Builders’ Stocks Taking a Beating on Wall Street
The April plunge in new home starts may have taken the White House by surprise Tuesday, but Wall Street has suspected since March that the housing recovery was faltering.
Stocks of most major home builders began to slide about eight weeks ago, and the selloff picked up speed in recent weeks. Result: Most builder stocks are trading at or near their lows for the year, down 25% to 45% from peaks reached in February.
Shares of Columbia, Md.-based Ryland Group, for example, now trade at $21, down from $28 earlier this year. Los Angeles-based Kaufman & Broad, the biggest builder in California, has seen its shares crumble from $25 to $15.125 this year--even as the Dow Jones industrial average has surged to new highs.
The government’s report Tuesday that housing starts fell 17% in April from March levels just confirmed the problem that builders telegraphed to Wall Street this spring: Many would-be home buyers suddenly vanished from the market, and the industry isn’t quite sure why.
That disturbing element of mystery is the biggest reason why some analysts are reluctant to strongly tout the builders’ stocks today, even though the shares appear to be fantastic bargains based on 1992 and 1993 earnings expectations.
“At current prices, the stocks are cheap if the housing cycle is going to play out fully,” says Gary Gordon, analyst at PaineWebber in New York. “The question is whether it will.”
In previous economic recoveries, of course, the housing market led the way. Whenever mortgage rates fell and confidence in the economy rebounded, there has always been a large group of Americans looking to buy first-time homes or trade up. On cue, that group materialized early this year, and housing starts rose from January through March.
Many experts had figured that April would be weaker, in part because warm weather in much of the nation had bolstered the February and March numbers. But David Seiders, economist for the National Assn. of Home Builders in Washington, admitted Tuesday that the size of the April decline was “more than we thought we’d see.”
Worse, Seiders says, an early May survey of builders nationwide by his group showed a “further weakening in buyer traffic.” Builders are perplexed, Seiders says, because “it feels like other parts of the economy are coming back. So why in the world should (our) market weaken now?”
Some analysts argue that buyers were chased off when interest rates on conventional mortgages inched over 9% in March. But rates have since fallen back to around 8.6%, yet buyers remain reluctant to step up.
For that reason, PaineWebber’s Gordon warns investors not to assume that another cut in interest rates by the Federal Reserve--which could come soon--would necessarily spark a rally in the home builders’ stocks. Wall Street is taking the view that mortgage rates aren’t the problem in keeping home sales on track, Gordon says--but rather, that the problem is many consumers’ lack of confidence about the future.
“Lower rates are terrific, but people need to feel secure about their jobs” to buy homes, he notes.
So for now, Wall Street seems in no mood to pay up for builder stocks until home sales show sustained new strength. Last year, just the promise of a housing recovery lifted these stocks. This year, investors want proof in hand.
But aren’t the stocks truly cheap? If new housing starts just meet rather mediocre expectations of about 1.3 million units this year (up from 1 million in 1991), the builder earnings estimates for ’92 in the accompanying table are very reasonable, analysts say. With most of the stocks trading for 10 to 13 times those ’92 earnings estimates--versus 18 times earnings for the Standard & Poor’s 500 index of major stocks--the builders indeed look like a steal.
Stephen Dobi, analyst at Smith Barney, Harris Upham & Co. in New York, argues that the housing cycle still is young, and that Wall Street has overreacted to softer-than-expected spring demand. While some bearish analysts suggest that the builder stocks may remain out of favor well into 1993, Dobi scoffs. “We are not aware of any previous housing cycle in which housing stock prices peaked this early into (the) cycle,” he says.
He predicts that shares of the nation’s largest builder, Dallas-based Centex Corp., will surge from $42.625 now to $55 by year’s end; Kaufman & Broad should hit $25 by then, Dobi says.
At Prudential Securities, analyst Lawrence Horan agrees the potential payoff in the builder stocks is significant from these levels. But he figures that the stocks are only for the truly patient now. “Interest in the group is largely dead except for people who want to own them through next spring,” Horan says.
Builders’ Stocks Hit Home builders’ stocks have fallen sharply from their highs reached earlier this year--leaving the stocks very cheap relative to expected 1992 earnings per share (EPS). The P-E is current stock price divided by estimated 1992 EPS.
1992 Tues. 1992 estimates: Stock high close EPS P-E Centex Corp. $55 $42 5/8 $3.33 13 Del Webb 23 7/8 18 1.75* 10 Kaufman 25 15 1/8 1.32 11 & Broad Lennar Corp. 29 3/4 20 1/8 1.48 14 PHM Corp. 31 3/4 21 7/8 2.20 10 Presley Cos. 17 3/8 9 5/8 1.13 9 Ryland Group 28 21 1.89 11 Standard 14 9 5/8 0.74 13 Pacific Toll Bros. 14 9 5/8 0.53 18
* For fiscal year ending June, 1993
All stocks trade on NYSE.
Earnings estimates are analysts’ consensus estimates, compiled by Zacks Investment Research.
