Recently, Williams Financial Group (WFG) hosted Tom O’Grady, CR, CKBR from the National Association of the Remodeling Industry (NARI) on our quarterly Management Discussion Call Series. The NARI is the only trade association dedicated solely to the remodeling industry. The Association represents 7,000 member companies nationwide, comprised of 63,000 remodeling contractors. NARI is a professional association whose members voluntarily subscribe to a strict Code of Ethics and is the “voice of the remodeling industry”.
In addition to chairing the Strategic Planning and Research Committee, Mr. O’Grady has over 35 years of experience in the remodeling industry. In our opinion, we believe the insight provided by the NARI survey and Mr. O’Grady’s industry experience provides a unique, unbiased perspective of current activity and the outlook for the R&R segment.
Our general take-away was in-line with our current thematic view of the R&R market and our growth expectations over the longer term. Home price appreciation should support increased improvement spending as underwater homeowners return to a neutral position and prep for listing or begin making necessary repairs. We also believe the historically low inventory levels will continue to support current pricing trends over the next several quarters, which provides additional lift to the R&R segment as delayed renovation/repair projects are completed. We remain bullish on the names with heavy leverage to the R&R and DIY segment and expect 2H13 to be a turning point in the improvement space. With that, we would look to acquire higher quality names with deep penetration in this space as longer term plays into the improving housing environment. Specifically, in the names we cover, we believe JHX’s exposure to both new housing, and the R&R market provides an attractive derivative play to leverage improving housing dynamics.
- Kitchens, baths, and room additions rank in the top three renovation areas among NARI members across the country. Outdoor kitchens, energy efficiency upgrades, home theaters, home offices and custom cabinetry are a few of the areas beginning to gain some traction. Larger scale projects are expected to remain subdued through most of 2013, accelerating into 2014 with pricing improvements driving the increase. We would suggest appliance, fixture, flooring and cabinet manufacturers as potential leverage here.
- Invitations to bid, a core indicator of market activity, have steadily increased with most opportunities in the kitchen and bath segments.
- Major replacements as measured by percent of total revenue fell from 27% to 23% in 4Q12 vs. 4Q11. The decline is attributed to both volume and dollar content in the major replacement category as well as increased activity in kitchen and bath remodels, unfavorably impacting the contribution from major replacements. However, we do expect major replacement, specifically in areas such as siding, windows and roofing to gain traction over the next few quarters as home prices move higher.
- Homeowners appear to remain cautious as some instability in the housing market persists. However, remodels that make homes more livable have led renovation activity. With many homeowner projects sidelined during the downturn, meaningful levels of pent-up-demand are expected to come on-line, supporting longer term growth opportunities. .
- Dollar value of projects have not yet seen a meaningful increase, although are expected to begin to accelerate by the end of the year and into 2014. As larger scale projects come on-line, value should begin to see incremental improvements. Prior to the downturn, a typical kitchen remodel averaged $70-80k. However, over the last few years, project values have declined to the $50-$60k range. We would anticipate remodel value to slowly increase returning to more normal levels, supported by improving home values and increasing consumer confidence.
- The greatest growth opportunities are seen in more specialty areas such as “age-in-place”, utilizing universal design to retro-fit existing homes to adapt to the needs of seniors or those with disabilities. Electronic systems integration is another area that will likely provide further growth opportunities. NARI has partnered with CEDIA (Custom Electronic Design & Installation Association) to provide education to contractors in preparation for growth in this area. The universal design concept incorporates items such as ramps, easy access bathing accommodations, wider doorways, cabinets and bathrooms designed for wheelchair access, and single story floor plans.
- Repair and remodel contractor energy efficiency upgrades typically include items such as windows, doors and HVAC units where tax credits are available. New housing demand has obviously benefitted the HVAC sector with shipments up 17.3% y/y in January according to data released by AHRI (Air-Conditioning, Heating and Refrigeration Institute). HVAC typical life-span ranges from 10-20 years with the avg. around 15 yrs. In our opinion, outside of new home construction demand for HVAC units, we believe the replacement cycle for HVAC equipment in homes built during the housing run-up are nearing end-of-life, supporting the longer term demand trajectory for HVAC equipment.
- Labor shortages throughout the construction industry continue to be large issues, not likely to abate for some time. Constraints are exacerbated by a lack of new entrants into the labor pool. Given the average age of a remodeler associated with the NARI ranges from 40-50 years of age, coupled with insufficient additions, attrition will likely drive labor capacity even lower. In view of the labor constraints impacting the entire construction industry, we feel installation services will become increasingly common as the value proposition to builders becomes increasingly evident leading to incremental top line growth while creating cost saving synergies and loyalty from customers. In our opinion, Builders FirstSource (BLDR, Buy) is likely one of the better positioned firms to capitalize on this dynamic.
- While input costs are an issue, most contractors build in document provisions with specific allowances for price increases based on prices when a project is quoted, eliminating margin erosion. We would anticipate pricing pass through ability will reduce value engineering strategies employed by contractors in the R&R segment, which will likely support pricing improvements and demand for premium grade products such as James Hardie (JHX, Buy) siding and stone façade materials produced by Headwaters (HW, NR).
- Although DIY activity has clearly accelerated, most homeowner completed projects are relegated to simple repairs consisting of flooring and paint. Often, homeowners will undertake projects that require skill well beyond their ability, requiring the aid of a professional to complete the project. With an increasingly savvy consumer, specifically in regards to price, customers are more willing to supply the materials in an attempt to find cost savings. In our opinion, names levered to the DIY channel will be key beneficiaries over the next few quarters as homeowners ramp spending on flooring, paint and similar products. To gain exposure to the DIY segment, we would consider firms such as Armstrong (AWI, NR), Mohawk (MHK,NR), Masco (MAS), Trex (TREX, NR), Lumber Liquidators (LL, NR), Caesarstone (CSTE, NR), The Tile Shop (TTS, NR), and big box retailers.
- Outlook: The latest survey results indicate the 3 month growth outlook is increasingly positive. 76% of respondents are expecting significant growth, 17% anticipate demand to be relatively flat and only 7% see market conditions deteriorating. The outlook improved 6% in aggregate on a sequential basis. In our opinion, the survey indications are in-line with our core thematic view of growth in the R&R segment into the back-end of the year and beyond. We believe the segment will present attractive growth opportunities over the longer term and would view firms with exposure to this space favorably.
This Apr. 9, 2013 note is written by David N. Williams, Equity Research Analyst for Home Building & Building Products division at Williams Financial Group Capital Markets, the research division of WFG Investments, Inc., based in Dallas, Texas.
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