Homebuilders: Industry Update
Even as homebuilder sentiment begins to fade back to pre-election levels, hard data suggest that the housing market remains healthy and could be poised to take off from its ranged-bound position. In June, housing permits and starts came in well above Wall Street consensus. That’s the good news. The great news is that momentum is mounting in single family home growth.
It’s all about the good old fashioned single-family home with the white picket fence that young families stake their first step as contributors to society. It involves child birth and mobility. It’s a reflection of confidence in the nation.
Keep in mind that there is a long way to go, as there has been a paradigm shift among younger adults with respect to living in big cities. They are living in the moment and putting off the rigors and responsibilities of raising families. (I don’t give much credit to college debt as the reason for slower household formation, since millennials without college degrees are staying in their parent’s basement longer.)
U.S. homebuilders continue to be in a position of opportunity that’s hampered by forces beyond their control, including labor and lending conditions. The good news is that both are showing a sign of improvement as construction employment is gaining traction, and financial institutions are looking to make more loans in a rising interest rate environment.
With that being said, progress has been inconsistent with new home sales often missing Wall Street consensus. The five-year trend is undeniably higher and this momentum can pick up more momentum as household formation begins to improve. A record low home ownership should also be viewed positively.
Homebuilder Share Prices
Homebuilder shares are finally picking up the kind of steam we were looking from two years ago. One of our favorites, iShares U.S. Home Construction exchange-traded fund (ITB), recently achieved its highest level since the summer of 2007. Underscoring this momentum is the fact that ITB is up 26% in 2017, but only 18% over the past 52-weeks. This kind of runaway will break out, only needing a nudge to keep the momentum going.
The next big technical test of resistance is 37.00, and then the big challenge of re-testing will be at 44.00 on the downside as critical support begins at 31 to 30.
In the month of June, new home sales climbed 2.9% month-to-month and 8.9% year-to-year.
Homes priced $750,000 and above saw the robust demand. Regionally, the west remains on fire, which benefits Toll Brothers (TOL) and KB Home (KBH). Meanwhile, overexposure in the south could cause problems for D.R. Horton (DHI) home construction this quarter.
Note: 5.3 months’ supply is up month to month and year over year, but it’s still low enough to continue the pricing power.
Source: US Census Bureau Southeast*
Peer to Peer
It was a great quarter for all homebuilders, although Toll Brothers enjoyed the largest percentage increases in business. However, the average selling price for Toll Brothers declined almost 3% as the rest of the market saw pricing power.
From a valuation point of view, KB Home is clearly an attraction, but this reflects margins below the industry average.
CEOs in the industry were all singing from the same hymn sheet in their most recent conference calls:
Douglas C. Yearley, Jr., Toll Brothers’ chief executive officer, points to a “solid and improving demand and the financial strength of our affluent buyer base are driving our growth,” and added that “this was the best spring selling season we have had in over ten years.”
Here are several confident statements from Jeffrey T. Mezger, CEO of KB Home, with the company’s recent earnings release:
“The housing market recovery continues on a steady path, supported by favorable industry fundamentals.”
"Recent improvements in consumer sentiment and employment, combined with relatively low mortgage interest rates signaling further strength in the demand for housing.”
Lastly, Donald R. Horton, Chairman of the Board of D.R. Horton: “The spring selling season is going well, as the value of our net sales orders increased by 52% sequentially from the December quarter and 17% from the March quarter last year. “
“We also remain focused on growing our revenues and pre-tax profits at a double-digit annual pace, while continuing to generate positive annual operating cash flows and improved returns. With 27,100 homes in inventory at the end of March and a robust supply of lots, we are well-positioned for the remainder of the spring and the second half of fiscal 2017.”
TOL (Toll Brothers)
We remain at a Buy rating. While the average selling price will continue to drift according to guidance ($775,000 to $825,000) in the current quarter, selling, general & administration (SG&A) cost came in at 10.8% in the most recent quarter from 11.5% a year earlier, and are expected to be 10.4% this quarter.
DHI (D.H. Horton, Inc.)
The robust growth and confidence guidance suggests an opportunity to justify industry-high valuations. We expect improved execution, and results that will exceed Wall Street consensus for the remainder of the year.
Note: We currently do not have a rating on KB Home (KBH).
Charles V. Payne
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