The Home Depot (NYSE: HD) priced US$3.5bn worth of new bonds on Tuesday to decent demand, after recently topping Wall Street’s earnings expectations, and despite a downbeat housing market.
The Atlanta-based home improvement retailer said it intends to use the net proceeds from the four-part issuance for general corporate purposes, including share buybacks.
Bond investors generally snapped-up the ‘A’-rated deal, which was comprised of 3.5-year fixed- and floating rate notes, as well as 10-year and 30-year fixed-rate paper.
Most of the interest appeared to be focused on the longest-dated tranche, which saw roughly 17bps of spread compression across the transaction’s pricing evolution to price at 128bps more than the benchmark yield of 3.325%.
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Gimme Credit analyst Carol Levenson said the new notes will likely help to refinance certain of Home Depot’s maturities and that funding used for share repurchases are expected to exceed free cash flow this year.
Prior to the sale, Home Depot had “once again soundly beat Lowe's” in comparable-store sales growth in the latest quarter, with a 5.4% increase in the U.S. compared to Lowe's 2.0%, which along with fewer competitors due to bankruptcies, signals further gains in market share, Levenson said.
Moreover, Home Depot’s “excellent profitability and return on capital remain among the highest in the retail industry, and its financial policies are consistent and conservative,” Levenson continued, adding that while she remains typically averse to borrowing for stock buyback purposes, in the case of Home Depot, “the company does this within the constraint of not exceeding its target adjusted debt/EBITDAR ratio of 2x.”
The retailer said in its latest updated guidance that it anticipates around US$8bn of share repurchases in fiscal 2018, up from US$6bn in August.
Housing slowdown
Meanwhile, Home Depot’s upbeat financial performance and outlook continues to contend with several headwinds, including a sluggish housing market, increasing household debt, rising interest rates and higher mortgage costs.
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Home prices in the U.S. grew 5.5% in September, according to the latest S&P CoreLogic Case-Shiller National Home Price Index – the sixth straight month of slower growth, and the lowest level since January 2017. Average home prices for the top 10 metropolitan areas rose 4.8%, down from the previous month of 5.2%.
Ralph Mclaughlin, economist at CoreLogic, said that despite the continued increase in home price appreciation, “it appears that the momentum in housing market is slowing,” and observers of the housing market “may have noticed other major indicators such as housing starts, new home sales, existing home sales and homebuilder confidence have also trended down over the past few months.”
Mclaughlin continued that while these trends “point to a softening in the housing market, there is little reason for panic. Current housing supply is still low: new and existing housing supply remain well below long-term historical averages.” He added that future housing demand “should continue to be robust: households under the age of 35, which account for the largest pool of potential homebuyers, are starting to show signs they’re buying homes. Both factors should help long-term investors in the housing market remain confident.”
However, other indicators, including household debt levels, do not appear as encouraging for the housing marker – especially millennials with increasingly burdensome student loans.
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Debt levels rising
The New York Fed recently cited figures from the Center for Microeconomic Data (CMD) that showed aggregate household debt balances increased in Q3’2018 for the 17th consecutive quarter and are now US$837bn higher than the previous peak of US$12.68tn, set in Q3’2008.
As of September 30, 2018, total household indebtedness was US$13.51tn, a 1.6% rise over Q2’2018 and 21.2% above the Q2’2013 trough.
Mortgage balances, as shown on consumer credit reports on September 30, stood at US$9.1tn, an increase of US$141bn from Q2’2018, while balances on home equity lines of credit (HELOC), have hit a 14-year low.
Furthermore, non-housing balances jumped by US$88bn in Q3’18, with auto loans up by US$27bn, credit card balances having risen by US$15bn, and student loan debt having spiked by US$37bn.
Analysts at McKinsey recently noted that broader measures of household financial wellness, beyond mortgages, “remain worrying.” They observed, for instance, that outstanding student loans now top US$1.4 trillion, exceeding credit card debt, and unlike nearly all other forms of debt, they cannot be discharged in bankruptcy.
According to CMD, 11.5% of aggregate student debt was 90+ days delinquent or in default in Q3’2018, a “substantial increase” from the prior quarter.
Homebuilders under pressure
Against this backdrop, many homebuilders’ shares have been suffering.
The SPDR S&P Homebuilders ETF (XHB) shed more than 31% of its value in late October from roughly the start of 2018, with firms such as Toll Brothers (NYSE: TOL), D. R. Horton (NYSE: DHI) and Meritage Homes Corp (NYSE: MTH) each down nearly 45%, 36.5% and 40.25%, respectively.
Home Depot’s equity seems to be following a similar trend seen in the first quarter of 2018, when its stock fell around 17%. While the company’s shares reached at recent 52-week peak of US$213.85 in mid-September, they have since dropped by a little more than 21%.
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In intraday trading Wednesday, Home Depot, Toll Brothers, D. R. Horton, Meritage Homes and XHB were all down between 0.5%-2.75% following disappointing new home sales figures for October.
The market’s perception of homebuilders’ and home improvers’ creditworthiness has also generally deteriorated, with widening in the five-year credit default swap (CDS) spreads of Lennar Corp (NYSE: LEN), D. R. Horton, Beazer Homes USA (NYSE: BZH), and KB Home (NYSE: KBH) of between 40bps to almost 250bps over the past three months.
Single-family housing starts had also posted a decline in November, as builders grappled with affordability issues.
NAHB chair Randy Noel said earlier in November that rising affordability concerns “continue to weigh on single-family production even as total housing starts edged higher in October.”
According to data from the U.S. Department of Housing and Urban Development and the Commerce Department, total housing starts rose 1.5% in October to a seasonally adjusted annual rate of 1.23 million units from an upwardly revised September reading. Year-to-date, new housing starts are 5.6% above their level over the same period last year.
Noel noted that builders are “showing caution as mounting housing affordability concerns are forcing some consumers to delay making a home purchase.” He added that while a growing economy and positive demographic tailwinds are supporting housing demand as interest rates rise, “policymakers should take note of the November decline in builder confidence as a sign that housing affordability conditions will weigh on the housing market going forward.”
Interest rate risk takes toll on bondholders
Although the Federal Reserve has been hiking U.S. interest rates on its path towards policy normalization, uncertainties over the future frequency of increases has recently seeped into many investors’ outlooks, as geopolitical risks have intensified, and tariff-related concerns have adversely impacted the risk tone.
Over the past year, the yields on the 10-year and 20-year U.S. Treasury notes, and 30-year Bond, have risen by around 92bps, 85bps and 78bps, respectively. The yield on the 10-year note was last at around 3.04% intraday Wednesday, down 20bps from its 52-week peak set earlier in November.
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Although rates have been volatile, some of Home Depot’s longer-dated bonds have remained relatively resilient. Its 2.8% notes due September 2027, for example, have fallen about 3.65% in value over the past year, while its 5.95% debt due April 2041 has shed a little more than 7%.
According to IBKR Trader Workstation, the bonds were last trading 0.45% and 0.16% higher on the day Wednesday to US$92.294 and US$119.990, respectively.
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