(By Kevin Donovan) Everyone from Warren Buffet to the neighborhood appliance salesman has been looking for a housing revival to give the economic recovery staying power. Investors think they've spied it, bidding up the stocks of home-building companies to 52-week highs this spring.
We don't think it's too late to join the housewarming party, but we would be selective on new positions. Valuation drives us to buyD.R. Horton and PulteGroup and stand neutral on Lennar and Toll Brothers at this point.
But is it morning in America again? The data are encouraging and buttress the argument that the U.S. economy is on the mend. The National Association of Realtors reported last week that sales of existing homes rose 3.4% in April, and the U.S. Commerce Department followed up with news that new home sales rose 3.3% last month.
Meanwhile, home-building companies' recent reported results – featuring earnings beats, growing backlogs and upbeat outlooks – have been kindling wood for big share price gains.
In the fiscal first quarter (ending February 29), Lennar earned $0.08 per diluted share, vs. analysts' average estimate of $0.04. The company also reported an industry-high 20.9% gross margin in the quarter, up 90 basis points. What's more, new orders were up 33% year over year.
Predictably, Chief Executive Officer Stuart Miller was effusive about the outcome and outlook, noting that demand for new homes had been strong enough to allow the company to raise prices and reduce incentives.
Toll Brothers reported fiscal second-quarter earnings of $0.09 per share vs. the mean expectation of $0.04 and a 47% year-over-year increase in the number of contracts.
Pulte continued to lose money in the first quarter, but its loss of $0.03 per share was better than the $0.04 analyst prediction and $0.10 loss a year ago. Backlog grew 12%. CEO Richard Douglas Jr. commented he was "cautiously optimistic that housing demand may have reached a positive inflection point."
D.R. Horton posted fiscal second-quarter earnings of $0.13 per share vs. a consensus estimate of $0.04 and $0.09 a year ago. Backlog was up 17%.
The stocks of home builders have cooked in a lot of the good news. The iShares Dow Jones Home Construction Index Fund (ITB) has returned about 31% this year.
Of the four largest-cap participants in the sector, Lennar and Toll Brothers are sporting the richest price-to-earnings multiples on both a trailing 12-months and forward basis. The other two large-cap builders, D.R. Horton and Pulte, still have reasonable PEs, particularly on a forward basis. We think they can close the valuation gap as evidence of a sustainable housing recovery becomes perceived as fact rather than hope.
D.R. Horton (DHI)
Toll Bros. (TOL)
Of course, the sector is not without peril. The industry has a symbiotic relationship with the overall health of the economy. A sustained housing rebound requires a healthy wider economy, which in turn depends in large part on all the collateral growth created by a healthy housing industry.
Two big risks loom. Most immediate is the potential for unraveling in the Euro zone and widespread recession on the continent that leaks to the U.S. The other is the potential for the U.S. to fall off a "fiscal cliff," in the words of the Congressional Budget Office, if the Bush tax cuts are allowed to expire and automatic government spending cuts kick in next year.
We can't handicap those risks, but we do believe housing can recover and stocks can appreciate further without the industry returning to pre-recession "bubble" levels.