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Industry Analysis: Retail Building Supply
Homeowners and professional contractors visit companies in the Retail Building Supply Industry to purchase the materials and tools necessary to build houses, complete remodeling projects, and perform household chores and maintenance.
Overall, the industry is mature, and its sales growth tends to move roughly in line with the trends of the broader economy. This group is highly competitive, and is dominated by a couple of big multinational warehouse chains. The remainder of the industry is comprised mostly of small, specialty retailers, serving niche markets. The few publicly traded companies compete against a large number of private hardware stores and lumber yards.
As with most retailers, growth is typically generated in two ways, opening new locations and increasing same-store volume. Opening new doors is a straightforward strategy, and is usually the main driver of sales growth when a company is in its early stage. As a chain gains scale, however, this approach becomes increasingly difficult. The best and most profitable locations are established first, and then managers must be careful not to place additional stores too close to those already existing, lest they cannibalize each other's sales.
Companies that operate in specialized markets, working primarily with professional builders or in the commercial-construction space, don't have such concerns since they typically have fewer locations. Walk-in shoppers are rare in this area because materials are usually ordered and shipped directly to job sites. In fact, some companies have no storefronts, only warehouses from which they ship materials.
There are a number of important performance metrics that investors can utilize to evaluate Retail Building Supply stocks. On the Value Line page, some members of the group have arrays that follow the standard industrial format, and others have a similar layout but with two important differences. Gross margin (sales less the cost of goods sold, before depreciation, divided by sales) may be included in the array, giving investors another measure of profitability in addition to operating margin (operating income, before depreciation, divided by sales) and net profit margin (net profit divided by sales). The number of stores may also be included, which will gauge how quickly a company is expanding and whether growth is coming from same-store sales or new locations.
Comparable-store sales, or "comps", is another key metric to consider when examining retail building supply companies. Comps are especially important once a company reaches maturity, as they become the primary driver of top-line growth. Store remodeling, product expansion, advertising, and markdowns and promotions are all methods used to boost comparable-store sales.
The Housing Market
The state of the housing market has a huge impact on the Retail Building Supply industry, and is a key determinant of the health of sales and earnings. Rising home prices, which can be supported by several factors, such as low interest rates, healthy economic growth, and a favorable employment situation, are generally a boon to the industry. The most obvious benefit of higher prices is the creation of new houses to meet strong demand. Too, rising home values allow homeowners to borrow, via equity loans or credit lines, to finance remodeling projects and other upgrades. As long as the real estate market is sound, the costs of such projects can be quickly recouped.
Depending on the segment they serve, each company's exposure to the general housing market will differ. Big-box retailers, for example, are very sensitive to housing trends, since they depend on high-end items, such as appliances and equipment used in remodeling projects, to drive sales and earnings. Other companies may focus on specialty categories, like small-scale agriculture, which can provide some insulation from the broader housing sector. Still, to varying degrees, all companies in the industry are dependent on the housing cycle.
As with any business, management's execution and ability to keep costs low go a long way in determining profitability. Companies in this industry typically have operating margins in the high single-digits to low double-digits. Labor normally accounts for the lion's share of costs, especially at those entities with vast store networks and lots of sales associates. Commodities prices also affect profitability; gasoline and diesel fuel are major components of transportation costs.
In our view, Retail Building Supply issues are suitable for most investors. Generally, their Stock Price Stability ratings are above average and the companies have solid Financial Strength ratings. Beta coefficients approximate the market average of 1.00.
The largest, best-established members of the industry pay modest dividends, and in good economic times, provide worthwhile growth and income. In a severe recession, however, they are susceptible to share-price erosion. (These equities are not considered defensive plays.) Investors with a somewhat conservative leaning usually hold the higher-capitalization issues. At times, there is opportunity for those who are risk-tolerant and seek good long-term share-price appreciation potential. Newcomers to the industry, serving a lucrative niche market, can garner much attention.