Time To Consider The Homebuilders Yet?

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

After the financial crisis hit, few sectors in the market got hit as hard as the homebuilders. While the housing market is indeed improving, homebuilders such as KB Home (NYSE: KBH) are just beginning to pick up the pieces and get their business back on track. Even after an 18% revenue increase in 2012, the company’s sales are still a whopping 86% below their pre-crisis peak in 2007. While no one (at least not that I’ve spoken with) expects new home sales to hit those levels again, will the combination of favorable home buying conditions get KB Home back on track?

About KB Home

KB Home builds and sells a variety of home types, and also provides title and insurance service to homebuyers. The company has operations in ten states including some of those hardest-hit by the housing market collapse, like Florida, Nevada, and Arizona. KB Home built almost 6,300 homes in 2012, an increase of 8.1% from 2011. 

The Housing Recovery and What it means For KB

In 2006, at the height of the housing bubble, KB Home had a sales backlog of over $6 billion worth of new homes. This plunged to a low of $264 million in 2010 before it began to rebound. As of the end of the last quarter, the company’s backlog stood at $704 million, and this is perhaps the most telling number that will come out of the company’s next quarterly report on June 27.

With almost every industry analyst predicting a rise in home sales for the rest of 2013 and the next few years, KB Home is projecting 33% higher revenues this year, the biggest year-over-year increase since the housing bubble burst. Factors like higher buyers’ confidence, more affordable home prices, and near-record low mortgage rates are expected to outweigh such negative factors as tighter lending standards and a less-than-stellar job market in the U.S. In fact, KB Home is expecting to post its first yearly profit since 2006. To give a clearer picture of just how nasty the collapse of housing was, over the period from 2007 until the present, KB Home lost a collective $36.23 per share, almost 1.8 times the current share price!

Other Homebuilders: Lennar and D.R. Horton

Lennar (NYSE: LEN), one of the largest U.S. homebuilders, fared slightly better due to its more geographically diverse exposure. KB Home, on the other hand, was disproportionally exposed to the biggest of the “bubble” markets as noted earlier. As a result, Lennar returned to profitability several years ago, and has been in the black since 2010. However, Lennar trades at a premium valuation of 21.1 times this year’s earnings, which is a significant premium for an uncertain housing recovery.

D.R. Horton (NYSE: DHI) is also one of the largest U.S. homebuilders, and in fact in 2005 it became the first builder to sell more than 50,000 homes in a single year. For the same reasons as mentioned for Lennar, D.R. Horton also returned to profitability in 2010 and has stayed there since. These two companies are actually very close to each other, investment-wise, with nearly identical financial results over the past several years. Between the two, I would give the edge to D.R. Horton for two reasons. First, at 19.3 times this year’s earnings, it is slightly “cheaper” than Lennar. Also, when comparing the balance sheets of both companies, both have right around $1.1 billion in cash on hand, but D.R. Horton has about half the debt load of Lennar which is a significant difference when it comes to long-term profitability of a business.

Alternate Approach: Home Depot

Perhaps the homebuilders are too risky for you. Another way to play the housing recovery while still being able to sleep at night is with Home Depot (NYSE: HD), the nation’s leading home building and home improvement retailer. Home Depot is a good way to play because it works whether the market for new homes improves or not. At 24.6 times earnings, Home Depot might sound pretty expensive, but consider a couple of points. Home Depot has an excellent track record of profitability, and has produced solid earnings numbers (and raised its dividend) every year in recent history. Also, if homebuilders are projecting a 33% increase in sales, that means 33% more supplies will be needed to build those new homes. Finally, Home Depot is one of the most shareholder-friendly companies in the market. While their 2% dividend isn’t the best, they more than make up for it with an excellent share buyback program. In fact, since 2009, the number of outstanding shares has dropped by about 11%. Not bad for bad economic times!

Conclusion

While KB Home may indeed produce the best gains if all things go well with the housing recovery, that is a big “if”. If you insist on one of the homebuilders, D.R. Horton looks like the way to go, with Lennar not too far off. The safest way, by far, is through a retailer that supplies homebuilders as well as existing homeowners who need to renovate and make improvements, like Home Depot.


Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Home Depot. 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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