There are two basic forces that drive sales of homebuilding products. One is new construction. The other is remodeling, repair and minor home improvements.

Contractors making the kind of bulk purchases common to new construction tend to deal with local suppliers, or with larger companies built by consolidating local suppliers, led by Builders FirstSource (BLDR) and TopBuild (BLD). Homeowners or contractors dealing with smaller projects often head for Home Depot or Lowe’s (LOW).

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So, at the end of March, when Home Depot (HD) announced an $18 billion deal to increase its focus on those professional markets, it drew attention. The big box retailer is scooping up McKinney, Texas-based SRS Distribution, a supplier to roofing, landscaping and swimming pool contractors.

The deal, with a total value of $18.25 billion, is the biggest in Home Depot’s 46-year history. It helps to underscore the market strength in the professional building suppliers market. And it helps explain why names like Core & Main (CNM), Ferguson (FERG) and Atkore (ATKR) have shown such resilience during the stock market’s recent consolidation.

Home Depot To Focus On Professional Market

The home improvement retail giant worked for decades to consolidate lumber yards and hardware stores under one roof. Its focus was on the “do-it-yourself” homeowner looking to add value to their property.

Now Home Depot is stepping up efforts to attract professional remodelers and contractors, what it calls its “Pro Ecosystem.” Reportedly half of the company’s business currently comes from professionals. But those tend to be comparatively smaller purchases compared with the bigger project-scale sales catered to by the pro service shops.

Home Depot claims that SRS increases its total addressable market by approximately $50 billion, to about $1 trillion. The deal is expected to close by the end of fiscal 2024.

Wedbush Securities analyst Seth Basham told IBD in a recent interview that it remains to be seen just how far Home Depot will push into the professional builders market.

“They have ambitions to grow that commercial business so that it’s materially larger than the DYI business,” Basham said. “Their mission is to continue to capture market share and to do that, it’s going to take a larger focus on the professional side.”

Home Depot Stock Vs. Building Supply Stocks

Home Depot’s decision to wade further into the professional contractor sector comes as mortgage rates have increased once again, twisting the financial screws on homebuyers, homeowners and homebuilders. Lumber prices spiked during the pandemic years and remain volatile, but are at levels for below their 2021 peak. Labor remains tight and expensive, a driving factor in builder profits.

Meanwhile, the 41 stocks in the IBD-tracked Building-Construction Products/Miscellaneous industry group collectively ended April up 8% for the year, vs. a 5.5% gain for the S&P 500. From the end of October, the building products group rallied more than 46%, vs. the S&P 500’s gain of not quite 21%.

The group ranks No. 11 out of the 197 industries tracked by IBD.

Core & Main has surged 45% in 2024, pulling back only modestly from highs to test support at its 10-week moving average. Builders FirstSource is up 19%, with TopBuild climbing 11%.

Ferguson, a U.K.- based plumbing supply distributor, has gained less than 12%, but is up 44% since the end of October and is trading above its 10-week line.

Atkore has a year-to-date gain of 9%, after rallying 40% since the end of October. It just finished up the fifth week of a flat base. The company reports its fiscal second-quarter results on Tuesday.

Retailers Lag By Comparison

Other resilient names in the group this year include plastic pipe maker Advance Drainage (WMS) and Owens Corning (OC).

Meanwhile, the 12 names in the retail building products group, including Home Depot, rose 8% through the end of March before pulling back. Year to date, Home Depot stock is down about 1%. Big box rival Lowe’s (LOW) has edged up 5%.

Morgan Stanley analyst Simeon Gutman wrote on March 28 that Home Depot’s efforts to grow its professional business segment have put the retailer “on a collision course with many of the industry’s largest distributors.”

Home Depot Pursues Fragmented Professional Sector

Basham told IBD that Home Depot’s DYI business — which accounts for more than half of its sales — faces “limited growth opportunities.”

“The opportunities for growth are in the professional side of the business and they’ve made a number of moves to accelerate growth in that segment over the last few years,” Basham said.

The analyst pointed to Home Depot’s reacquisition of Home Depot Supply in 2020 for $8 billion and the 2015 purchase of Interline Brands for $1.6 billion as examples the retail giant betting on the professional builders sector.

Basham added that the acquisition of SRS shows Home Depot specifically targeting specialty trades as opposed to the general contractor.

For now, however, Home Depot and Lowe’s, which is also targeting the professional contractor market, are no immediate threat to the major players in the building supply sector.

“It’s too fragmented at this point,” Basham said.

The analyst added there are many regional building products distributors and smaller specialty distributors that may have higher prices but have a high level of services, which is greatly valued by contractors.

“Over time, one of the ways Home Depot would like to win is on prices,” Basham, admitted.

Homes, Builders And Mortgage Rates

Meanwhile, U.S. single-family homebuilding came under clear pressure in March. That could be because a return to higher mortgage rates made potential homebuyers think twice.

Mortgage rates peaked in October, but have rebounded from January lows as the Federal Reserve reevaluates its monetary policy path. As of Friday, the 30-year fixed mortgage rate was around 7.22%, according to Freddie Mac. That was up from about 6.7% four-weeks earlier.

Single-family housing starts, which make up the majority of homebuilding, have seesawed wildly in recent months. They remain well below their peak in April 2022, according to the Commerce Department’s Census Bureau.

This comes as builder sentiment is flat in April. But it is up sharply from November lows, according to the National Association of Home Builders/Wells Fargo Housing Market Index.

“April’s flat reading suggests potential for demand growth is there, but buyers are hesitating until they can better gauge where interest rates are headed,” NAHB Chief Economist Robert Dietz said in a statement.

Markets were adjusting to rates being somewhat higher due to recent inflation readings, Deitz said. He added that “we still anticipate the Federal Reserve will announce future rate cuts later this year, and that mortgage rates will moderate in the second half of 2024.”

Builders are also facing “tighter financing conditions” and single-family production will likely decline again in April, according to the NAHB.

Urban Shift Boosts Builders And Suppliers

Home Depot’s DIY segment sales declined more sharply than its professional segment sales over the last year, according to Wedbush Securities. Interest rates may being playing a role.

Higher interest rates means fewer refinanced mortgages — a leading source of capital for homeowner remodel and expansion projects. Basham told IBD that homeowners are pulling back on discretionary projects and appliance purchasing. However, he added that in some cases they are also downsizing larger remodeling projects where they would use contractors.

The migration of urban residents to smaller, more affordable or spacious real estate markets is driving a strong current of remodeling, expansion and new-home demand. That has kept analysts boosting their targets on many stocks in the building products group.

Analysts Remain Optimistic

HSBC assumed coverage of Ferguson in mid-March with a price target of 263, 21% above where shares traded this week. Also in mid-March, Bank of America hoisted its price target on TopBuild to 475, from 410, and kept a buy rating. Builders FirstSource earned a 240 target in early April, up from 235, keeping its overweight rating from Barclays. On April 8, despite the fact that Core & Main is sitting on a six-month gain of 93%, Wolfe Research lifted its target to 67 from 64 and kept an outperform rating.

It’s a trend that also stands to benefit when interest rates finally start to come down.

“The outlook for the industry certainly is better growth in the professional segment over the next few year as we start to see interest rates come down, housing starts rise and project activity pickup,” Basham said.

“Looking at the sector as a whole, we expect growth in the back half of 2024, with stronger growth in 2025 as interest rates come down and housing turnover increases,” he added.

Please follow Kit Norton on X, formerly known as Twitter, @KitNorton for more coverage.

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