Home Depot earnings stoke optimism. Is it misplaced?

Investors are like basketball players in one sense. They'll scramble after a good company whose sales are hitting the floor because they expect they will rebound.

So when Home Depot announced second-quarter earnings Tuesday that beat analysts' expectations, its share price went up.

But what if Wall Street's expectations game doesn't apply to housing? What if, instead of a basketball, investors in the housing sector are playing with, say, a ripe cantaloupe?

The US housing slump has gone on for so long and let so much air out of housing-related industries that the bounce, when it comes, could be very messy – and only slightly up.

Consider your own home. Sure, there are lots of improvements you could make. But in an era where housing appreciation is no longer automatic, those improvements start to look more expensive and, probably, less necessary.

That translates to fewer trips to Home Depot or Lowe's, whose stock plunged 10 percent Monday after it reported its second-quarter profits fell 19 percent.

The challenge was summed up neatly by a commenter about Market Watch's story on Home Depot (HD): "The problem for HD is the 'upgrading' part of the market, built around constantly rising home values, will not come back. We are looking in the years ahead for people to 'fix what is broken.' "

In Wall Street's eyes, Home Depot is doing better than Lowe's because its profits dropped only 7.2 percent, with aggressive cost-cutting helping to cushion a 9 percent drop in sales. In its earnings report, it raised its expectations for earnings per share for the fiscal year, saying they'd be flat to up 7 percent, despite an expected 9 percent decline in overall sales.

Ultimately, though, sales have to grow for the housing market to recover robustly.

The problem of falling sales extends far beyond public companies like Home Depot and Lowe's. Smaller, privately owned firms in housing-related industries have also been hit.

Between September 2007 and September 2008, 10 of the 12 industries with the biggest declines in sales were housing related, encompassing everything from furniture stores to real estate agents, according to Sageworks, which collects and analyzes private-company data from accounting firms.

In the latest July to July cycle, sales for each of those 10 industries had fallen even more. Real estate agents and brokers topped the list with a 13 percent drop, followed by plywood, veneer, and other engineered wood manufacturers, down 12 percent.

"A lot of these industries are leading indicators of the housing industry," says Dan Saklad, chief operating officer for Sageworks in Raleigh, N.C. So far, they're not pointing up, he adds.
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