Will Home Prices Drop?

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During their latest episode of the VALUE: After Hours Podcast, Morris, Taylor, and Carlisle discuss Will Home Prices Drop?. Here’s an excerpt from the episode:

Tobias: Finger on the pulse. So, Alex, you’ve been doing some work on HD. What do you–? [crosstalk]

Jake: Home Depot for the laymen.

Tobias: Home Depot. Sorry.

Jake: [laughs]

Tobias: For the laymen. What’s the view on Home Depot for the economy, the market? What are we looking at here?

Jake: Yeah.

Alex: Yeah, I think the best way to sum up the story is, as were talking about before we hopped on, if you go back to, call pre-pandemic, it’s a business with no unit growth or effectively no unit growth.

Tobias: So, no new stores is what that means.

Alex: No new stores. It’s a crazy story. It’s a really interesting story. From early 1990s to mid-2000s, stores went from 200 to 2,000 basically, or 2,200. Completely put the brakes on in 2007, 2008, and people were skittish, as you might expect. 10 times earnings, something like that. It’s been an absolute monster over the last 15 years. Even before the pandemic, they really focused on running the core business well, and it shows in some of their comparative results with Lowe’s and other players.

Jake: Operating leverage is so amazing to see play out, right? When you drive revenue through the same four walls at such a better clip, it just so much hits the bottom line. It’s amazing.

Alex: Yeah.

Tobias: Do they have some research or some– There must be some reason for they’ve just decided, whatever it is, 2,200 stores, is that what you said? Is that saturation? They’ve decided that’s close enough to everybody to, they don’t need any more stores?

Alex: Yeah. So, in the 2007, 2008 period, as they looked at where they were at, they actually had, I think, numbers, half a billion dollars of stores in the pipeline. I think this is before things got really, really bad, but I think they had half a billion of stores in the pipeline. They essentially just took a write-off on and said, “We’re not going to build these.” The days of us just– Some of it was international in terms of where they were looking to grow, at least in the early 2000s. But I think they just realized, “Let’s focus on what’s happening inside the four walls,” then obviously, the e-com and distribution stuff around all of that, and it’s proven to work quite well in terms of unit economics.

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But yeah, so call it a mid-single digit grower and then you’re just living up the pandemic. You have everything that’s happened subsequently. Past three years, revenue growth, CAGR has been, I think, 13%. So, obviously, well above the trend. You have this interesting dynamic, where the primary driver hasn’t been transactions. It’s actually only grown low single digits from Q4 ’19 to Q4 ’22. The driver has been ticket. It’s tough to parse out exactly the percentage contribution from these buckets. But it’s pretty clear from how they report the numbers and what they’ve said previously that early on a big driver was what you would call real organic ticket growth from mix shift to more pro customer spend more than anything else, which is driving up the number of dollars in a basket, and really speaks to remodeling and home investments and the like in 2020, 2021, 2022. As you’ve gotten to the later part of that period, it’s been a lot more of cogs inflation and the like.

Now where they’re at today, you’re seeing where customers were a little bit more willing to eat some of those price increases and still not impact volumes as much as that price was hitting them. It’s now leveled out with one another and they’re pretty clearly saying, “Hey, customers are becoming a lot more sensitive than they were previously.” I think they wrapped up the macro data pretty well with a comment where they said, “Home prices–” From pre pandemic to June 22, I want to say, they said home prices increased by 45% and subsequently in the past X number of months, they’ve declined by roughly 3% cumulatively on whatever data they’re looking at. So, I think it just speaks to the nature of what has happened. Then, there’s also obviously with rates and everything else, I saw in a recent Wall Street Journal article, NAR said, “Home affordability is at its lowest level since 1985.”

So, I think there’s just a big question about what the trend looks like for this business in 2023, 2024, and beyond. Their guiding to comp is basically flat, which is worse than what they’ve been reporting, but certainly, it doesn’t strike me as being particularly pessimistic. I was listening to the F&D call before we hopped on, Floor & Décor, and one of the analysts asked during the Q&A, which I liked a lot. “How long is this going to last and how severe is it going to be?’ [laughs] That was a good question. Unfortunately, they didn’t have the answer either.

Tobias: Oh, I was waiting for the answer.

Jake: Yeah.

Alex: [laughs] Yeah, they didn’t have the answer. Unfortunately, they didn’t have the answer either, but it was a good try. [laughs]

Jake: Alex, do you have a sense of what drives–? Okay, I’m trying to imagine turnover of houses, I would think that people come in, they want to make it their own, they spend money at Home Depot. Or, is it, “My house price went up. I have home equity now. I take money out and I do stuff to it.” What drives more, do you think? Turnover or home equity HELOCS, basically?

Alex: Yeah, I think it’s both. I think it also depends probably, as you look at specific categories– I’ve seen something recently, for example, “Hey, when the economy does a little more poorly or when home prices come in a little bit, it doesn’t necessarily lead to all that work just going away, but it might be that kitchen or bathroom is now going to be-

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Alex: -a great job and– [crosstalk] Yeah, it might be a smaller project in the house that is not going to stretch you too much on the amount of work, or hiring someone, or the budget, et cetera, et cetera. So, I think it partly depends on who you’re talking about in this space. It’s funny. If you look back in 2006, 2007, 2008, 2009, I think that’s right, HD comps were down every year during that period. Cumulative comp’s down more than 20%. The mix between the two was essentially split between ticket and transactions. So, obviously, that period was very unique. I don’t know if this is going to be anything like that, but– [crosstalk]

Tobias: Toby says it will be worse.

Alex: Yeah. Well, if it is, then that’s a problem for– [crosstalk]

Tobias: I don’t know.

Jake: [laughs]

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