Home Depot: 'Overall consumption of goods is seeing some weakness,' analyst explains

UBS US Hardline & Broadline and Food Retail Analyst Michael Lasser joins Yahoo Finance Live to discuss the decline in Home Depot Q1 sales, consumer demand in the DIY sector, lumber prices, and the impact of weather on retailers.

Video transcript

- Home Depot's first quarter was hit hard by declining revenue and sales growth as consumer spending on home improvement softened from its pandemic boom. The worst may be far from over. Home improvement demand is only expected to decline further in the year ahead.

Here with what this trend means for the retail sector, Michael Lasser, UBS US hardline, broadline, and food retail analyst. Michael, it's great to see you because, man, this was quite a quarter and quite an outlook from Home Depot and an unusual one for them, right, in terms of not only the numbers, but the commentary. I know there were some specifics in here. But sort of writ large, what does it tell us about consumer demand, particularly for the DIY sector?

MICHAEL LASSER: What it tells us about consumer demand for the DIY sector is that it's normalizing. After a period of outsized strength over the last few years, we are seeing that the consumer is shifting the spend to things like services, going out to eat, traveling. And that's having an impact on the consumption of goods. That's likely to continue for at least the near term.

Now, the big wild card from here is whether or not the labor market remains stable. If the labor market declines from here, that's going to provide probably another leg of downside for the consumption of goods as consumers continue to pull back on their overall consumption trends. So it's something that is worth watching. But with that being said, right now the overall consumption of goods is seeing some weakness.

- What does normalization mean for margin expectations for companies like Home Depot or Lowe's in that specific part of the retail environment?

MICHAEL LASSER: So demand normalization for the home improvement retailers means that they are experiencing some margin pressure. And that's because sales are under pressure. What you would normally expect is that the deleverage associated with the fixed cost of this business on negative sales is going to create some margin pressure. And you're seeing that.

There is a unique environment where inflation is moderating, and these companies have passed along significant cost increases over the last few years. So it's likely over time that that will provide some margin relief. But for now what's happening is margins are under pressure as sales decline.

- Michael, got to ask you about lumber, right, because that's one of the areas where we have seen lumber prices come down. And explain this to me because I assume that that's a problem because Home Depot can't hold lumber prices up here if the underlying price is going down because consumers won't-- I guess they're aware that lumber is going down, and they're not going to pay the same prices for it. Walk me through that.

MICHAEL LASSER: You're exactly right. Lumber is a commodity. So the prices change on a week-to-week basis. And the home improvement retailers pass along the changes on almost on a real-time basis.

So versus the same point a year ago, lumber right now is down about 64%. Now, normally you would expect that when that happens, unit volumes will pick up. This is an elastic category. And if someone had put off building a new deck, as an example, because lumber had gotten so costly, that consumer might now think about restarting that project as lumber prices have come down.

But what has happened this time around, lumber is falling so fast that we have yet to see the unit response. That should happen over time. And from here, as we get into the second half of the year, the lumber prices will start to lap easier comparisons. And so the decline should moderate.

- That said, though, isn't the margin on something like lumber consistent? In other words, does Home Depot, are they able to peg it at the same gap on the way down, right, their price versus what underlying lumber is?

MICHAEL LASSER: That's right. Lumber tends to be a lower-than-average margin category. It's commodity, so it's very price competitive. And, as a result, they tend to price to whatever the market is bearing at that time. So what actually happens is as lumber prices come down and this becomes a smaller portion of total sales, it's actually a good guy because you have a smaller portion of your sales coming from a lower-margin category.

Now, over time this tends to normalize. And it's not as much of a longer-term consideration. But, as you're rightfully pointing out, this can have some shorter-term implications. And we're seeing that in the volatility as of late.

- Michael, you began to touch on just a moment ago, just kind of want to clarify or perhaps ask you to add on to this a little bit more, where would you say that we are at in the DIY cycle?

MICHAEL LASSER: I think we're moving through the middle stages of the DIY cycle. As you are probably well aware, the consumer had binged on the consumption of a lot of goods over the last few years in areas like patio furniture, grills, appliances. And so some of that is being pulled forward. And there's evidence of that now.

At some point, we'll get to a base level of demand, probably in the next few quarters. And those categories will start to grow again. And Home Depot and Lowe's should be prime beneficiaries as the cycle turns. But whether that cycle lasts another two quarters or eight quarters, it's really going to depend on the overall state of the consumer environment. And at this point, that's going to depend on the labor market.

- One more thing I wanted to mention about this quarter is what Home Depot talked about on the weather front, particularly in California, seeing some weather effects and the hit to sales. How broad is that impact going to be for other retailers that have exposure in those geographic areas, too?

MICHAEL LASSER: So we're going to see some of the same themes that Home Depot talked about on its call across the retail sector, not only because of the weather impacts-- and we've seen that already retailers like Tractor Supply and O'Reilly-- but also just the overall environment for discretionary spending on goods has certainly taken a step down over the last few months. And we expect to hear that from other retailers over the course of the next few weeks.

The question is whether or not this is a temporary condition because tax refunds are lower, the weather. SNAP benefits have been pulled back. And so do we start to see an improvement as we get into June and July? Or is this just the new norm? Consumer is fatigued on all the things that he and she have purchased over the last few years and. As a result, we're entering the later stages of the cycle. And it's best to have cautious expectations on the consumption of discretionary goods from here.

- Really solid insights always. Michael Lasser, UBS us hardline, broadline, and food retail analyst.

MICHAEL LASSER: Good to see you.

- Thanks so much, Michael.