Raymond James Financial, Inc. (RJF) Earnings Call Transcript & Summary

Good morning, everyone. This is Matt McClintock, the retail hardlines and softlines analyst here at Raymond James. That means I cover Home Depot, Lowe's and Floor & Decor. I'm joined today with Sam Darkatsh, the Raymond James expert on building products. He covers a wide range of interesting companies for today's topic, such as Mohawk, Whirlpool and Stanley. We view today's call as unusual for the sell side, as most building product analysts don't really collaborate with their retail partners across the street but at Raymond James, we are different. So our only goal is to bring you all information regarding the entire vertical of home improvement from suppliers to retailers in an efficient manner, so you don't have to waste your time calling multiple analysts that likely don't even know each other. And to put an emphasis on this, Sam and I absolutely do physical store channel checks together, which I don't think anyone else does. So from my perspective, which is the retailers, the Home Depot, Lowe's and Floor & Decor, there are 3 major points. And then I will make a few comments on recent physical store channel checks and turn it over to Sam. First, what if I told you we go completely against consensus numbers, and say comps only get better after the second quarter of this year. We actually have comps getting worse after that. This is a major call, because no one else is willing to step up and do it. Consensus has comps for both Home Depot and Lowe's up around 3% to 4% next year. We actually have them down 1% to 3%. It could be worse, but the fact is, we're the only team calling for that kind of pressure right now. Also, the fact is the congressional budget office expects unemployment rates of more than 10% for 2021. How does anyone think comps get better next year than this year, particularly when comps benefited massively from Home Depot and Lowe's being maybe 1 of only 10 open retailers for an entire quarter? Home Depot and Lowe's only comped low single digits in 2019, with the lowest fund employment rate on record. Why does anyone think that gets better in 2021 on top of good numbers in 2020? Second, whispers for the quarter are actually kind of crazy, hearing as high as 10% to 15% comps this quarter. We don't believe that for many reasons. The biggest one we think investors aren't thinking about is tender. Home Depot and Lowe's have never revealed how much of their sales are in cash. But even if it's 10%, that could look like a 10% comp on flat sales if everyone decided to stop using cash and use credit cards instead. We believe that consumers are much less likely to use cash in today's world than ever. We know many investors take Lowe's out-comped Home Depot this quarter based on credit card data. But the funny thing is, Home Depot likely had more credit card sales before, given its larger Pro business. So that actually could be a bad read given this unique circumstances in tender. Lastly, it's super hard to do a product category buildup where either Home Depot or Lowe's do 15% comps in this world. Fact is, there are a lot of large meaningful categories that simply have to be sizably negative, such as flooring. We know flooring is down probably 50% right now from Floor & Decor, which was out-comping Home Depot and Lowe's in this category before COVID. We have this kind of scenario analysis in our preview note yesterday, if you are interested. Sam is likely to provide even more evidence, but this kind of comp for this quarter is probably unrealistic. But we now do have both Home Depot and Lowe's comping 5% this quarter. Home Depot benefits from leading e-commerce capabilities, Lowe's probably caught up to Home Depot, though, as they did the typical spring promotion that Home Depot decided to hold back from. Also, we know Home Depot at more than 40% of sales has massively more Pro exposure than Lowe's, which is likely in the low 20s. And this is a onetime in life that probably hurts Home Depot versus Lowe's, given that there is a period of time where contractors just weren't doing a lot of work. Yet now that pros are recently completing those jobs that got pushed off, Home Depot is likely to be doing much better than Lowe's given that pent-up demand. And longer term, investors only care about e-commerce leaders, and Home Depot is probably several years ahead of Lowe's in that situation, although Lowe's is starting to address that with investments in their e-commerce capabilities. The third point, so why not sell both of them if I'm actually that bearish? Well, first, we actually believe both of them are going to beat -- both of these are going to beat consensus this quarter, and the fact that the sell-side has comps actually getting worse next quarter and the second quarter sequentially. And that looks super unlikely right now. We can actually see comps in the second