Suppliers Wonder: Where's the Bottom?

Building products and materials company executives reporting market conditions to Credit Suisse say things improved a bit in April, likely because of better weather, but growth is still missing from the horizon. Although many of these organizations hedge their reliance on new housing by serving the still-stable remodeling and commercial markets, those who are new-home dependent face continued uncertainty and intensifying pressure from their builder customers to slash prices to the bone.

Credit Suisse analyst Ivy Zelman and her research team put out a report last month that says the building products sector is stable, perhaps a bit improved from March, but it questions whether the big suppliers of cabinets, power tools, faucets, and paint will be able to sustain this pace.

The report, based on a survey of building products companies who account for about $51 billion in annual sales among home builders, says, "Demand for our building product survey respondents was predominantly flat in April versus March, with about 70 percent of respondents relaying flat sequential trends, higher than the first quarter, when 60 percent of respondents reported similar results. However, there were no respondents reporting weaker trends, which is a turnaround from last quarter when 16 percent of respondents cited deterioration."

Cost wise, there was some moderation. Nearly 70 percent of respondents to the survey report flat materials costs and 25 percent report declines, particularly on materials through the new construction channel, such as lumber and wallboard. Copper and stainless steel, however, continue to rise.

That's the good news. The report continues, "We anticipate that the incremental leg down that we are now witnessing in new residential construction will provide additional headwinds to the building products group in general, particularly those that are more tied to this channel." And it adds, "Pricing remains under significant pressure, with 56 percent citing lower prices in April and 44 percent reporting flat trends. The combination of higher costs with increased pricing pressure has obvious negative implications for profitability."

First-quarter results reported by The Home Depot on May 15 would seem to reflect those obvious negative implications. The company reported a 29 percent drop in profit–1.05 billion versus $1.48 billion during first quarter, 2006–on slightly improved sales, which were up to $21.59 billion from last year's $21.46 billion. But those revenue numbers were skewed by results at the company's HD Supply unit, which, because a favorable comparison resulting from the inclusion of revenue from acquisitions, were up 45.8 percent to $3.109 billion from $2.132 billion last year.

The company has stated that it's exploring strategic alternatives for HD Supply, including a possible sale or spin off. Meantime, it reported that sales at stores that were open for more than a year declined 7.6 percent. As a result, The Home Depot missed Wall Street's earnings estimate of $0.59 per share by six cents a share and cut its guidance for the rest of the year.

Credit Suisse's report offers evidence that builders are growing more aggressive in seeking price concessions. "Earlier in the year," says the report, "most large builders believed that new-home sales would begin to improve in mid- to late 2007. As the year has progressed and more new-home and existing home inventory remained on the market, that optimistic timeframe has been pushed back to the first or second quarter of 2008. Many builders attempted to negotiate 5 percent to 10 percent price reductions for 2007."

Cutting Into Muscle

They now may be looking for more. One supplier, whom the report does not identify, expressed concern that some large builders may be starting to sacrifice quality in the quest to cut costs. The report says that for this "major building products distributor, sales are down significantly from the prior year, and this contact indicated that it is receiving a lot of pricing pressure from builder customers, which seems to have increased in April. Most are asking from 5 percent to 20 percent off. This contact will not provide concessions unless it gets something in return (i.e., greater exclusivity, more products, etc.). If it does, it will typically give 5 percent to 10 percent concessions. This contact is really concerned with how many corners the publics are cutting right now to cut costs. It thinks quality is really being sacrificed and it is only a matter of time before it blows up in their faces."

The report also says a national framing and lumber contractor saw business increase a bit from a dismal winter, and it's surprised that lumber prices remain down significantly from 2006, and have slid further since the end of the year. This contractor reported pretty consistent pricing in the past 12 months, but the report states, "The intense builder pressure has continued, as they continue to ask for more than can be given. This contractor expects that the impact from mortgage tightening will have a moderate impact on its business, with a higher magnitude of decline expected from markets, such as Florida, where people were doing anything to buy a house. It has a pessimistic outlook for 2007 and ranks the market at a D-minus."

Beware Of Spillover

The overall building products sector has been buoyed by continued strength in the repair/remodel and the commercial segments, which have partially offset the downturn in sales to new-home builders. But there are increasing signs that consumer spending may be slowing, based on preliminary reports from retailers and on consumer confidence surveys, which could knock the underpinnings from the home improvement category.

Among the report's key conclusions were:

  • "Repair/remodel continues to exhibit stability, with home centers benefiting from better traffic/weather. However, large-ticket remodel projects remain under pressure and promotional activity helped spur some of the strength.
  • Commercial related activity was solid according to respondents.
  • Most respondents relayed flattish raw material trends following the spike in March, though there is variation depending on the material.
  • Pricing remains under pressure, with builder customers still aggressive and persistent."

–William Gloede