeting, we wanted to get exposure to quality companies like Home Depot that have been held down in this high interest rate environment but will see their industries improve as borrowing costs come down. Our Home Depot investment thesis is all about a pickup in housing turnover, the main driver of the home improvement retailer’s sales. In previous cycles, the mortgage rate range where you typically start to see the big increase in turnover was around 5% to 6.5%. The next cycle should be no different. We’ve already seen some confirmation that mortgages below the 6.5% level is where activity picks up, CEO Ted Decker said on the company’s second-quarter earnings call in August. When rates went below 6.5% toward the end of last year, he explained, there was an immediate increase in housing activity, mortgage applications, and mortgage refinance applications. HD YTD mountain Home Depot YTD So where are we today? Mortgage rates fell for the sixth straight week last week to 6.29% from 6.43%. And, what did we see? A weekly increase of 1.4% in total mortgage demand and a 1% increase in refinance applications. That’s not a lot of activity, but it shows the trend is going the right way. Mortgage rates are still at the top end of the range the aforementioned range. People are waiting for the bigger drop. We may not be that far away. Mortgage rates with a 5% handle could be on the horizon, at least that’s what Toll Brothers CEO Doug Yearley thinks. He said Wednesday on CNBC’s “Squawk on the Street” that the 30-year fixed rate mortgage could go below 6% if the Fed cuts three times in the fall. Once mortgage rates have a 5% handle, the housing market could take off. To be sure, a drop in mortgage rates won’t improve Home Depot’s business overnight. There’s typically a lag effect of a few months because it takes time to close a home and then figure out what projects you want to do. Still, if Yearley is correct, then it won’t be too long until mortgage rates are at a sweet spot where housing turnover really starts to pick up, making now the time to start buying Home Depot. The knock against retail right now is that the U.S. consumer is on shaky ground, but housing is a different animal because rising home values tend to lead Home Depot sales. As Decker pointed out at an investor conference last week that home equity values have gone up nearly $18 trillion since the end of 2019 and the tappable equity for a HELOC, a home equity line of credit, is around $11 trillion. With these numbers, it’s easy to see why Decker is optimistic that activity will normalize, and housing turnover and remodel activity will pick-up again. For now, though, Home Depot is still positing comparable sales declines, and the Street doesn’t expect a return to growth until the middle of next year. But we want to get ahead of inflection. It’s similar to what we are currently witnessing with Club name Best Buy , which has now rallied big on back-to-back quarterly reports in anticipation of its return to annual sales growth. One question you might ask is why Home Depot over chief rival Lowe’s . We think both stocks can work under this thesis, but we like Home Depot because it has more exposure to professional customers and less to do-it-yourself shoppers. Earlier this year, Home Depot beefed up its Pro business through a more than $18.25 billion acquisition of SRS Distribution, a professional building supply outfit that specializes in pools, landscaping and especially roofing. Management believes this deal increased its total addressable market by $50 billion to $1 trillion. Another reason for our Home Depot stock buys : A drop in interest rates should make dividend growth stocks like Home Depot look more attractive to income-hungry investors. The stock currently sports a dividend yield of nearly 2.4%, and this also pays us as we wait for mortgage rates to fall. The company historically has been an active buyer of its own stock, but the buyback is on pause until 2026 because it financed the SRS acquisition with $10 billion in bond issuances. We have a $420-per-share price target on the stock and our buy-equivalent 1 rating. (Jim Cramer’s Charitable Trust is long HD, BBY. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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