Investing in These 3 Homebuilders Will Not Disappoint You

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

2012 was a stable year for the housing market, with respect to both volume and prices. According to a study by Fiserv Inc., home prices could further increase 0.6% by the end of the third quarter of 2013. Additionally, the expected growth in prices for the next five years is around 3.3%.

With the expected rise in the near future, holding on to the right housing stock can make all the difference. Scouring the investment landscape, I have three recommendations from the homebuilding industry. These stocks have the potential to benefit from the macro factors prevalent within the industry. Let’s discuss them in detail.

Lennar (NYSE: LEN)

By the end of fiscal 2013, Lennar targets an increase in its community count by 20%. Currently, it is active in 459 communities, but expects to increase its reach to 550. I believe that the growth should be concentrated mainly in the second-half of 2013, because of the current land holdings and stages of development, which will delay Lennar in bringing its targeted communities to completion.

The increase in the count won't give all the help needed for growth. The conversion into actual sales is also important. For this, the high backlog conversion rate of the company comes in handy. Lennar maintains a high conversion rate within the range of 90%-100%. Although, the rate in the first-quarter did not fall in this range, it is expected to improve to around 90% in the later part of the year. This is in conformity with the fact that the major increase in community count is expected only in the later part of the year.

In the last quarter, Lennar revealed its plans to scale-up the multi-family construction business. The company has been in this business for the past two years, and now it aims to grow substantially over the next couple of years. It has 6,500 apartments in its pipeline, worth about $1 billion. It is expected that the construction of 3,000 apartments should begin in 2013.

About 25% of investment in these properties is required in the form of equity; and the rest in debt. They provide a long-term opportunity for Lennar to generate an attractive IRR of 25% to 45%. I do see some headwinds, as the comps of multi-family houses in the country for January 2013 were sequentially low, but the year-over-year growth was impressive.

The company has a decent pipeline of multi-family projects that should drive growth. Additionally, the aim to expand the community count should give some additional upside to the stock. Though the backlog conversion rate may face some headwinds in the short-term, the long-term position of the stock seems strong.

D.R. Horton (NYSE: DHI)

Fiscal 2013 for Horton seems robust, considering the end of the first-quarter in which the company had an inventory of 14,200 units, of which 52% are speculation homes (spec homes). Spec homes give an added advantage to buyers, as the customers know exactly what they are buying and they don't have to wait for a long duration before moving-in.

This gives spec homes a competitive edge over the custom homes, and helps a lot in their sales. The company maintains a backlog conversion rate of about 70%. In the coming quarter, a slightly higher backlog conversion rate is expected due to its spec home sales. I believe the company is in a strong position for the selling season in spring, and should see strong net order growth in the second-quarter.

In addition to this, the company has a high lot count. This gives the Horton a strong base for growth. In the last quarter, the total lot count increased to 177,000 which means the availability of sufficient supply for the next 8-9 years.

Additionally, the company also invested $912 million on land in the last quarter, which was nearly twice the average spending rate of the company. This should help Horton in the future as well, as in the recent quarters, it has benefited from the increased focus on finding new opportunities by evaluating new suburbs, and increasing share in the existing ones.

The expected spec home sales and the increasing lot count give the company a decent base. I'll recommend a buy on this stock.

KB Home (NYSE: KBH)

The company recently made some announcements that came as a relief to its shareholders. From the end of the last quarter till mid-January 2013, KB's orders were up 54%. After this, the stock price of KB reached its 52-week high.

The news was assisted by the rise in the capital base of the company. KB plans to issue common stock of $100 million, convertible senior notes of $150 million, and will avail a revolving credit with an initial principal amount of $200 million.

The market awaited this move ever since KB’s South Edge exposure was brought into light. Back in June 2011, KB settled the claims of its lenders for its part in the bankruptcy of the south edge community. The main use of these funds should be for land acquisitions, apart from the recent acquisitions in Raleigh and San Antonio.

However, KB lags behind the other two that were discussed above with respect to cancellation rates. In 2012, KB had a high cancellation rate of 36%, as compared to Lennar's 18% and Horton's 27%. Thus, to improve the rate and increase the backlog conversion rate, it is going to form a new mortgage company in a joint venture with Nationstar Mortgage (NYSE: NSM).

It will be deployed in the second half of 2013. Nationstar will continue to operate as the mortgage lender for KB until the joint venture is deployed. Prior to the joint venture, Nationstar served the home-buyers of KB as an on-site loan officer. The new company would provide certainty and improvement in the mortgage earnings of KB.

Strong growth in orders, along with the capital raised, and the new mortgage company make me bullish about the stock.

What do these homebuilders have to offer?

Lennar and Horton have their community and lot expansions, respectively, which give their future a solid base and clarity. Additionally, the inclination of Lennar towards multi-family construction, and Horton's spec houses provide an upside to their profitability.

And as for KB, the increased capital base and the new mortgage company strengthens my faith in it. For me all the three stocks are a buy.


Shweta 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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