Are Homebuilders Keeping in Line With Impressive Industry Growth?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I have been following the exciting homebuilding industry closely in recent months. What I have been noticing is that there is a huge difference between a thriving industry and a bargain stock. The homebuilding industry exemplifies this today: the industry is going gangbusters, but the stocks in this space are not bargains.

The macro picture

Homebuilders including Lennar (NYSE: LEN), and D.R. Horton (NYSE: DHI) have reported strong order trends above the expectations. Taylor Morrison Home has filed plans in January 2013 to raise $250 million in an IPO.

Cheap financing exists both for new home buyers and also for companies which could sell shares at rich valuations or debt at low interest rates. This is good news for companies is also bad news for investors (the people buying shares at high prices). Not surprisingly, homebuilders are raising funds from public-equity and debt markets. Similarly, demand for new construction is increasing among its buyers as a result of low mortgage rates and decreasing supply of existing residences for sale. The National Association of Home Builders expects builders to report 650,000 single-family homes during 2013, representing an increase of 22% from 2012.

Tri Pointe Homes (NYSE: TPH), a company financed by Barry Sternlicht, increased by 12% after raising $233 million through an IPO. The company’s shareholders sold 13.7 million shares for $17 each, above the range of $14 to $16.  The company will use the proceeds raised from the IPO to acquire land. Since 2010, Sternlicht’s Starwood Capital Group has invested $150 million in the company, holding approximately 84% in the company pre-IPO. He sold his 3.7 million shares in the company for $62.7 million during the IPO and retained 14.3 million shares.

According to the Richard Dugas, Chairman and CEO of the company, “We have every reason to expect that housing has indeed turned the corner and that industry sales in 2013 can continue to move higher as pent-up demand is released.”

The demand for new houses has increased due to tightening of existing properties inventories and mortgage rates float to record lows. New home sales in the U.S. increased by 20% during 2012 to its highest level since 2009. So, as was the case with on the corporate level, consumers are taking advantage of cheap financing.

However, there is more to investing than cheap financing. Even with cheap financing, if you pay too much you are setting yourself up for disappointment and possibly loss. Some of the expectations in the market are just too high.

D.R. Horton climbs after reporting doubled earnings

Analysts were expecting great results after Lennar reported a 32% increase in the home orders during the last quarter. This is an amazing result, but it is not as shocking as the results of D.R. Horton. D.R. Horton reported that first quarter earnings have doubled year over year, propelling company shares to their highest price in almost 6 years. The main factors that have contributed to this growth include low mortgage rates and a rising demand for housing among the general public. The Commerce Department indicated that for last year alone U.S. homebuilders were able to sell about 367,000 homes. This is the highest figure in three years.

D.R Horton CEO Donald J. Tomnitz exploited its market dominance to control costs as well as purchase land ahead of the other competitors who cannot command economies of scale. Mr. Tomnitz indicated that the company is set to add more homes to satisfy the strong demand being felt from different segments. He said, “We are anticipating a good spring selling season. We’ve put a significant amount of capital to work this quarter by increasing our investments in homes under construction, finished lots, land, and land development. D.R. Horton is in the best position it has ever been in its 35-year history.”

Vincent Foley and Cedric Morris, analysts with Barclays wrote, “D.R. Horton improved on its solid 2012 results and is well-positioned to benefit from increased demand during this year’s spring selling season.”

Macro Worries

The co-creator of the S&P/Case-Shiller index of property values, Robert Shiller said, “The housing market has been declining for something like six years now, it could go on, and that’s my worry. The short-term indicators are up now, it definitely looks better, but we saw that in 2009.”

On one hand, the property market saw values rising more than 7% in November when compared to a year earlier. This has been the ninth month in a row with an increase, as well as the biggest gain since May of 2006. Prices within normal levels have been increasingly common, while low mortgage rates are more frequent than a couple of years ago.

However, as the government is supporting most of those mortgages, a very abnormal market has been created. Sales of existing US homes also dropped during December, and were lower than most of the predictions from analysts. When taken in the context of a slow economy during the last five years and a subpar growth of the GDP, it's not surprising that hesitation about the future of the housing market still persists.

Prices that assume growth

Growth can’t keep beating rising expectations. PulteGroup (NYSE: PHM), the largest homebuilder by market value in the United States disappointed analystswith slowing home-order growth. To be fair its growth is still amazing: according to the Bloomfield Hills home orders increased by 27% during the fourth quarter. Apparently, amazing isn’t good enough to meet market expectations.

FBN Securities analyst Joel Locker said, “Pulte couldn’t meet lofty expectations. I don’t think sentiment could be higher in homebuilders. Investors expect significant earnings growth in the next few years to justify these stock prices.”

PulteGroup’s stock price was punished even though it beat analyst estimates and last year’s fourth quarter numbers. Clearly, stock prices are vulnerable to even great news.

Valuation

I wouldn’t mind owning a stock that fluctuates randomly on price if it was trading at a compelling valuation. Do any of these homebuilder stocks stack up?

Ticker

Company

P/E

P/S

P/B

D/E

KBH

KB Home

NA

1.03

4.52

4.57

TMHC

Taylor Morrison Home

35.61

1.08

19.26

4.43

DHI

D.R. Horton

8.36

1.61

2.11

0.72

LEN

Lennar

12.8

1.88

2.26

1.35

TPH

Tri Pointe Homes

NA

2.75

1.58

1.5

D.R. Horton and Lennar are the most interesting of these stocks. They have low price-to-earnings ratios and low debt-to-equity ratios relative to their peers.

Conclusion

It’s fantastic to be working in the homebuilding business right now, but you should be picky about buying these stocks since some homebuilder share prices anticipate great growth. Lennar and especially D.R. Horton are interesting stocks in this group.


BillEdson11 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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!

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