After a months-long rally, traders have cut US lumber prices back down to size. Prices for the commodity have halved from the May peak. The fall is being viewed as an early warning for the earnings of home improvement retailers. Share prices of Home Depot and Lowe’s, America’s largest do-it-yourself retailers, have fallen around a tenth over the same period.
But the collapse in lumber prices should not be mistaken for a collapse in end-user demand. The spike in wood prices seen over the past year resulted from a series of exogenous shocks. Firstly, sawmills misjudged demand at the start of the pandemic. Tariffs then hit import volumes from Canada just as a mountain pine beetle devastated forests in British Columbia. See the current retreat in prices as last year’s supply-demand imbalance correcting itself.
Viewed in this way, lumber costs do not accurately indicate future DIY retailer sales. True, the astronomical surge in lumber prices did turbocharge top line growth at both companies. Revenue growth will probably revert to pre-coronavirus levels. However, other measures — including transaction volume growth — show that Americans still spent big on remodelling and maintenance projects during the first quarter of the year, even as pandemic restrictions eased.
Despite solid underlying demand, Home Depot and Lowe’s shares, at 22 and 17 times forward earnings, look better value than one year ago. The pandemic has caused a delay for builders across the country. Supplying them through the backlog of projects should ensure steady business for both companies this year.
Longer term, spending on homes by both professional homebuilders and individual homeowners should remain elevated for some years to come. There is evidence that decades of home supply have not been keeping up with demand. Low mortgage rates means plenty of pent up demand for new buys and renovations. At the same time, rising house prices will motivate homeowners to keep investing to spruce up their abodes. Markets have shouted “timber” too early.
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