Home Depot: Why Spiking Mortgage Rates May Not Derail Its March to Sales of $100 Billion-Plus

Although Wall Street has sent Home Depot's (HD) stock down 7% in the past three months amid slowing sales trends in the U.S. housing market, the company's long-time CFO Carol Tome thinks investors need to keep things in perspective. 

"I think they [investors] are trying to determine if it's over [home remodeling cycle], are we out of gas. The answer is no. We [U.S. housing market] aren't fully recovered first of all. Secondarily, even when you reach full recovery, home prices don't stagnate -- we are having household formation in this country. As there is demand, prices will increase," explained Tome in an interview with TheStreet

Still, Wall Street continues to challenge Home Depot's upbeat assessment of housing.

Home Depot shares fell as much as 2.6% Tuesday despite third-quarter earnings coming in at $1.60 a share, beating analysts' forecasts of $1.58. Net sales rose 6.1% to $23.2 billion, ahead of estimates for $23 billion. U.S. same-store sales rose a solid 5.9% from the prior year.

The company raised its full-year earnings forecast to $6.33 a share from $6.31 a share.

In large part, the world's largest home-improvement retailer has the prolonged increase in home values to thank for its better-than-expected results. Rising U.S. home values are leading people to view investing in remodeling their homes as a wise decision. "Our customer is looking at his or her home and saying it's worth more today than it was yesterday. So their home has more value, there is a wealth effect," said Tome. 

The national median single-family home price reached $240,900 in the third quarter, up 5.2% from $228,900 a year ago and the last quarter's $240,700, according to the National Association of Realtors. It marked a peak in the quarterly median sales price. Overall, the median existing single-family home price increased in 87% of the 178 metro markets that were measured.

Subsequently, the National Association of Home Builders recently said its home remodeling index rose four points to 57 in the third quarter. Anything over 50 signals an improvement.

"Home Depot's markets are still outperforming," noted Credit Suisse analyst Seth Sigman in a note ahead of the results. In particular, Sigman noted still healthy housing markets where Home Depot has a store nearby are continuing to fuel demand from contractors, and among consumers for appliances and other items online. Home Depot told analysts on a conference call that sales to contractors -- which Home Depot calls 'Pro' customers -- outpaced the company's overall same-store sales increase and that sales of appliances rose by a double-digit percentage.

It's easy to see why the market would be skittish on Home Depot and rival Lowe's (LOW) , whose stock has plunged about 14% over the past three months.

Existing home sales reached a post Great Recession peak in June, and softened a little during the summer. Meanwhile, new home sales in September missed Wall Street forecasts by roughly 1.1%, while sales for August were revised down sharply to a 575,000 pace from a prior estimate of 609,000.

Tome says Home Depot remains on track to reach $101 billion in annual sales by 2018, a target it laid out in December 2015.  

TheStreet spoke with Tome about what is making Wall Street skittish about home improvement stocks and the threat of higher interest rates under a President Trump.

Home Depot CFO Carol Tome.

Rising home values are still leading people to invest in their homes.

TheStreet: The quarter looked fine, so what has made Wall Street so nervous lately when it comes to Home Depot's stock and others in the home improvement space?

Tome: Well, I think they are seeking clarity on when the cycle [home remodeling] is over. If you listened to the earnings call, analysts asked a number of questions about what we are seeing in our customer base, within departments and within geographies, and where we think we will go in 2017. They just don't want to miss the peak of the cycle. We don't think we are at that peak. In fact, we just reaffirmed our sales growth guidance. We haven't come out with our 2017 guidance yet, but we aren't coming off our 2018 financial targets which are to take our sales to $101 billion annually and our operating margin to 14.5%.

So we see lots of room for continued growth in the housing market and in home improvement spending. 

TheStreet: Investors are underestimating how home price appreciation in the U.S. continues to drive spending by contractors and consumers?

Tome: I think they [investors] are trying to determine if it's [home remodeling cycle] over, are we out of gas. The answer is no. We aren't fully recovered first of all. Secondarily, even when you reach full recovery home prices don't stagnate -- we are having household formation in this country. As there is demand, prices will increase. In fact, if you look at the number of houses that are for sale -- we are at something like 4.5 months of supply, that is under where it should be. There is a bit of a housing shortage in our country. Every way we look at it, we see continued growth.  

TheStreet: Mortgage rates have spiked following the election of Donald Trump as president, what's the level of concern that the U.S. housing market really slows down in early 2017?

Tome: We have run correlation analysis to see if there is any impact of interest rates and our sales. We can't find any statistically significant correlation. Then we looked at mortgage affordability to see if there is a concern. The mortgage affordability index is north of 150% currently, so that's good news. Then we also looked at what happened historically with interest rates and spending on homes. If you go back to 1995 to 2000, 22% of the average homeowner's income was used for their mortgage payments. Today, it's like 14%. Interest rates would have to go up to 7% before we returned to that historical average of 22%.

There is no projection that mortgage rates are going up to 7% in the first half of 2017, it would take a long time before it hits that rate. So we aren't concerned about interest rates.  

TheStreet: What about from a stock market sentiment perspective. If the Federal Reserve raises rates in December, and mortgage rates continue to rise that could be a double whammy, no?

Tome: There are maybe two ways to think about this. One, is what is going to happen to our customer and two, what will the market do? Our customer is looking at his or her home and saying it's worth more today than it was yesterday. Since 2011, homeowners have had a 95% increase in the value of their equity either through rising home prices or the fact they have paid down a good bit of their mortgage. So their home has more value, there is a wealth effect. And, they are using that to spend in our stores. 

Now what the market may do with rising interest rates, the market may sell-off -- I have no idea, that's not what I do for a living. 

Home Depot's appliance sales remained a bright spot in the third quarter.

TheStreet: We talked several months ago how Home Depot was stealing market share from ailing Sears Holdings (SHLD) in appliances. Home Depot had a strong third quarter in the tools business -- it was your third fastest growing department in the quarter. Do you think Sears is donating market share there as well?

Tome: We believe it's because of the breadth of brands that we carry inside of our stores and on our website for our professional customer. We carry every brand they want. And within the brands we carry, we have the broadest assortment out there and new innovations that in many cases, are exclusive to Home Depot.

If you think about the product categories that we overlap with Sears, it's over $6 billion of sales opportunity. Obviously, they are donating market share in all categories.

TheStreet: Lastly, you sounded very upbeat about the holiday season -- as have several other retailers. What gives you that confidence considering we just went through a contentious election season?

Tome: If I look at how we did during our Halloween & Harvest event, we had terrific sales. We bought a good amount of inventory for that event, I mean this was Halloween decorating. We also bought up for the Christmas holiday, and we are off to a great start so far. So, it's about the merchandise that you bring in, getting what customers want and driving value. 

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