quarter, maybe even being better for the first quarter. But we think this is probably going to be the peak for both mix. Nobody knows the future. So it's kind of hard to not know the -- beat expectation of retailers. The market itself clearly wants to lead in a v-shaped recovery, and these are good names to own for that. And then there's a couple of other points I want to make before I turn it over to Sam. First, we've been in the stores together. It certainly appears like Lowe's might have been a little less nimble than Home Depot during this issue. There are 2 reasons for this. First, Lowe's is doing promotions on things like refrigerators and storage. We believe there is no chance that drove incremental demand, probably at worst only lower margins than anticipated. If you don't know, these are 2 categories that have stock-outs across the board, so pricing elasticity is highly unlikely just given this whole COVID situation. Second. It appears like Lowe's is doing the same exact merchandising force as last year, Home Depot is not. I'll give you one example, but understand it's from a super limited sample set of Tampa, Florida. The major aisle next to seasonal at Home Depot had things like refrigerators and paper towels upfront. That same aisle at Lowe's has American flags, charcoal and lawnmowers. Lowe's would always have those 3 things in that aisle at this time of the year, Home Depot wouldn't. But clearly, it was nimble enough to realize what consumers wanted and put it upfront. We believe it's quite possible that Lowe's just wasn't able to change its strategy as quickly as Home Depot was to address this crisis. That's not really that surprising, given that there is a lot of work that Lowe's is doing to improve. But it needs to be thought about more with the investment community. Hence, I will give you one example why that's the case. Let's say Lowe's did the same promo on refrigerators of last year. For example sake, they sold 1,000 units last year. This year, they probably sell 3,000 units that they did expect to sell, so margin might actually be at risk to some extent. Before I turn it over to Sam, I want to say 2 things about Lowe's that mean more to me than all of these short-term trends. First, Lowe's definitely beats Home Depot in signage for social distancing. Really super impressed that they got the memo. It's very clear that they've set their stores up extremely well for social distancing. And second, investors probably don't know this, but Lowe's is actually providing a food bank for their employees, not only just for when they work, but also they take-home to their families. This might be the single nicest thing I have seen from any company or retailer at all and think investors need to expand their horizon on what matters these days. And with that, I'm going to turn it over to Sam.

Good morning, everyone, and I hope all the listeners out there are well and your families are healthy and safe as well. Let's talk about the building products and specifically, 4 themes, 4 almost universal themes that came out of earnings season specifically as it relates to home center activity in the first quarter. The first theme is that of POS. And it was pretty clear, and this probably does not surprise any listeners, that there was a significant barbell-type of trend or trends that we're seeing at retail at the home centers during the first quarter. February started out somewhere -- or February was somewhere between normal to good, especially given very easy weather comparisons. My read on it is that February would have been up somewhere in the 5% to 10% range. And then March -- and then into early to mid-April, maybe the first week or two of April, were weak for myriad obvious reasons. My read on that is roughly flat at best. And then beginning in the second week of April, POS activity, frankly, went gangbusters. We're hearing mid comps somewhere in the 30% to 40% range or so or on an across the board through-the-box basis. So -- and this trend that was seen in late April has continued into May. Second theme, POS at retail has been significantly above that of sell-in. And the retailers, both Home Depot and particularly at Lowe's, have not been ordering or reordering product nearly to the extent that their POS activity would normally warrant. I think there's 3 primary takeaways to this. First, I think it stands to reason that neither Home Depot nor Lowe's are necessarily convinced that the April and May POS activity is sustainable. And I think what that means is that they are both very careful not wanting to be caught with inventory if things moderate or deteriorate from present trends. This is especially the case, this being a lack of reordering in low GMROI and seasonal categories, things like power tools, outdoor power. And so the first takeaway from the retailer inventories being drawn down is lack of conviction by the buyers, meaning the