Build a Strong Portfolio With Home Building Companies

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

The US census Bureau estimates the number of privately-owned housing constructions to be around 1,036,000 this year, up from 780,600 last year. The primary driver for housing is employment, which has improved over the years. The U.S. unemployment rate has declined to 7.5%, as of April, from as high as 10% in 2009.

The increase in housing demand has created a supply shortage due to muted construction during the recession. Now, as the economy rebounds, home building companies are investing in land purchases and development. Here are three home building companies striving hard to capitalize on the market shortage and promote their own growth.

Better inventory and higher backlog

Hovnanian (NYSE: HOV) has about 6,800 lots in its U.S. inventory, out of which 70% are in California. The company plans to sell about 1,000 of these lots to developers this year. The demand for housing in California has been increasing due to rising job opportunities. The job market in California has an unemployment rate of around 9%, which is at its lowest point since November 2008. The job creation occurred primarily in professional and business services, leisure and hospitality, as well as education and health services. Improving job opportunities is expected to boost land sales revenue from $31.78 million last year to $36.28 million this year.

The company is going to benefit from the increasing backlog in housing. The company has a backlog of 2,827 homes in the quarter ending in June, an increase of 34% year-over-year. Subdued construction during the recession resulted in builders constructing fewer homes, which resulted in a backlog when the demand increased. The housing demand for this year is expected to be around 1.2 million, while construction is expected reach a maximum of 950,000. Thus, there is opportunity for increased home building. The company has 177 communities as of June this year and plans to increase the community count to 184 by the end of the year. This will boost the home building revenue from $1.41 billion last year to an expected $1.83 billion by the end of this year.

Futuristic concepts and new service

KB Home (NYSE: KBH) acquired land in east San Diego county to build solar homes. It plans to build homes on the concept of net-zero energy. The government’s California Solar initiative provides subsidies to users of solar power, and these new homeowners will be eligible. As California’s economy improves, KB Home will capitalize on the opportunity provided by this initiative. The company earns more than 50% of its revenue from the California market. This new concept in homebuilding is going to attract homeowners and will thus boost its homebuilding revenue from $1.56 billion in 2012 to an expected $2.44 billion in 2014.

The company is providing home customization services, where it offers customers the choice to select their floorings, counter tops, whether to install a central vacuum system, integrated sink, and home appliances. KB Home’s decision to roll out this service through KB Home Studio will help it to garner better prices per house and increase its margins. It is offering this service at a time when the housing market is facing increasing demand. The average price of a house is around $175 per square foot, whereas the average price of a custom built house is $201 per square foot. This service will give the company the ability to generate more revenue per customer. Therefore, it is expected that the EPS will rise from negative $0.76 last year to $1.00 next year.

The segments and the acquisition

Standard Pacific (NYSE: SPF) is focusing on the segment of buyers upgrading or purchasing luxury homes, as these buyers are less price sensitive and give the company better margins. As these homebuyers have more purchasing power, they demand a house built to their tastes and preferences. The average home price for Standard Pacific is in the range of $375,000 and the cost of customization is around 10%-12% of home building revenue. By 2015 the company is targeting a customer mix of 70%-75% upgrade buyers and 10%-15% luxury buyers. This strategy is going to improve and safeguard the company’s margins. The EPS expected this year is $0.39 and $0.55 the next year. Moreover, this EPS trend is expected to continue in the future.

The Centerline acquisition in June is going to provide the company with a stronger foothold in Florida and the Carolinas, where the economy is improving. The acquisition will add around 3,000 lots to the company’s existing 30 communities. This acquisition is in line with the company's strategy of acquiring and developing raw land to accommodate the demand in home building in the coming months. The company has an advantage over its peers in developing raw lands because it has experience, industry connections, and cash to fund it. At present, the company has land for 7.7 years of developmental work compared to the industry standard of 5.5 years. This will further boost the revenue from $1.19 billion last year to $1.99 billion this year.

Conclusion

Hovnanian's major market in California is improving, and thus, the company is benefiting. At the same time, the company is profiting from the increased backlog due to the overall improvement in the home building industry. KB Home is driving its home sales through its new concept of zero net energy homes. It is also offering customers the option to customize their homes, which is expected to give the company better margins. Similarly, Standard Pacific is targeting customers with greater purchasing power to protect and improve their margins. Additionally, it has better land inventory than its competitors.

Therefore, I recommend a buy on all the three stocks.

With the American markets reaching new highs, investors and pundits alike are skeptical about future growth. They shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam. Click here to read the full report!


Madhukar Dubey 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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