Housing Stocks Are in a Trot
Gerelyn is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Returning stability to the housing market doesn't mean diddly if Warren Buffett decides to undermine that recovery. Mr. Buffett's comments on a recent CNBC interview, however, weren't too scathing - although they were still sobering. He reminded starry-eyed investors that the housing market is not "galloping back" but it is "improving." Housing stocks may not be in a comeback of thoroughbred proportions but at least they are trotting in the right direction -- and considering the epic downturn in our not-too-distant history, that's not so bad.
The most recent Case-Shiller home price trends shows promise. The results suggest that home prices, which remain below levels from a decade ago, will show growth of 0.6% between the third quarter of 2012 and the third quarter of 2013. Things look better for the long term, as prices are expected to rise at an annualized rate of 3.3% in the five-year period leading up to the third quarter of 2017. The average long-term rate of price appreciation is 5%.
Hovnanian Enterprises (NYSE: HOV) is positioned to capitalize on this trend. While Hovnanian's top line growth is not where it was pre-housing crisis and the home builder has yet to return to consistent profitability, conditions are improving. For instance, six years ago, the Red Bank, N.J.-based home developer was earning $6 billion in annual revenues, levels that far exceed more recent performance. Nonetheless, revenues have grown from $1 billion in 2011 to $1.5 billion in 2012. Other factors are working in Hovnanian's favor, too. In addition to the improving housing conditions, whether the pace be akin to a trot or a gallop, this company, which has a presence across 16 states, can't seem to find enough land supply to keep up with demand.
Hovnanian also has a diverse business mix spanning entry-level housing to active adult communities and luxury homes, compared to rivals focused solely on the luxury market. Diversity helped Hovnanian throughout the financial crisis as the company didn't have to reinvent the wheel to service the entry-level housing market because of its existing presence in this segment.
Homebuilders like Hovnanian rely on purchasing new land to fuel an expansion. Hovnanian, however, is burning through communities faster than company officials expected -- especially in places like northern California -- and they are having a hard time finding new land, according to Larry Sorsby, the company's chief financial officer, speaking at a recent J.P. Morgan debt conference. It's not such a terrible problem to have, as an inventory glut would be worse. Hovnanian is using the cash flow that it earns from closings to invest in additional land, when it can find those acres that meet its criteria. Nonetheless, the home builder increased its land position in fiscal 2012 and expects to do the same in fiscal 2013, Sorsby said.
Hovnanian recently refinanced some of its debt to more attractive levels and doesn't have any plans to return to the equity markets any time soon because the stock price has been depressed. The company needs to show some consistency in its profitability, as the effects from the credit crisis are still haunting performance on some levels. Nonetheless, the homebuilder market is smaller than it was before the meltdown and Hovnanian is in a position to take additional market share. Considering the promise for more land growth and some earnings stability and revenue growth, I believe the stock has upside potential for the patient investor.
When Hovnanian reported its fiscal first quarter results on March 6th, the stock price fell more than 5% intraday. The homebuilder reported a 32.9% increase in revenues to $358.2 million compared with $269.6 million last year. Gross margins improved slightly to 17% from 16.5%, although management has stated that there would be some volatility in gross margins in coming quarters. Profitability continues to elude Hovnanian, as the company reported an $11.3 million net loss, or -$0.08 per share compared with a loss of $18.3 million or -$0.17 per share in the comparable period last year. The results were two cents better than analysts were expecting, according to Bloomberg. Home deliveries and net contracts for new homes were higher in the quarter. Ara Hovnanian, president and CEO, said in a press release:
Given the size of our contract backlog, the average gross margin on homes currently in contract backlog and assuming that market conditions remain stable, we are pleased to project our return to profitability for fiscal 2013. It has been a long and difficult cycle, but we finally see the benefits of the many steps we have taken to prepare ourselves for this inevitable market upturn.
Home improvement stores
Meanwhile, home-improvement retailer Home Depot (NYSE: HD) has been one of the stocks that has helped the Dow Jones Industrial Average set a new record high in recent days. Shares of Home Depot recently set a new 52-week high when the price surpassed $70.30. It might not be too late to get in on some of these profits.
Home Depot is focused on growing both its brick-and-mortar and online presence including a push toward mobile applications. Its home services business, which allows sales professionals to visit customer's homes to help with the planning and execution of home improvements, is expanding. Home Depot's made two acquisitions last year to support its home services business specifically for flooring installations as well as kitchen and bath remodelings. According to Kevin Hofmann, the president of Home Depot's online business, the home services segment is 4% of the company, which suggests it could be a catalyst for future growth.
Shares of Lowe's (NYSE: LOW) are hovering near their 52-week highs as well. The company recently reported a slight 0.5% decline in its fourth quarter sales to $11 billion and a 0.06% rise in fiscal year 2012 sales to $50.5 billion. Fourth-quarter net earnings declined by 10.6% while diluted EPS were flat compared with the year ago quarter. The retailer attributes the disappointing quarterly performance to the extra calendar week in 2011 that created a tough comparison for 2012. For the fiscal year, net earnings increased 6.5% to $2 billion or $1.69 per diluted share.
Lowe's also revealed a $5 billion share buyback program, which replaces an existing repurchase program that was already in place and is expected to occur over the next two years. Perhaps the share buyback will boost forthcoming earnings per share. Lowe's is predicting fiscal 2013 diluted earnings per share of $2.05 and 4% sales growth in the period.
Home Depot has a trailing price-to-earnings ratio of 23, compared to a trailing P/E of approximately 22 for competitor Lowe's. In recent days, after reporting a 32% increase in its fourth quarter earnings combined with a 14% rise in sales, Home Depot lifted its quarterly dividend by 34% to $0.39 per share, which places the dividend yield at 2.3% compared with a quarterly dividend of $0.16 and a yield of 1.7% at Lowe's. Between the two stocks, Home Depot has more growth momentum working in its favor.
All in all, the housing sector offers investors a compelling opportunity. The population is rising, home foreclosures and delinquencies are slowing, and homeowners are investing in their properties. At this pace, stocks in this sector have growth potential in 2013.
GerelynT has no position in any stocks mentioned. The Motley Fool recommends Home Depot and Lowe's. 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!