Builders’ Stocks on Solid Footing
Investors could have constructed a model portfolio this year simply with home-building stocks.
Shares of the nation’s major housing producers have been surging since mid-summer, owing to growing optimism about economic and demographic trends that seem to bode well for continued strong demand for new homes.
Indeed, despite numerous signs of weakness in other sectors of the economy, the new-housing market has remained relatively robust. In large part, that’s because two prime groups of buyers of new homes--aging baby boomers and immigrants--don’t appear to be losing their appetite for better housing.
Some analysts see that appetite remaining healthy, barring a sharp recession that would drive unemployment rates up. For now, “U.S. housing demand is supported by perhaps the most favorable macroeconomic and demographic climate for home ownership in more than 30 years,” analyst Scott Soler of Morgan Stanley Dean Witter declared in a recent report.
The building industry also has other factors working in its favor, fueling interest in the stocks, including falling mortgage rates, tight supplies of new homes in many markets, better management at some of the companies, and share prices that are still arguably cheap compared with the companies’ earnings power.
Many of the major home-building stocks are up 40% or more so far this year, a jarring exception to the lackluster showing by the stock market in general and the debacle in technology stocks in particular.
Yet many analysts maintain “buy” ratings on the shares, including Irvine-based Standard Pacific Corp., already up 94% this year; Centex Corp., up 42%; Lennar Corp., up 102%; and Westwood-based California powerhouse Kaufman & Broad Home Corp., up 30% this year.
In a stock market where earnings growth is getting harder to find, many builders continue to post big gains in orders, sales and profits. For instance, Lennar--which also has operations in Southern California--said Monday that its November orders (adjusted for its purchase of U.S. Home Corp. earlier this year) jumped 21% from a year earlier.
Standard Pacific, meanwhile, posted a 43% gain in November orders.
“While many technology and industrial concerns came up short in the third quarter, builders delivered an average [earnings] increase of 40%” from a year earlier, noted analyst John Stanley of the investment firm UBS Warburg.
Analysts also are projecting higher earnings for most builders next year, though the expected percentage increases for some companies are modest.
To be sure, there has been some slowing of building activity. Housing starts nationwide this year are expected to dip from last year’s record 1.66 million units, to about 1.6 million, according to industry analysts.
In California alone, building-permit activity in October signaled that about 132,500 houses will be built this year, up 3.6% from 1999 but below the 156,000 units earlier forecast by the state Finance Department.
Also, sales of new houses nationwide in October slowed a bit, falling 2.6% from September’s pace, the Commerce Department said Monday. But the total was up 2.4% from a year earlier, and many economists say the numbers overall remain strong.
Indeed, all of the housing figures point to still-healthy demand for new homes, especially in high-growth states such as California, Nevada and Texas, analysts said.
“There is some erosion in the size of the [new-housing] market, but it remains at substantially healthy levels,” said Robert Curran, an analyst at Merrill Lynch & Co.
What’s more, he said, “some of these larger companies are gaining market share [from smaller builders], and that’s why they’re reporting increases in home deliveries and profitability.”
A downturn in borrowing costs also is helping drive the stocks. The Federal Reserve has lifted short-term market rates six times since June 1999 to slow the economy, but many analysts now believe the Fed’s next major move will be to cut rates. Meantime, both short- and long-term mortgage rates have already come down from their 2000 peaks.
The rate on conventional 30-year, fixed-rate mortgages averaged 7.65% for the week ended Dec. 1, down from 7.84% a year ago and well below the peak of 8.64% reached in May, according to the latest survey from the mortgage-finance concern Freddie Mac.
The rate for one-year adjustable-rate mortgages tied to Treasury bills averaged 7.24% last week. That was down from 7.28% the prior week, though still well above the 6.49% average of a year ago. (Some other rates used for adjustable-rate mortgages, such as those tied to the 11th District cost of funds, also are still creeping higher, but they tend to lag changes in market rates by several months.)
In any case, the rally in home-building stocks also seems to contradict another trend: Many other housing-related stocks--such as those of companies that supply building materials--aren’t doing well at all.
For example, the stock of kitchen-cabinet maker American Woodmark Corp. is off 39% so far in 2000; Elcor Corp., a maker of roofing shingles, is down 54%, and faucet and cabinet builder Masco Corp. has dropped 15%.
Why the discrepancy? Many of the materials producers not only compete in the residential-construction market, but also in the home-improvement retail sector, where prospects have dimmed somewhat as evidenced by the slowdown in Home Depot’s sales growth, analysts said. That has “impacted stock-market perceptions” of the materials companies, Curran said.
He also noted that, while home builders compete in a very fragmented industry--allowing the largest companies to focus on fast-growing, more profitable regional markets such as California if other markets slow--the companies “selling lumber or cement or wallboard are affected by the absolute level of demand nationally” for their products, and that demand has softened in recent months.
Finally, what is bad for materials producers--falling prices for their goods--can be an advantage for the builders who are buying the products.
