Why this outperforming sector could be next to suffer a major downturn

The property market may be losing stream fast but it’s the home renovations market that’s next to roll over, according to UBS.

This is a counter consensus call and even UBS admits it is early in making this bearish prediction, but if the broker is right, it will spell bad news for the share prices of stocks exposed to this industry, such as Wesfarmers Ltd (ASX: WES), DuluxGroup Limited (ASX: DLX) and Metcash Limited (ASX: MTS).

Apart from Metcash, these stocks have been outperforming the market with Wesfarmers (the owner of Bunnings Warehouse) rallying 22% and paint supplier DuluxGroup jumping 12% over the past year when the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index is up 9%.

Hardware chain owner Metcash would be outperforming too if not for its shock profit downgrade for its grocery business in May, but even then, the stock is up 7% over the same period.

However, it might soon be time to start locking in profits as UBS noted that the lead indicators for renovations have suddenly slumped!

“Over the last year credit tightened and home prices fell, but only recently is this negatively spilling over to renovations,” said the broker.

“A broad retracement in lead indicators of renovations suggest activity is about to roll over.”

These lead indicators include the 8%-10% year-on-year (YoY) drop in new and established home sales to its lowest level in 20 years, declining property listings as confirmed by REA Group Limited’s (ASX: REA) results, a circa 20% YoY slump in owner-occupier loans for alterations and additions (A&A) and the 9% drop in A&A building approvals in June after months of solid growth.

This warning runs contrary to conventional thinking as history has shown that the renovations market tends to outperform when home sales hit a soft patch.

We are also not seeing signs of any real weakness in household fittings and furnishings. If anything, this category is up and I have even recently written about how bathroom fittings company Reece Ltd (ASX: REH) would be well placed to weather the housing downturn.

But I think it pays to keep a closer eye on further signs of trouble in the renovations market as UBS believes it is only a matter of time before we see sales of household goods drop.

Further, an easing in the renovations market doesn’t necessarily mean big profit downgrades either. There’s still every chance that the renovations market will only suffer a relatively mild downturn.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. The Motley Fool Australia has recommended REA Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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