Why the weak US housing market is bad news for B&Q

Last year's weakness in the UK housing market has taken its toll on the DIY sector. This year it's the turn of the US housing market to slow down - and that's also going to hurt.

Last year's weakness in the UK housing market has unsurprisingly taken its toll on DIY chains.

Both GUS, which owns Homebase, and B&Q owner Kingfisher reported that profits at their home improvement units had plunged over the past year.

But, the property bulls say, with the recovery in the housing market, shouldn't life be getting better for DIY stores this year?

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Don't count on it...

GUS, which owns Argos and credit-checking group Experian, saw its full-year results battered by a plunge in profits at its DIY chain, Homebase. Earnings more than halved, from £113.8m to £51.8m. It's not a result to write home about - but GUS said that at least it had outperformed the DIY retail market in general.

The result certainly compared favourably with the 75% profit plunge recorded by Kingfisher's DIY chain, B&Q.

Underlying sales that is, sales excluding openings of new stores - at the home improvement group fell 8.8% in the 13 weeks to April 29. Profits fell a staggering 75% on last year, down from £71.2m to £18m.

B&Q is suffering from the same problems as every other retailer, only magnified by 2005's housing slowdown. The company has had to slash prices in the face of weak demand and strong competition profit margins fell by 3 percentage points. Meanwhile costs have risen by 4%.

And things don't look set to improve any time soon. Chief executive Gerry Murphy said that "the UK market remains very promotional and weather sensitive." Given the unseasonably wet May we've had, there could well be more bad news to come from Kingfisher.

Kingfisher was the worst-performing stock in the FTSE 100 last year. But despite a further 2% fall in Kingfisher's share price yesterday, the group is still pretty optimistically valued. As John Foley on Breakingviews.com asks: "Why are the rickety group's shares still trading at a 30% premium to the retail sector?"

As he points out, it's got nothing to do with any confidence in a recovery, and everything to do with bid hopes. Investors are still hoping that US giant Home Depot is planning to swoop.

But unfortunately for Kingfisher, Home Depot is facing precisely the same pressures that B&Q has endured over the past year and a half or so.

The US housing market is now following in the footsteps of our own. The bad news is coming in thick and fast. Mortgage applications fell by 6% last week the biggest fall since February. There were more than half a million homes for sale at the end of April the most ever, according to Bloomberg.

Toll Brothers, the largest US luxury homebuilder reported recently that profit rose at its slowest pace in three years during the three months to April 30, with orders in the quarter down a third on the year before. The group cut its 2006 earnings forecast.

Unsurprisingly, confidence among US homebuilders is at its lowest in 11 years, according to the National Association of Home Builders. If you want to read more, we published a piece on the fragile state of the US housing market earlier this week if you missed it, click here: Is the US housing market crumbling?

And of course, retailers in the States face the same rising fuel prices and interest rate hikes that are battering the UK high street. If anything, the impact of higher interest rates is worse over there because they have risen further from a much lower base.

So the idea of embarking on a major overseas acquisition in a declining market is probably not particularly attractive to Home Depot at the moment.

And for any property bulls still convinced that the recent uptick in the housing market is anything but a suckers' rally, results from energy supplier Scottish Power made unpleasant reading. Because it looks like consumers are facing even higher energy bills.

The group, which has already hiked gas prices by 15% and electricity bills by 8% this year, said "further rises will be unavoidable in the short-term given continuing high wholesale prices."

Not only does that squeeze the consumer, it's another reason for the Bank of England to be worried about inflation. And it looks like new member Professor David Blanchflower will be more of a hawk than his predecessor Professor Stephen Nickell.

The new MPC member told a Treasury Select Committee: "We need to focus on inflation." Well, of course that's pretty much the entire reason for the Monetary Policy Committee's existence.

But Professor Nickell seemed to be far more concerned about consumer spending and growth than the inflation figures. So the fact that Professor Blanchflower admits he is watching inflation and has "started to work on the data" suggests that he is, at the very least, a lot less likely to vote for a cut than the man he's replacing.

Higher interest rates and home improvements don't sit well together. Kingfisher may yet be the worst performer of 2006 as well.

Turning to the stock markets...

The FTSE 100 ended lower, giving back much of the previous day's rally. It shed 91 points to close at 5,587. Miners were once again in the doldrums - copper miner Kazakhmys fell 6% to £10.20. But the main loser was poker group PartyGaming, which fell 6% to 122.75p ahead of further debates in the US over outlawing internet gaming. For a full market report, see: London market close

Over in continental Europe, the Paris Cac 40 lost 61 points to close at 4,870, while the German Dax fell 91 to end at 5,587.

Across the Atlantic, US stocks managed to push higher. Economic news was mixed - orders for durable goods (that is, goods expected to last more than 5 years) fell 4.8% in April, much more than expected. The news helped sentiment over interest rates, but also raised concerns of slower economic growth. The Dow Jones Industrial Average rose 18 points to 11,117, while the S&P 500 rose 2 to 1,258. The tech-heavy Nasdaq gained 10 to 2,169.

In Asian trading hours, the Nikkei 225 slumped 213 points to 15,693, as a Ministry of Finance report showed that international investors are pulling out of the country. Last week foreign investors offloaded the most Japanese shares since December 2001.

This morning, oil was edging higher in New York, trading at around $70 a barrel. Brent crude was also higher, trading at around $67.90.

Meanwhile, spot gold slid as low as $639.20 in New York trading, but picked up to around $644.40 an ounce this morning. Silver edged up to $12.51 an ounce.

And here in the UK, Ken Morrison, the chairman of the William Morrison supermarket chain, has said he will retire in January 2008. The chain was once the darling of the City until it over-reached itself with its purchase of Safeway in 2004.

And our two recommended articles for today...

How will you live without cheap oil?

- The first commercial oil well changed the world. Now oil is vital to the global economy. Our transport, our clothes, even our food chain is utterly dependent on a steady flow of cheap oil. But now that flow is about to dry up, says Byron W King in The Daily Reckoning. To find out what Peak Oil means, and why you need to start preparing right now, click here: How will you live in a world without cheap oil?

Are the good times over for world markets?

- The markets are in turmoil. Stockmarkets across the world have plunged, metals prices are down and volatility is surging. The big question is - what happens next? Is this just a correction, ask Andrew Selsby and John Robson of RH Asset Management, or is the bear market back with a vengeance? To find out what they think, and to find out where the best buying opportunities will be when the dust finally settles, click here: Are the good times over for world markets?

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.