(Apr 12): Last week, I talked about why US consumers may well be the key driver for near-term global growth, contrary to widely held views. To very quickly recap, thanks to a decade of deleveraging, in the aftermath of the global financial crisis, US households have rebuilt their balance sheets. Household debt now stands at only 71.3% of GDP, down from the peak of 98.6% in 2007. Crucially, debt servicing as a percentage of disposable income has dropped to the lowest level in decades — leaving consumers with more to spend and/or save.
All these things bode well for US consumption, including the housing sector. On the strength of this conviction, I have added three US consumer and housing-related stocks to the Global Portfolio — The Walt Disney Co, Home Depot and Builders FirstSource.
To be sure, new housing starts have stagnated while existing home sales weakened through 2018 (see Charts 1 and 2). This was likely due to rising interest rates and, to a certain extent, home prices. The US Federal Reserve raised policy rates four times last year. The 30-year fixed-rate mortgage rate rose steadily from under 4% at the beginning of 2018 to nearly 5% in November (see Chart 3).
However, interest rates have since fallen sharply, back to around the 4% level currently — after the Fed pivoted from a hawkish to dovish stance. The central bank has indicated that there will likely be no more rate hike this year, contrary to its earlier projection of at least two more increases of 25 basis points each. Indeed, in the absence of any material pickup in inflation, there may be little need for additional hikes in the foreseeable future.
Meanwhile, wage increases have continued to gain momentum, as is to be expected in the current late-cycle expansion. The job market is tight, with the unemployment rate at 3.8%, the lowest in nearly five decades.
The Housing Affordability Index, which declined through 1H2018, has rebounded as income gains outpaced the increase in costs of home ownership (see Chart 4). A higher index number indicates that more households can afford to purchase a median-priced home.
A recent survey by Fannie Mae indicated a surge in housing sentiment, bolstered by a combination of lower mortgage rates, higher disposable incomes and growing job confidence.
US non-farm payroll remains very healthy, with more than 180,000 jobs created a month in 1Q2019, on average. Meanwhile, applications for unemployment benefits dropped to the lowest level since December 1969, when the total workforce and population were comparatively much smaller. According to the Labor Department, total job openings (7.1 million) in February were higher than the number of officially unemployed people (6.2 million).
Home Depot is the largest home improvement retailer in the US, with big-box format stores across the country (as well as in Canada and Mexico) supported by an extensive network of distribution centres and delivery infrastructure. It has committed to invest US$1.2 billion ($1.6 billion) in logistics infrastructure by 2022. Currently, about 90% of the US population can expect one-to-two-day delivery services.
The retailer sells practically everything under the umbrella of home and improvements, such as appliances (refrigerators, ovens, garbage disposal units, fans, air conditioners and so on), tools and hardware, lumber and building materials, plumbing, paint, furniture, electrical, lawn and garden supplies, plants and outdoor living.
Home Depot has historically reported consistent revenue growth, averaging 7% in the past three years. In recent years, it has focused on integrating its physical and digital channels and has been, by most accounts, successful. Online sales grew 24% last year and now account for roughly 8% of total sales. About half of these sales are picked up in-store.
The company’s strategy of improving its existing stores and online platform has contributed to its track record of improving margins and economies of scale. Free cash flow has grown consistently since 2011 — to about US$10.6 billion last year — as have dividends per share.
In addition to boosting dividends in the latest quarter, the board also authorised a new US$15 billion share-repurchase programme. Valuations are reasonable at trailing price-to-earnings ratio (PER) of less than 21 times.
Builders FirstSource is one of the largest suppliers of structural building materials in the US, catering to professional homebuilders and sub-contractors for new residential construction as well as the repair and remodelling market. It has a broad and diversified customer base across the US, especially in the South and West regions.
The company’s manufactured products include roofs and trusses, wall panels, stairs, vinyl windows and doors. In addition, it also distributes a wide range of building materials such as lumber and treated wood, cabinets, columns, decking, doors, drywall, fireplaces and steel, among others. Builders FirstSource also offers services such as design, product installation and turnkey framing.
Builders FirstSource acquired its largest competitor, ProBuild Holdings LLC, in 2015, creating a more diversified company with greater geographical reach and economies of scale. It has been generating positive annual free cash flow, which helped pare down gearing, from 12.7 times in 2015 to the current 2.6 times. Valuations are attractive at just over eight times trailing PER, below the industry average of more than 10 times.
The Walt Disney Co. also fits well into our positive outlook for US consumer spending, with its broad exposure to studio entertainment, theme parks and resorts as well as consumer merchandise.
Its share price has been locked within a tight trading range for some time. With the uncertainties surrounding the acquisition of 21st Century Fox resolved and increasing clarity on its streaming services, Disney+, we believe the timing is right for the stock to finally perform.
The House of Mouse has a formidable movie line-up for 2019, starting with Captain Marvel, which topped US$1 billion at the box office worldwide. The theme parks are expected to continue doing well, boosted by new attractions, including the highly anticipated Star Wars: Galaxy’s Edge, as well as higher ticket prices. The media giant is trading at a trailing PE of just 16 times.
The Global Portfolio ended weaker for the week as investors turned more cautious with stocks having chalked up strong gains so far this year. Total portfolio returns stand at -1.2% since inception. By comparison, the benchmark MSCI World Net Return Index is up 4.7% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
This story appears in Issue 877 of The Edge Singapore (week of Apr 15) which is on sale now. Subscribe here