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Wells Fargo analyst Zachary Fadem says the big home-improvement retailers are trading more like discretionary stocks vulnerable to weaker consumer spending than is justified.
Stefani Reynolds /AFP via Getty Images
The current state of the economy is a bit like a choose-your-own-adventure book. Think that the doom and gloom is overstated? Wrap yourself in the blanket of a tight labor market, rising wages, and Americans’ high savings and low delinquency rates.
Worried the worst has yet to come? Wallow in record inflation, the Federal Reserve’s aggressive moves, recession fears, and the potential for the job market to weaken.
Of course, most investors have chosen the latter path. That is reflected by stocks’ big declines in both retail and the consumer discretionary sector as a whole in 2022.
Wells Fargo
retail analyst Zachary Fadem seems to agree. On Thursday, he wrote that the macro backdrop is “increasingly dubious,” leading him to stick with strong operators in relatively defensive categories.
He pointed to auto parts retailers
AutoZone
(AZO) and
O’Reilly Automotive
(ORLY). Another stock he favors is the rural retailer
Tractor Supply
(TSCO), which outperformed hard-line retail peers—those selling durable products such as washing machines rather than soft goods such as clothes—and the broader market during the recessions of 2001 and 2008.
Auto parts retail’s most recent earnings were a bit varied, but other analysts have also argued in their favor, given their defensive nature. O’Reilly has easily outperformed the market since Barron’s recommended it last spring. Tractor Supply has been gaining fans as well, delivering a strong update the same week that Target stock (TGT) melted down after management cut its financial forecasts for the second time in three weeks, citing rising inventories of unsold goods.
Fadem also likes the home-improvement retailers
Home Depot
(HD) and
Lowe’s
(LOW), for many of the same reasons Barron’s does. He argued that they are trading more like discretionary stocks vulnerable to a pullback in consumer spending than is justified. Backlogs of orders from professionals in the home-improvement business should buoy comparable-store sales through the end of the year, while homeowners will still need to do maintenance and repair work even as rising interest rates hurt the housing market, he believes.
Not everyone is as sanguine on those companies.
MKM Partners analyst David Bellinger initiated coverage of both Home Depot and Lowe’s with Neutral ratings on Thursday, setting targets for their stock prices of $285 and $190, respectively. In morning trading, Home Depot was at $272.59, down 34% so far this year, while Lowe’s traded at $174.94, for a 2022 loss of 32%.
He is largely positive on both companies, but concerned about the likelihood that the current economic environment will continue to weigh on the stocks. “We expect market dynamics, including higher rates and moderating home price appreciation, to outweigh what are likely to be still solid yet slowing fundamental trends at the company,” Bellinger wrote of both Home Depot and Lowe’s.
That said, most analysts are sticking with home improvement, as 71% and 73% of those tracked by
FactSet
have a Buy rating or the equivalent on Home Depot and Lowe’s, respectively. There aren’t any bearish calls on the Street.
Yet while there are plenty of arguments for the longer-term success of the companies, that has done little to blunt the near-term pain. Both stocks have underperformed the broader market so far this year.
Write to Teresa Rivas at [email protected]
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