Home Depot and Lowe's that these trends are going to continue. The second takeaway is Lowe's seemingly still has far too much inventory within its stores. So if there are any vendors that are particularly overweight Lowe's, it's going to hurt them more so than those vendors that more overweight Home Depot. And the last takeaway here is that June POS is going to be critical for the vendors. If June POS is heavy, that's going to bode very well for the second half because that means that retail reorders are going to have -- replenishment is going to have to happen in mid- to late June, especially ahead of the July 4 Labor Day and then eventually November promotional holiday seasons. If June, however, is light, my guess, especially based on the reticence of Depot and Lowe's to already reorder, we might just see near universal shutdowns of reordering in the back half. And so June, I don't mean to make a massive point on this, but June is a very critical month in terms of activity for back half -- portending for the back half. Third theme, the first quarter was very different across categories at retail. I had a CEO of a significant vendor to the home centers tell me offline that once COVID hit, the home center consumer, the first thing they did was they painted a room inside their home. The second thing they did was they mowed the lawn and tended to their garden. And the third thing they did is they did a small DIY project at home. And you could really see -- and what they did not do is buy big ticket, discretionary installed type products outside of perhaps refrigerators and freezers. And this really bears out when you take a look at the individual POS activity by categories. So DIY paint in the first quarter, up double digits; garden products, up 20% to 30% in many categories for the entirety of the quarter; tools, up double digits and up maybe as much as 50% to 80% in late April. But then looking at other categories like flooring, down 30% to 40%; appliances in April, down high teens, both including and excluding refrigerators and freezers; cabinets, down double digits. So we see a real bifurcation and difference in category activity even within the first quarter itself. Fourth primary theme is pricing. Lowe's seemingly was, as Matt indicated, was quite promotional during the first quarter. And I think he was speaking to their, perhaps challenges with being nimble. I think that would be what you would see there. It was almost in our store walks the other day, it was almost lappable to the extent of their promotions. They were running promos on things like refrigerators and freezers and storage containers. Home Depot was not promotional during the first quarter, as you wouldn't think they should be because of a lack of elasticity of demand. What we are seeing, though, increasingly is that, especially at Home Depot, there seems to be an indication that Memorial Day, late May, Home Depot will be returning to normalization of their promotional activity levels. And again, this is going to be really important to see how Memorial Day in June turns out, especially for the vendors because it's going to bode either well or poorly for back half. Last thought here before I open it up to, again, Matt and to your questions potentially. Matt suggested concern or doubt that the whisper numbers of a first quarter comp of 15% is simply unrealistic. And I concur. I think there's 3 primary reasons why a 15% comp, even though it might be indicated by the credit card data, is just simply not in the cards. Remember, you have 4 to 6 weeks -- out of a 13-week quarter, you have 4 to 6 weeks of very low activity. The Pro conceivably was nonexistent. And again, big ticket categories were heavily constrained. Another way of looking at it, it's a 13-week quarter. Even if the last 2 weeks of April were up, let's say, 30% to 40%, simple math, simple averages, all else equal, would still suggest that the other 11 weeks of the quarter would still have to be up double digit in order for there to be a 15% comp for the entirety of the quarter, half of which of those other 11 weeks would have been the late March, early April time period. So I think Matt's spot on with a mid- single-digit comp for the first quarter. The exit comp, very strong and again, June will be a real strong, real good poker tail as it relates to second half activity. And I'll stop there.

Well, thanks, Sam. So if anyone on the line actually has a question, you can enter the question into your Zoom box, and we'll hold for a second to see if there's any questions. Well, Sam, I think we did a good enough job explaining it. There are no questions at this time. So we just want to thank everybody for joining us for this quick update on home improvement. The whole vertical expects us to do this again next quarter and going forward. We hope you're all safe and healthy, and wish you a great weekend. Good bye.

Stay well.