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Home improvement sector trails overall housing turnaround

Barclays Capital (BCS) moderated its near-term outlook on home improvement stocks despite mounting evidence that increased homebuying is driving a positive feedback to housing markets across nation.

“This strength has not extended to the remodeling sector to the degree we had expected,” Barclays housing analyst Stephen Kim said.

The divergence is rooted in the housing market’s significant over-correction throughout the past five years, resulting in pent-up demand for housing purchases, Kim said, while most remodeling activity is discretionary. A minority of building product company sales is connected to new residential construction. The bulk of their exposure is tied to remodeling demand, commercial construction, and international markets.

Analysts expect data this week to show a 3% bump in existing home sales in July, bringing the annual rate to 4.5 million. And the National Association of Home Builders index stands at its highest level since February 2007. Both housing starts and permits in the second quarter are above the first quarter average.

Remodeling demand normally tracks well with housing starts, but the strength in the housing market has so far not carried over into such demand. A consistent message throughout the most recent round of second-quarter earnings reports, Kim points out, was that discretionary remodeling expenditures began to moderate over the past few months — echoing indications of flagging confidence in other consumer sectors as well.

Barclays downgraded Stanley Black & Decker (SWK) and Armstrong World Industries (AWI) from overweight to equal weight (click on chart for further detail).

On Monday, Lowe’s (LOW) reported that earnings fell 10% to $747 million, or 64 cents a share, in its second quarter as comparable-store sales dropped. The company just missed analysts’ average estimate of 70 cents a share, according to Zacks Investment Research. A year earlier, the Mooresville, N.C.-based home improvement retailer earned $830 million, or 64 cents a share, a year earlier

Last week Lowe’s rival, Home Depot, said second-quarter net income rose to $1.5 billion, or $1.01 a share, from $1.4 billion, or 86 cents a share, from the year-ago period. The company smashed analyst expectations of 69 cents a share.

Home Depot’s better-than-expected second-quarter earnings in the indicated big-ticket transactions — those $900 and above, 20% of U.S. sales — are up 3.4% from a year ago because of the strength in HVACs, appliances, kitchen and flooring.

“While we are mindful of this incremental data point, we believe the growth Home Depot is seeing in big-ticket transactions can be attributed largely to continued share gains from Lowe’s rather than a meaningful change in consumer behavior,” Kim said.

Home buying demand is exhibiting a greater sensitivity to home price increases than remodeling. That’s because prospective homebuyers closely monitor the prices of homes in real time, whereas homeowners typically receive infrequent updates on their home values.

Drastically reduced home equity and the recent weakening of consumer confidence, Kim said, is constraining remodeling demand.

“Longer term, we expect a recovery in home prices to eventually restore confidence to the discretionary remodeling market,” Kim said. “However, in the meantime, remodeling expenditures are likely to be constrained by the recent downtick in the broader economy.”

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