Home Builders Continue To Impress

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

New home constructions in the U.S recently touched 5 year highs, thanks to Fed’s monthly liquidity injections in a low interest rate environment. As a result, home builders have had an enjoyable ride this year. However, analysts at S&P estimate that new housing starts could further increase by 34.6% in FY13.

The best way to play the housing boom would be to load into homebuilders, with maximum exposure to construction-related activities. PulteGroup (NYSE: PHM), Toll Brothers (NYSE: TOL) and D.R Horton (NYSE: DHI) are currently the market leaders, and also provide mortgage banking services.

A turnaround story

Out of entire industry, PulteGroup has staged perhaps the sharpest turnaround. The company had reported a quarterly net loss of $1 billion in 2011, which quickly rose to a quarterly net profit of $81.76 million in the recent quarter. As a result, its shares have risen by nearly 390% over the last 2 years.

PulteGroup had merged with Centex Corp in 2009 to form a construction behemoth. Their individual revenues aggregated to $11 billion in 2008, which deteriorated to just $4.6 billion in 2010 (post acquisition). Besides that, the merged entity also drained $2 billion of its cash reserves in a matter of just a year.

But the rebounding housing market is proving to be a boon for PulteGroup, as the company posted its first profit in Q1FY13 since 2010. For the mentioned quarter, its home sales revenue rose by 35% YoY, while it closings rose by 23% YoY. Its sharp turnaround was partly bolstered by a 10% increase in its average selling price (annual).

As of now, most investment research firms have an outperform rating for PulteGroup, primarily due to the rebounding housing sector and its extensive market penetration. Analysts at RBC Capital Markets have a price target of $32 per share, which calls for a 60% upside from its current price.

A Growth Play

Even D.R Horton is growing at a rapid pace. The company has six different business segments, out of which its home construction segment generates 97% of its overall revenues. This revenue mix not only reduces its banking related default risks, but also allows the company to perform like a pure play construction company.

For the recent quarter, D.R Horton’s order backlog stood at $2.386 billion as compared to $1.358 billion in last year’s quarter. That’s an impressive spike of 76%. Its quarterly net income surged by 173%, while its net sales orders rose by 34%. Its also worth noting that, its gross margins have appreciated by around 20% over the last 5 years.

It is due to its continued solid financial performance, that its shares have risen by nearly 65% of the last year. At the current price, D.R Horton appears to be slightly undervalued with a forward P/E of 13.56x along with a PEG ratio of 1x.

Analysts believe that D.R Horton would most likely retain its growth momentum, and estimate its annual EPS to grow by 40% over the next year. Barclays has an overweight rating for the company, with a price target of $31 per share (around 35% premium).

An Undervalued Growth Play

Amongst the mentioned companies, shares of Toll Brothers have appreciated the least over the last year. However, its order backlog for Q2FY13 stood at $2.53 billion, which rose by an impressive 68.9% as compared to Q2FY12. Furthermore, its debt/equity ratio of 78% is lower than most of its peers in the industry.

Toll Brothers recently utilized its clean balance sheet to raise $300 million by issuing 10 year bonds at an interest rate of 4.375%. Thanks to the recovering bond market, its interest rate was lower by 150bps as compared to its last issuance in January 2012.

The company currently enjoys an ROI of 9.84%, and if its fully invests its $300 million, we could be looking at around an additional $29.8 million in annualised returns (theoretically).

As of now, its forward P/E of 11x along with a PEG of 0.26x suggest that its shares are heavily undervalued, and analysts estimate its annual EPS to surge by 86.4% over the next year. Barclays has an overweight rating for the company, with a price target of $44 per share (around 30% premium).

Final words

In my opinion, all the mentioned companies have immense growth potential. However instead of picking out a winner, I believe that creating a portfolio of all three companies would be a great way to play the housing boom.

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Piyush Arora 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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