Bullishness on the homebuilding sector has been fueled by historically low mortgage rates, limited supply and rising demand as pandemic fears accelerate a move from denser cities to the suburbs. Several contributors to MoneyShow.com review their top ideas among homebuilding stocks.
1) From city to suburbs
Before COVID, the U.S. housing market was steadily chugging along, with sales and permits in a solid trend higher. Now, in the wake of economic lockdowns, the industry is booming — especially in the suburbs, as people migrate away from struggling city hubs.
The pandemic also led many companies to rethink their office space leases, as management realized employees were being as productive — if not more so — working from home. These days, the employment landscape seems to be shifting toward remote work… adding demand to the already undersupply of homes for sale.
TOL has a great footprint in some of the best housing areas in the country. I’m talking about great relocations and retirement areas like Arizona, Florida, Texas, and Nevada — just to name some state income tax-free areas — as well as beautiful spots on both the east and west coasts.
2) Low interest rates
We all know by now that the Federal Reserve has been taking unprecedented action to keep the economy afloat. One such measure has been a pledge to keep interest rates low for years to come. While it remains to be seen how such intervention will play out in the long term… in the short term, low rates are great for home buying.
And because the low rates tend to favor the already wealthy (who have already been less impacted by the pandemic anyway)… and because it’s easier to qualify for a loan when you have greater assets… luxury homes will likely be the big winners of this boom.
While more developed areas may see a slowdown in their housing markets as people move out to the suburbs… city living makes up very little of TOL’s revenue.
3) Strong future demand
In its third quarter (Q3) report, the firm highlighted its strong demand and backlog (future orders). June of this year was the best June in the company’s history for contracts (houses). Management also expects to increase margins back to pre-coronavirus levels of around 21.5% by next quarter.
Due to strong demand and limited supply, the company has pricing power… In other words, it’ll continue to benefit from this strong trend for some time as it targets the affordable luxury market.
The work-from-home world has pulled forward a lot of demand for housing. Toll Brothers is a strong business with a solid management team and good financial conditions. For as long as this trend continues, it’ll act as a great tailwind for the company. Buy Toll Brothers up to $46. Use a 25% hard stop from your cost basis.
The company has 118 communities in 16 states where it builds and sells its homes. The average home goes for $248,000 but houses can range to ~3,000 square feet and as many as 5 bedrooms with prices over $400,000.
LGI has 45,000 lots owned and controlled for future development and is benefiting from a lack of entry level homes on the market and the desire of pandemic-weary people to move out of densely populated living situations and into homes that offer more space and privacy.
A third positive here is the low interest rate environment with mortgage rates around 3%, due to rates slashed because of the pandemic. Analysts expected EPS to slide $0.20 in Q2 from last year’s figure to $1.62, but instead LGI tabled $2.21, an amazing $0.79 consensus beat and 36% growth over last year, despite the pandemic.
Revenues weighed in at $481 million vs. last year’s $495 and estimates of $474, $7 million more than the consensus. I adjusted the recommendation price to $80 for % gain purposes (40%). Analysts are looking for EPS of $9.21 for 2020 and $10.20 in 2021. A PE of 12 on 2020 EPS is pretty lean. I continue to rate the stock a “buy”.
MDC Holdings (MDC) released preliminary net new order activity for Q3 ahead of its upcoming appearance at the Zelman Virtual Housing Summit. Management said that for the first two months of Q3, net new home orders increased 75% year-over-year to 2,477, compared with 1,418 for the same period in 2019.
The increase was driven by a 73% improvement in the monthly sales absorption rate to 6.48 and a 1% increase in the average number of active subdivisions to 191.
While COVID-19’s full impact on the economy in general is still unknown, we believe that MDC is poised for long-term success. Interest rates are extraordinarily low and will most likely remain that way for at least the next few years, which should help MDC as the cost of borrowing for both it and its potential customers remains extremely attractive.
MDC sports a broad geographic footprint, boasts successful cost control initiatives and maintains a solid balance sheet ($1.52 billion of liquidity at the end of Q2) that the company can draw from if it must remain in a defensive posture through the crisis or can use to smartly acquire land in attractive markets. Additionally, we like MDC’s focus on first time buyers (many millennials) with its Seasons collection of homes.
Despite the strong performance of the stock thus far in 2020, MDC’s dividend yield is still 2.9%, well above that of the 10-year U.S. Treasury Note (0.69%), and shares are trading slightly above 8 times expected NTM adjusted EPS. Our Target Price for MDC has been boosted to $59.
Meritage Homes (MTH) operates in nine states and targets first-time and first-trade-up home buyers. Homebuyer interest has surged, reflecting favorable demographic trends, low mortgage rates, and a flight to the suburbs fueled by the pandemic.
Total U.S. new-home sales jumped 14% in July compared to June, to an adjusted annual rate of 901,000, a 14-year high. Helped by a shortage of used homes for sale, Meritage saw a 32% jump in home orders in the June quarter. The order backlog increased 19% to 4,395 units, which were valued at $1.65 billion. The company controlled nearly 43,000 lots on June 30.
