More Cynicism for Home Depot, Lowe's

UBS suggests that the weak housing market isn't done wreaking havoc on the stocks.
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Another Wall Street analyst has gone negative on the two leading home improvement retail chains, as conditions in the U.S. housing market continue to deteriorate.

Shares of

Home Depot

(HD) - Get Report

and

Lowe's

(LOW) - Get Report

were down Monday after UBS Investment Research analyst Brian Nagel cut his rating on both stocks to reduce from neutral.

"The housing market in the U.S. continues to slow more then initially expected," Nagel said in a note to clients. "Softer housing data lately and prospects for continued weakness in the U.S. housing market suggest to us that sales and earnings trends at Home Depot and Lowe's should slow significantly from recent levels."

While a housing slowdown is a foregone conclusion on Wall Street, investors and economists are debating how deep the slowdown will go and what effect it will have on the broader economy.

Recent gains in the stock market suggest that the outlook for a so-called soft landing for the economy has become the prevailing view, as traders bet that a strong labor market and double-digit profit growth for corporate America will cushion whatever pain is wrought by the housing slump. Still, pockets of skepticism remain, and Nagel joined one of them with his pessimistic view on the home improvement retail business.

While a number of analysts have come out with similar warnings in recent months, about half of those covering Home Depot and Lowe's on Wall Street still hold a buy rating on their stocks. Consensus estimates reported by Thomson First Call show that most of them are predicting continued earnings growth for both companies in 2007, but Nagel now expects their earnings will decline next year and the stocks are headed for trouble soon.

Both retail chains will report third-quarter earnings results in late November, and Nagel said in his report that the releases will be an occasion for both companies to lower Wall Street's expectations for their 2007 prospects. He now expects Home Depot to earn $2.75 a share next year, down from his previous estimate of $3 and Wall Street's consensus estimate of $3.22.

Likewise, Nagel lowered his 2007 profit outlook on Lowe's to $1.85 from $2.10 a share. Analysts are expecting earnings of $2.20.

The two rivals have already lowered expectations for results in the back half of 2006, and their stocks are both down for the year. But shares of both retailers have staged rebounds in recent months, along with the rest of the stock market.

Nagel said the outlook has become too rosy. His updated EPS estimates for the home improvement chains reflect same-store sales trends that shift to "down low to mid-single digit rates over the next few quarters from flat to slightly positive lately."

Using historical data, Nagel makes a case that both retailers have become increasingly linked to the real estate market, and he estimates that as much as half of the fluctuation in their comps can be attributed to changes in the macro environment for housing.

"Shifts in housing data typically precede changes in comp trends at Home Depot and Lowe's by about six to nine months," Nagel said.

Meanwhile, he notes that a number of major suppliers to home improvement chains, like

Sherwin Williams

(SHW) - Get Report

and

Stanley Works

(SWK) - Get Report

have reported housing-related weakness recently.

Shares of Home Depot recently were down 16 cents, or 0.4%, to $37.04; shares of Lowe's fell 35 cents, or 1.2%, to $28.70.