(By Michael Vodicka) Stocks are in rally mode today after pending home sales jumped to a 2-year high. That's an unusual dose of bullishness out of the typically dreary housing sector, which has been an economic laggard in the last few years. Home builder Lennar Corp (LEN) fanned the fire with earnings that handily beat expectations, sending shares up more than 5%. Both of those bullish stories come on the heels of news earlier in the week that new-home sales had also reached a 2-year high.
So does that mean the housing market is finally stabilizing and ready to turn? If so, that would have huge implications for stocks and the economy. If this rash of bullish data out of housing turns out to be the beginning of a trend and not just seasonal momentum, it's a good time to look at a housing stock.
My favorite is DR Horton, Inc. (DHI), a home builder based out of Texas with a market cap of $5.5 billion. That makes DR Horton bigger than some of its home-industry peers like KB Home (KB) at $675 million and PulteGroup, Inc. (PHM) at $3.8 billion. DR Horton operates in 25 states and 73 regional markets, so as you can see, this is no Johnny come lately company that jumped into housing during the boom to make a quick buck. DR Horton is a strong brand and leading name in home building.
DR Horton has been strong in 2012, with shares hitting a new multi-year high in May and currently up 45% on the year. Take a look at the bullish action on the chart below.(click to enlarge)
Those big gains on the chart have been fueled by signs of stability in housing, but the company has helped its cause with a string of impressive quarterly results. In its most recent Q2 results from late April net income jumped 46% from last year to $41 million. Earnings of 13 cents crushed estimates of 4 cents by 225%. The company also announced a dividend of .0375 cents per share, another signal of growing confidence.
But looking forward, with housing showing signs of stability, DR Horton is well positioned to capitalize.
DR Horton is a well-established name in the home building industry. With operations in 25 states and 73 regional markets, the company has well diversified market exposure that will both protect it from volatility and enable it to pursuit higher growth opportunities in stronger markets.
DR Horton is also seeing a clear trend or growing demand. That shows up in its back log, which jumped 17% from last year to 6,189. But the value of the backlog increased even more, up 25% to $1.1 billion. That kind of demand will help DR Horton stay fully deployed and maximize productivity.
DR Horton is also strategically positioning itself to cater to higher-end home buyers who tend to have more disposable income. The company acknowledged that this was a big driver in its ability to raise the value of its backlog by 25% on a 17% volume increase.
The biggest threat to DR Horton is general weakness in the economy. That might sound like a general statement, but housing stocks are definitely cyclical and particularly sensitive to economic weakness. If the trend in weaker economic data continues through the summer and the seasonal spring boom in housing fades, home-builder stocks in general will be under pressure.
Estimates and Valuation
With the company posting a big earnings surprise in April, analysts were quick to upgrade their earnings projections. The full-year 2012 estimate is up 23% in the last 90 days to 67 cents, a big rebound of 462% from last year, while the full-year 2013 estimate jumped 10% to 87 cents, a very solid 29% growth projection.
Although that bullish movement in estimates did help the valuation picture, DR Horton hardly qualifies as a value stock. Its forward (P/E) ratio of 25 is well above its median of 8 from the last ten years. But here is a caveat on the valuation conversation: this is a company with a lot of operating leverage against the housing market. If stability in housing holds, DR Horton will see significant earnings growth. And for the time being, the market is asking potential investors to pay up for that growth.
The Take Away
Bigger picture, even though DR Horton is one of the bigger and more established names in the home builder space, it's hardly a global mega cap with a fat dividend. So you should expect volatility from a stock like this that swings pretty hard on strength or weakness in housing.