Is The U.S. Housing Recovery Story Already Baked Into These Real Estate Companies?
Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors have multiple ways to bet on the U.S. housing recovery. The stock of homebuilders, home-improvement retailers, and online real estate search firms all benefit from an upswing in housing. Which are in the best positions for a recovering housing market? More broadly, do any of these firms share prices make them reasonable buy candidates, or has the real estate recovery story already been priced into real estate stocks?
Lennar Beats Expectations
Lennar's (NYSE: LEN) most recent earnings report beat market expectations. Net income for the three months ended November 30 rose from $30.3 million, or 16 cents per share last year, to $124.3 million, or 56 cents per share, versus the average analyst estimate of 45 cents per share, as reported by a Bloomberg survey involving 20 analysts.
The improvement in Lennar’s income was fueled by rising revenues as homebuyers jumped on record low interest rates while the supply of existing housing units was depleted. Gross margin was strengthened due to decreased promotions and higher selling prices. Sales revenue rose 42 percent from $953 million last year to $1.35 billion in the latest earnings report. The average selling price of houses ascended from $243,000 to $261,000. Gross margin on the sale of homes increased from 19.4 percent to 23.5 percent. New orders generated 32 percent more compared to the previous year to 3,983 housing units, while the current backlog increased by 87 percent to 4,053 housing units. Current backlog is an indicator for future sales. Lennar’s future plans also include an investment in the multifamily segment, with $1 billion in the pipeline that is to be developed over the next three years.
A survey conducted by Bloomberg involving 49 economists revealed that the National Association of Home Builders/Wells Fargo index of confidence is expected to experience a continuous upward surge for the ninth straight month. In January, the index is expected to rise to 48, which is believed to be the highest since April 2006 if actual reports meet average expectations. Core Logic reported the highest increase in average U.S. home prices since May 2006. The increase reached 7.4 percent in November from the previous year.
Wells Fargo analyst Adam Rudiger, however, said, “The headline EPS beat was largely driven by tax benefits. We are somewhat concerned that elevated investor expectations in the face of more difficult order comparisons in 2013 may make further share gains more difficult to come by.” The earnings report includes an $18.6 million tax benefit. Rudiger computed that without this tax gain, earnings for the company would have only been 47 cents per share. Lennar’s Rialto Investments reported that operating earnings declined to $4.6 million, compared to $8 million during the previous year. This company’s segment invests in distressed real estate. Rudiger associates the decreased revenue of this segment and increased costs with the ownership and management of properties.
Reis (REIS) reported that the U.S. apartment vacancy rate reached an 11-year low to 4.5 percent in the fourth quarter. This is due to foreclosures experienced by millions of people and stricter mortgage requirements, making it more difficult for interested home buyers to obtain housing loans, favoring rentals.
Home Improvement and the Housing Recovery
The recovering U.S. housing market prompted homeowners to spend more on home improvement. Home Depot’s (NYSE: HD) average transaction in the third quarter rose roughly three percent to $55 while the number of purchases climbed 2 percent to 331 million. Rising property values are bolstering household finances and spurring consumer spending. Home Depot CEO Frank Blake, said “The earnings reflect the start of the path toward the healing of the housing market.”
Like Home Depot, Lowe’s (NYSE: LOW) saw boosted third quarter earnings. Sales beat analyst growth forecasts of 0.8 percent to $11.9 billion with actual sales growth of 1.8 percent to $12.1 billion. Gross margin also improved from 34.1 percent last year to 34.3 percent. Cost-cutting measures closed 27 of its stores and eliminated 500 of its staff this year. Growing sales and cost controls resulted in income for the quarter jumping by an amazing 76 percent. International Strategy & Investment Group analyst Greg Melich said, “Lowe’s made progress on recovering some of the gross margin over the last year and comps were up.”
Online Real Estate Search
Conceptually, online search is better than homebuilding as a business model. Without a housing inventory there should be higher return on assets. In addition, residential property is essentially a commodity market which forces homebuilders to compete on price. Websites connect buyers and sellers, acting as network goods which can avoid price competition. They don’t have to compete on price for traffic as long as they are among the most popular platforms. Immunity to price competition is a big plus for online search sites.
The financial ratios of many of these real estate-linked stocks should give investors pause:
Traditional homebuilder stocks are unattractive. Lennar braves terrible risks yet it has price-to-sales, price-to-book, and price-to-earnings ratios that are each a bit higher than the S&P 500 average despite the fact that it is a cyclical stock. For this reason it is not a compelling buy candidate as growth has been priced into the stock. KB Homes is not compelling because it has a huge debt-to-equity ratio and has not generated a profit for the last twelve months. Hovnanian is not a compelling stock either because of its negative equity book value. (Its negative accounting equity is why the P/B and D/E ratio are incalculable). Stocks with negative book values for equity have underperformed other stocks historically.
Trulia and Zillow are far worse investments because of their huge price multiples. These stocks are just too rich.
Even home improvement retailers have become pricey. Between Lowe’s and Home Depot, Lowe's is the more attractive stock. Investors can buy more sales per dollar than they can from Home Depot stock which is trading at a higher price-to-sales multiple. However, both firms are trading at high price-to-earnings multiples and neither is compelling on the basis for valuation.
Lowe’s is the least unattractive real estate stock. All in all, none of these stocks are attractive buys on an absolute or industry-agnostic basis.
BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends Home Depot and Lowe's Companies. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!