Investor sentiment has turned against Richelieu Hardware Ltd. RCH-T in a big way over the past couple of months, reducing a darling stock of the pandemic to an early casualty of housing market pessimism.
Richelieu’s shares are down by 26 per cent since early February, as rising interest rates have weighed on assets linked to the boom in real estate activity.
That’s a big speculative dip for a company with one of the best long-term track records in the S&P/TSX Composite Index. Richelieu’s stock posted losses in just four of the past 20 calendar years.
“When you have a quality compounder that grows at a high-teens pace more years than not, and you get a 25-per-cent pullback in the shares, you want to sharpen your pencil,” said Brian Madden, chief investment officer at First Avenue Investment Counsel.
But there’s a catch for would-be buyers, Mr. Madden said. Richelieu’s slide is probably not over yet.
As a manufacturer and distributor of home finishings and components, like doorknobs and cabinet hardware, Montreal-based Richelieu has reaped the benefits of the surge in home improvement.
In an era of isolation and quarantine, homeowners took on renovation projects on a mass scale, remodeling home offices, updating kitchens and adding decks.
Richelieu saw a huge spike in demand, its net earnings in fiscal 2021 rising by 66 per cent from the prior year.
The main concern for home-improvement names is that so much future demand has been pulled forward, a reckoning is sure to follow in the renovation space.
It may already be starting, in fact.
Spiking mortgage rates are generally expected to weigh on both home sales and repair and remodel activity, or, R&R. The rate on the most popular mortgage in the U.S. market is now higher than 5 per cent for the first time since 2011.
“In recent weeks, we have heard increasing trade reports of R&R demand disappointing this spring,” CIBC World Markets analyst Hamir Patel wrote in a recent note.
As a result, growth in Richelieu’s base business could return to normal levels more quickly than expected. Organic growth, which excludes growth generated by acquisitions, will likely be negative by next year “as affordability constraints dampen housing activity,” Mr. Patel said.
The odds of a housing market downturn alone is a lot for Richelieu shareholders to process. But there are additional headwinds to consider.
A potential recession has suddenly become the fixation of both Bay and Wall Streets, prompting some big changes in stock market preferences.
Last month, the U.S. yield curve inverted, meaning some short-term yields on U.S. Treasuries rose above long-term yields, which is considered a strong predictor of a recession.
“The warning signs are everywhere, and everyone’s moving out of consumer discretionary,” said Brian Acker, chief executive officer of investment managers Acker Finley. “There’s a big rotation into recession-resistant companies.”
At the moment, Richelieu is on the wrong side of some big forces in the global economy and financial markets, which will likely take some time to play out. Central bankers and policymakers are facing an unusual set of circumstances related to the pandemic, including rampant inflation and a broken global supply chain.
Richelieu’s stock has been in bear-market territory – meaning a decline of 20 per cent from its peak – for just over a week. But it’s already sold off so aggressively, some investors might see a compelling entry point to bet on a solid long-term performer.
At Richelieu’s current valuation, the market is implying this year’s earnings will come in at about $1.30 per share, Mr. Acker said. But analysts are forecasting double that. That’s a big margin of safety, even if estimates for the company are in flux, Mr. Acker said.
The case for Richelieu could be strengthened for those who believe in the resilience of the housing market, which has long defied portents of doom.
“Crying wolf about Canadian housing in any number of instances over the last 20 years has been wrong,” Mr. Madden said.
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