Housing Recovery: Builders and Materials
Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The focal points of economic downturns are the hardest hit. It is no surprise that the most over-inflated sectors of an economic boom are the ones that deflate, and then get further hammered as sentiment creates a feedback loop. The focal point of the current economic downturn would be financials, which have mostly recovered due to government assistance and housing. Housing got some help from the government, but only as it relates to mortgages. Not much was done about the oversupply of foreclosed homes and the glut in new developments remaining from when times were good. Housing is depressed, and there is no crystal ball for when it will be better. It should improve eventually and it might be a good idea to have a shortlist of potential investments.
There are also things that should be on watch in case there has been a paradigm shift among homeowners. Has the American homeowner become a more frugal individual moving from highly paid consultants like interior designers to do it yourself disciples who ask for advice via the internet? Finding investments is not just about analyzing companies and markets. It is about analyzing society. If you do that you might see where it is moving next, and an opportunity presents itself. I do not expect the housing sector to be forever depressed, and if companies have international exposure it can offset lags in certain countries.
Luxury Housing First
Luxury housing is rebounding and that is unsurprising. The people with higher incomes would be the first to be on a firm foundation to buy a house, and they could afford luxury houses in a soft market. Developers are starting up big projects again. Toll Brothers (NYSE: TOL) is one of a few developer choices, and all of them have had some of the same positive signs. I like Toll Brothers because I think luxury homes will allow for a more durable margin for the developers. I do not doubt that luxury home buyers negotiate just as hard, but the mark-up on the original price for the homes is probably larger. Toll brothers is not trying to cater to people who can barely afford houses. Toll Brothers is starting on new developments as the link above explains.
The Santa Ana development is likely to be a massive one. It will be one of the main focuses for the company into 2014 when the first model homes open. It looks like Toll Brothers is taking advantage of the long decline for construction, and is only now starting to position itself for the unleashing of pent-up demand. After all this time there are people that will pull the trigger on buying a house after waiting for so long thinking prices and interest rates would continue to fall.
Take a look at the key stats, though keep in mind that Toll Brothers has yet to sell off big developments. Key things to look for are whether it can carry out its plans. With cash at almost $1 billion it seems possible. The land has already been purchased, and it does not take much to actually construct a house. In California, the location of the Santa Ana development, land is usually the biggest part of the purchase price. Cash to fund the operation of building the housing units is critical, and it is good to see that there is plenty. Toll Brothers will not be building all the houses on the development at once. They will build a large amount and start selling the early ones as they roll across the development. Debt looks a little high, but it is not surprising considering the developments that are beginning. I am not looking at the last few quarters to argue that Toll Brothers is undervalued. That would be amazingly easy, but no such luck.
I want to see a company positioning itself for the future. I am also looking to see if the company can fit together with where the future is headed. The housing market is still a bit soft, and buyers who waited will realize that they will not be able to pick up a luxury house for as cheap as it is now for a while. That is why I think Toll Brothers will get the first benefit from a housing rebound.
Houses Need Upgrades
The Home Depot (NYSE: HD) might not be a traditional choice to play the housing rebound. However, everyone I know that bought a house discovered that if they wanted some changes made asking the developer to do it was always more expensive than hiring a contractor. It may be more hassle, but people will place a premium on hassle. For other small changes, people are starting to learn to do things themselves. I do not know if this is part of a bigger cultural shift to a hands on society, but I see it enough to take note. One of the most common updates, at least in my estimation, is people wanting to go with hardwood floors over carpet.
Home Depot is a great retailer. It is not about to be taken down by Internet retail. However, the stock has been on a bit of a tear the last year. Looking at some of the key stats, we see a lot of free cash flow, which is great. It allows home depot to expand, and I expect that it will become an extremely stable dividend stock. Look at the 3 year return of 120%. I know it is hard to buy a stock that is just up so much, but sometimes that is how you miss the boat. You can wait for a pullback, but Home Depot is a great company. Definitely have it on the list of potential safe investments.
Lumber Liquidators Holdings (NYSE: LL) provides wood flooring and other flooring products. It supplies the materials for one of the most common upgrades for homes. Flooring is due for a rebound just like home construction. Looking at the key stats, you can see that the company has no debt. Cash at over $30 million could be a bit higher, but judging by its current ratio of over 2 it should be more than enough. The year-to-date return of 178% is monstrous, but there could still be some gains left to go. Eventually, this will also be a dividend stock. I do not see it diversifying into new areas and continuing to be a growth story.
The time for housing to recover is nearing. It cannot stay perpetually depressed. It might rise slowly, but rise it will. There are lots of good signs all over the place. I think luxury housing developers will receive the first benefits, which is why I like Toll Brothers with their massive development in Santa Ana. Home Depot has been a great retailer for a long time. It can form part of the stable base of any portfolio. Lumber Liquidators is slightly more risky, just because if hardwood falls out of favor it might hurt the company. Still, a housing rebound should help all three companies. As we come out of the recession, stock gains will be driven by macroeconomic winds. The companies best positioned to rise with the market will fare the best. If the economy was growing rapidly we would have to dig into companies' expansion plans. Right now we can just judge existing core businesses and wait for the economy to allow it to flourish.
TheArchivist has no positions in the stocks mentioned above. The Motley Fool owns shares of Lumber Liquidators. Motley Fool newsletter services recommend Lumber Liquidators and The 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.If you have questions about this post or the Fool’s blog network, click here for information.