Meritage has rallied 65% this year but upside remains. Surging profit estimates could prove conservative, and the stock remains reasonably valued. For 2020, the consensus calls for per-share earnings of $9.32, implying 43% growth. The consensus was $6.09 two months ago. Revenue is expected to advance 15%.
The stock earns an Overall quantitative score of 99 (out of 100) and Value score of 74, reflecting a trailing P/E of only 11. For comparison, the 24 homebuilders in our research universe earn an average Overall score of 85 and have a trailing P/E of 18. Meritage is being initiated as a “Buy”.
The population of the United States is shifting. More than 10% of our population uproots themselves and their family annually. For the past 10 years, folks have been heading to the South from the Midwest and Northeast, by the droves.
Now the pace seems to be picking up. And it seems to be shifting from urban to rural. New Jersey is one of the top move-out states for the last decade, according to United Van Lines, and it takes the #1 spot this year, mostly because of high taxes.
In second place is Illinois (high taxes), and the remaining top five states that people are fleeing are New York (expensive housing and high income, property and sales taxes), Connecticut (expensive housing, utilities, and taxes), and Kansas (low wages).
Alternatively, the top five move-in states are: Idaho (great job market and low cost of living), Oregon (influx of tech industry jobs), Arizona (year-round sun and low cost of living), South Carolina (affordability, pleasant climate), and Washington (lots of jobs for young professionals).
Those reasons for moving are being augmented by the effects of COVID-19. Rapidly declining rental prices are plaguing large urban centers, implying that supply is up, while demand is down. The moves will affect many industries: energy, transportation, home goods and appliance sales, and housing, of course.
Right now, overall, housing is in pretty good shape. And that’s great news for the homebuilders – indeed, these six homebuilder stocks are all rated “Strong Buy”. Let’s take a look at them:
LGI Homes (LGIH)
The company specializes in entry-level homes, such as detached and attached homes, and move-up homes under the LGI Homes brand name; and luxury series homes under the Terrata Homes brand name.
It owns 113 communities in Texas, Arizona, Florida, Georgia, New Mexico, Colorado, North Carolina, South Carolina, Washington, Tennessee, Minnesota, Oklahoma, Alabama, California, Oregon, Nevada, and West Virginia.
For its second quarter, EPS were $2.21, up from $1.82 a year ago, and beating estimates of $1.49 per share. Shares trade at a P/E of 13.77.
Lennar Corporation (LEN)
The company primarily sells single-family attached and detached homes in communities targeted to first-time homebuyers, move-up homebuyers, active adult homebuyers, and luxury homebuyers.
It has communities in 21 states, and also provides mortgage financing, title insurance, and closing services. Lennar made $1.65 per share in its last quarter, beating forecasts of $1.18. Shares trade at a P/E of 11.34.
D.R. Horton (DHI)
The company sells single-family detached and attached homes in the East, Midwest, Southeast, South Central, Southwest, and West regions in the United States.
It owns communities in 20 states and 51 markets in the United States under the names of D.R. Horton, America’s Builder, Express Homes, Emerald Homes, and Freedom Homes. The company also provides mortgages, title, and closing services.
DHI earned $1.72 per share last quarter, beating estimates of $1.30. Twenty analysts have increased their estimates in the past 30 days. And the shares trade at a P/E of 12.78.
Pulte Group (PHM)
The company builds single-family detached, townhouses, condominiums, and duplexes under the Centex, Pulte Homes, Del Webb, DiVosta Homes, and John Wieland Homes and Neighborhoods brand names.
It is the third largest homebuilder in the U.S., with communities in 40 major cities. Pulte earned $1.29 per share last quarter, higher than Wall Street’s estimates of $0.87. It trades at a P/E of 10.42.
Toll Brothers (TOL)
The company operates in two segments, Traditional Home Building and City Living. It designs, markets, and sells homes in urban infill markets through Toll Brothers City Living.
And Toll Brothers develops, owns, and operates golf courses and country clubs; develops and sells land; and develops, operates, and rents apartments.
It also owns architectural, engineering, mortgage, title, landscaping, lumber distribution, house component assembly, and manufacturing operations. The company serves move-up, empty-nester, active-adult, and second-home buyers in 24 states.
Toll Brothers beat earnings estimates last quarter, posting EPS of $0.90, topping the $0.71 forecast. The company is expected to grow earnings at a rate of 38% next year, on 15% sales growth. The P/E is 12.54.
The company builds attached and detached single-family residential homes, townhomes, and condominiums primarily for first-time, first move-up, second move-up, and active adult homebuyers.
It also offers insurance products and title services, and has operations in Arizona, California, Colorado, Florida, Nevada, North Carolina, Texas, and Washington.
KBH beat Wall Street’s earnings estimates last quarter by $0.03, posting EPS of $0.55. The company recently reported that gross orders in June and July had increased 14% year over year to 3,275, and net orders grew 17% to 2,682. The shares trade at a P/E of 11.03.
As you can see, each of these homebuilders is doing very well, earnings estimates are increasing, and the shares look fairly undervalued. It’s a personal preference, but it may not hurt to add one or more of these homebuilder stocks to your portfolio.