Of course, the home-building industry could take a sharp turn for the worse if the economy next year makes a “hard landing” that results in recession, or if mortgage rates suddenly jump.
Another threat comes from the rest of the stock market, where “the correction in Nasdaq [stocks] could turn into a major rout, imploding consumer confidence and overwhelming the impact of low [mortgage] rates” that are now helping the home-building stocks, UBS Warburg’s Stanley recently told clients.
Still, the stocks’ fans on Wall Street say their low price-to-earnings ratios make them attractive bets for investors who don’t expect the bottom to fall out of housing demand any time soon.
Morgan Stanley’s Soler also are argues that many major builders’ management teams “are now operating less like wild real-estate developers and more like legitimate companies, with share buybacks, aggressive consolidation and information-technology investments at the top of their capital-allocation lists.”
For now, the builders are not only enjoying economic trends that work in their favor--such as falling lending costs and cheaper raw materials--but also exceptional demographic trends, Soler said.
“While they are rarely, if ever, factored into analysts’ or economists’ forecasts, two powerful demographic cohorts--the baby boomers and U.S. legal immigrants--continue to significantly impact the U.S. housing market,” Soler said.
As those groups migrate “into their peak home-ownership years,” he asserted, housing demand should “remain strong through 2006 or 2007.”
Among the stocks Soler favors are Centex, which he says is the largest and “most diversified” U.S. builder, and D.R. Horton, the fourth-largest builder “and one of the most geographically diverse” in terms of the markets in which it builds.
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Major Home Builders, By the Numbers
Despite signs of a slowing economy, demand remains strong for newly built housing, and home builders’ stocks have rallied as a result. Yet many of the stocks remain relatively cheap compared with their expected earnings power. Here’s a look at some of the major players:
Stock: Toll Bros.
Ticker symbol: TOL
Monday close: $38.19
52-week high/low: $40.25/15.81
YTD Change: 105%
Estimated EPS, 2000: $3.59
Estimated EPS, 2001: $4.08
2000 P/E: 11
*
Stock: Lennar
Ticker symbol: LEN
Monday close: 32.81
52-week high/low: 34.88/15.25
YTD Change: 102
Estimated EPS, 2000: 3.36
Estimated EPS, 2001: 3.87
2000 P/E: 10
*
Stock: Standard Pacific
Ticker symbol: SPF
Monday close: 21.38
52-week high/low: 23.50/ 8.94
YTD Change: 94
Estimated EPS, 2000: 3.25
Estimated EPS, 2001: 3.49
2000 P/E: 7
*
Stock: NVR
Ticker symbol: NVR
Monday close: 92.15
52-week high/low: 113.20/42.00
YTD Change: 93
Estimated EPS, 2000: 13.19
Estimated EPS, 2001: 15.10
2000 P/E: 7
*
Stock: Pulte
Ticker symbol: PHM
Monday close: 37.69
52-week high/low: 41.75/15.25
YTD Change: 68
Estimated EPS, 2000: 4.95
Estimated EPS, 2001: 5.39
2000 P/E: 8
*
Stock: Beazer Homes
Ticker symbol: BZH
Monday close: 32.25
52-week high/low: 34.44/17.06
YTD Change: 68
Estimated EPS, 2000: 4.87
Estimated EPS, 2001: 5.93
2000 P/E: 7
*
Stock: Ryland Group
Ticker symbol: RYL
Monday close: 36.50
52-week high/low: 39.25/15.19
YTD Change: 58
Estimated EPS, 2000: 5.78
Estimated EPS, 2001: 6.24
2000 P/E: 6
*
Stock: D.R. Horton
Ticker symbol: DHI
Monday close: 18.56
52-week high/low: 20.00/ 9.98
YTD Change: 47
Estimated EPS, 2000: 2.67
Estimated EPS, 2001: 3.12
2000 P/E: 7
*
Stock: Centex
Ticker symbol: CTX
Monday close: 35.06
52-week high/low: 39.00/17.50
YTD Change: 42
Estimated EPS, 2000: 4.19
Estimated EPS, 2001: 4.74
2000 P/E: 8
*
Stock: Kaufman & Broad
Ticker symbol: KBH
Monday close: 31.31
52-week high/low: 32.81/16.81
YTD Change: 30
Estimated EPS, 2000: 4.06
Estimated EPS, 2001: 4.66
2000 P/E: 8
*
Stock: S&P; 500
Monday close: 1,324.97
52-week high/low: 1,527/1,315
YTD Change: --10
Estimated EPS, 2000: 58.00
Estimated EPS, 2001: 63.37
2000 P/E: 24
*
Estimated EPS: Analysts’ consensus estimate of earnings per share.
2000 P/E: Stock price-to-earnings ratio based on current stock price and estimated 2000 earnings per share.
Sources: Bloomberg News, Zacks Investment Research
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High on Housing
Despite signs of weakness in many parts of the economy, sales of new homes nationwide remain at robust levels--helped in part by sliding mortgage rates. Strong housing demand has in turn powered home builders’ stocks since summer, even as the stock market overall has slumped.
