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Building Products - Retail Outlook: Economic Growth Lends Support

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The U.S. economy is picking up pace (4.1% growth in second-quarter 2018) with strong consumer spending driven by steady rise in income, strengthening labor market, as well as increasing business investments and government spending. Positive trends in the economy are driving many U.S. industries, including the housing market that has witnessed increased housing demand lately.

Notably, the spring buying season witnessed significant demand for buying a home across most parts of the United States due to the steady economy and improved employment levels. However, home sales remained stable due to budget constraints as home prices and mortgage rates continued to surge. Further, rising interest rates, trade-war anxieties (due to tariffs on aluminum and steel), labor shortages, apprehension of two more hikes in 2018 and limited land availability are some concerns looming upon the housing sector.

Albeit, the prospects for the building products industry, which produces and sells goods used in building homes and offices, are bright. Dealing in lumber, insulation materials, drywall, plumbing fixtures, flooring, and furniture, players in this industry are poised to gain from a shift to digitalization as the industry continues to evolve.

Further, higher home prices and rising interest rates are are acting as deterrents to home purchases, leading consumers to focus on undertaking home improvement and remodeling projects. This is likely to benefit the Building Products – Retail industry due to increased demand for lumber and other building materials. This is where home improvement retailers like Home Depot HD and Lowe’s Companies LOW stand to gain.

Industry Outperforms Shareholder Returns

Relentless efforts to enrich customers’ experiences, solid focus on omni-channel capabilities and innovations, robust services to Pro-customers as well as optimizing costs and boosting productivity are driving solid performance of a sizeable number of stocks in the space.

The Zacks Building Products – Retail Industry within the broader Zacks Retail-Wholesale Sector has outperformed both the S&P 500 and its own sector over the past year.

While the stocks in this industry have collectively gained 27.8%, the Zacks S&P 500 Composite and Zacks Retail-Wholesale Sector have rallied 26.1% and 16.4%, respectively.

 One-Year Price Performance

However, it’s worth noting that there was a significant lack of synchronization in the performance of individual stocks within the group. Some Building Products – Retail stocks are grappling with strained operating margins and higher costs to support omni-channel and supply-chain capabilities as well as stiff industry competition.

Building Products – Retail Stocks Look Expensive

Due to the outperformance of the industry over the past year, the valuation looks really expensive now. One might get a good sense of the industry’s relative valuation by looking at its price-to-earnings ratio (P/E), which is the most appropriate multiple for valuing Retail stocks because their earnings are effective in gauging performance.   

This ratio essentially measures a stock’s current market value relative to its earnings performance. Investors believe that the lower the P/E, the higher the value of the stock will be.

Generally, the price of a stock is directly proportional to its earnings. As earnings forecasts move higher, demand for the stock should drive its price. If the P/E of a stock is rising steadily, it means that investors are pinning their hopes on the company’s inherent potential.

The industry currently has a trailing 12-month P/E ratio of 23.3, which is in line with its median level but below the highest level of 26.3 witnessed over the past year, thus having more upside potential.

The space looks quite expensive when compared with the market at large, as the trailing 12-month P/E ratio for the S&P 500 is 19.4 and the median level is 20.2.

 Price-to-Earnings Ratio (TTM)


Outperformance May Continue Due to Upbeat Earnings Outlook

Solid focus on enhancing services to Pro customers, strategic acquisitions to widen footprint, expand brand assortments and effective cost-containment efforts are expected to help Building Products – Retail stocks continue generating positive shareholder returns in the near future.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the earlier valuation analysis reflects that there is little upside left, there are enough reasons for investors to continue looking for a good entry point.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance is its earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences the performance of its stock.

One could get a good sense of a company’s earnings outlook by comparing the consensus earnings expectation for the current financial year with the last year’s reported number, but an effective measure could be the magnitude and direction of the recent change in earnings estimates.

The consensus earnings estimate for the Zacks Building Products – Retail industry of $6.21 implies a significant year-over-year improvement from $5.57 in August 2017. Moreover, the trend in earnings estimate revisions has been favorable lately. 

Price and Consensus: Zacks Building Products - Retail industry

Looking at the aggregate estimate revisions, it appears that analysts are hopeful of this group’s earnings potential.

The consensus EPS estimate for the current fiscal year has been revised 11.5% upward since August 2017.

Current Fiscal Year EPS Estimate Revisions

Zacks Industry Rank Indicates Solid Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.

The Zacks Building Products – Retail industry currently carries a Zacks Industry Rank #62, which places it at the top 24% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Our proprietary Heat Map shows that the industry’s rank has improved considerably over the past four weeks.

Building Products – Retail Space: Earnings & Revenue Trends

The past earnings trend of this Building Products – Retail space as a whole reveals that the group has been witnessing an uptrend since 2009, prior to which it was declining for about two years.

Building Products - Retail EPS

Similarly, the top-line performance of the industry as a whole too has been mirroring growth since 2009.

Building Products - Retail Revenues

Bottom Line

Healthy economic environment along with rising consumer spending and home prices gives a bright future for the Building Products – Retail industry. Further, the space is expected to gain from companies’ consistent efforts to boost interconnected strategies and diversifying business operations. The players in the space are focusing on technological advancements to upgrade payment modes, better interpret customers’ needs and fit their demands conveniently and quickly, facilitate business operations in a modernized way, among others.

However, the Fed’s interest rate hikes do remain concerns for slower activities in the evolving housing markets in the United States. Recently, The Federal Reserve has kept interest rates unchanged, paving the way for a hike in September. Apprehension of two more hikes in 2018 might make things difficult.

Though the valuation looks a little pricey at this time, keeping long-term expectations in mind, investors may look for some good entry points in the stocks that will help them make the most of the momentum in the industry.

Notably, we have three stocks in our Zacks Building Products – Retail industry currently having a Zacks Rank #2 (Buy) that have been witnessing positive earnings estimate revisions. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Fastenal Company (FAST - Free Report) : This Winona, MN-based wholesale distributor of industrial and construction products globally, has surged 28.6% in the past year. The Zacks Consensus Estimate for the current fiscal year EPS was revised 2.4% upward in the last 30 days.

Price and Consensus: FAST

Builders FirstSource, Inc. BLDR: The consensus EPS estimate for this Dallas, TX-based company moved nearly 0.5% higher for the current fiscal year in the last 30 days. The stock has rallied 5.4% over the past year.

Price and Consensus: BLDR

BMC Stock Holdings, Inc. BMCH: The Atlanta, GA-based company has gained 7% in the past year. The Zacks Consensus Estimate for the current fiscal year EPS was revised nearly 2% upward in the last 60 days.

Price and Consensus: BMCH

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