A new analyst call on Home Depot reflects our feeling on what to do with the stock
Melius Research appears to be aligned with our idea that now is the time to hold your nose and do some buying in this market — at least as it relates to some beaten-down names tied to housing. That’s the message in a Tuesday note from analysts at Melius who initiated coverage on the housing sector — putting a buy rating and a $397-per-share price target on Home Depot . They are among the 58% of Wall Street shops with buy ratings; 38% have holds; and the rest are sells, according to FactSet. The Club put a buy-equivalent 1 rating on the stock after earnings this summer . The Melius analysts pin their optimism on the idea that things are set to improve in the existing home market, which is where the demand for repairs and remodeling projects tends to come from. That’s why they like Lowe’s , too. “We view existing home supply’s rise as perhaps the most consequential trend for the housing ecosystem, more so than most of the current demand headwinds,” Melius wrote. The headwinds, as Melius sees it, are more in the new housing market due to not only a high-interest rate environment that is crushing monthly affordability, but also a slower job market. It’s not surprising that consumer confidence remains low as people are wary of taking on large, multi-decade financial commitments. In fact, the analysts said that job growth and consumer confidence are “largely viewed as two of the three most critical demand drivers for housing (rates being the third).” While they like homebuilder Toll Brothers, the analysts rate D.R. Horton , KB Home , and Lennar as sells. In recent years, a major factor stalling the real estate market and keeping existing home supply suppressed has been the “lock-in” effect. This happens when existing homeowners, who may want to move, choose not to because the rate on their existing mortgages is so much more attractive than what they could get in the current mortgage market. Sure, you may have bought a house in 2020 at $750,000 and now want to sell at $1 million and move, but do you really want to give up that sub-3% mortgage rate in exchange for 7%? All else equal, going from 3% to 7% on a 30-year fixed mortgage increases your principal plus interest payment by about 58% each month. We’ve been waiting for about two years for mortgage rates to fall below 6% and stay down there. While it’s been a wrong call, we’re holding a small position in Home Depot to be ready for when rates eventually fall. Additionally, over the past couple of tough years, the company has been buying building distributors left and right, getting bigger in pro for when the housing turn comes. That said, maybe lower rates aren’t the only way to get the existing home market going again. The “lock-in” effect is abating. “Specifically, 50% of homeowners are now in sub-4% mortgages vs. 61% three years ago, while 22% have 6%+ mortgages vs. 10% three years ago,” the Melius analysts said. “We expect this trend to continue over at least the next 2-3 years and drive a tipping point-like positive inflection in existing home sales and repair/remodel demand.” While that doesn’t bode well for new home demand, it certainly favors Home Depot. The analysts said, “Supply is likely to remain a headwind to the new home market over the next couple of years, as new homes for sale are already at their highest level in two decades and existing homes for sale should continue to rise steadily going forward.” To be sure, this isn’t a ringing endorsement to buy because things are great; rather, it’s a call to buy because things don’t seem able to get much worse — at least for the existing home market that matters so much more to a name like Home Depot. The Melius call is not so much a way to time a perfect buy as much as it is to start thinking about what can go right for Home Depot, and figuring out buy levels that allow you to get to establish a good cost basis (or improve your existing one) on which to build the position ahead of the expected turnaround. While technical analysis is not how we think about what to buy (we’re fundamentalists at heart), it can be a useful tool to inform on opportunistic levels. A quick look at Home Depot’s chart does support the idea that we are seeing those levels. Shares are currently trading at their lowest levels going back to October 2023. During the past five years, Home Depot’s lowest close was in June 2022, at about $270 apiece. That doesn’t mean things can’t get worse; stocks stop at $0, as they say. However, it does tell you just how bad sentiment is — and, in a way, indicates that current levels are buyable. From a valuation perspective, Home Depot trades at about 18 times forward earnings estimates, which is below its five-year average of about 24 times. So, if you’re looking to get on the books in a name that still amounts to a good house, in a very bad neighborhood, on the idea that the neighborhood is set to get much better, Home Depot is attractive at current levels because any relief in interest rates is likely to be met with a swarm of buyers. Remember, any break in the Middle East turmoil could flip high oil on a dime and lead to much lower prices. If that happens, some say when, the pressure comes off bond yields and the Federal Reserve. The discussion could quickly move from how many more Fed rate hikes are in the cards to how long until rate cuts become a possibility. If we zoom in on a one-year Home Depot chart, we find that the downward momentum in shares may also be set to reverse, as the MACD indicator is on the verge of crossing through the signal line. Confirmation is considered to come when the so-called moving average convergence divergence crosses through the zero line. While a technician may opt to wait for that to actually happen, we’re pointing it out because it serves to support our fundamental view. It’s the fundamentals that carry much more weight for us. It is also worth noting that the relative strength index (RSI) just crossed back above 30, meaning that shares were at their most recent lows in oversold territory below 30. Bottom line Melius is not giving us a back-up-the-truck call, nor the sense that you need to rush in before it’s too late. What you have is a stock that may well have found a bottom and prove to be a coiled spring in the quarters ahead, especially should rates come down on the back of a Middle East resolution. The idea isn’t to time when a coiled spring pops but rather to figure out when it’s already so coiled that the risk/reward ratio simply can’t be ignored. Given our view that Home Depot really is being plagued by the operating environment, and not managerial or execution issues, we think that the stock, only 4.5% above its five-year closing low and about 34% off its record-high close of $431 in December 2024, is now at that point. Given our existing position, we want to see a bit more confirmation that the bottom is in. However, for those looking for a contrarian idea that plays right into lower oil and, in turn, interest rates, shares sure are interesting down here. (Jim Cramer’s Charitable Trust is long HD. 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. 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