Housing Winners and Losers: the Market vs. the "Minutes"
Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With potential policy changes revealed in the recent Fed “minutes,” along with some soft jobs numbers, housing stocks recently took a breather from their meteoric rise. In the wake of these developments, here’s what you need to know.
What happened:
The Fed backed off (ever so-slightly) from their recent QE policy, which is to keep buying bonds until unemployment drops below 6.5%. Recent poor jobs numbers put the timeline on lower unemployment in question, and the Fed is showing increased concern that its bond buying policy might cause rampant inflation and hinder the economy.
Translation: It’s no longer a given that interest rates will stay at current historic lows
Here’s what to do about it:
Winners and Losers: Proven Performers
Sure, higher interest rates could curtail new housing demand, but Lennar Corp (NYSE: LEN) should remain a compelling investment. The company has managed to meat or beat earnings expectations for 13 straight quarters, even during some tumultuous times.
But higher interest rates could definitely hurt Wells Fargo (NYSE: WFC) in the short term, because the bank relies on real estate loans for 31% of revenues (25% mortgages, 6% commercial). Simply put, no “mega-bank” relies on new mortgages to drive its business (today) as much as Wells Fargo.
Wells Fargo has made the largest bet on U.S. housing growth, even though most investors associate mortgage exposure with Bank of America due to the impacts of the “Great Recession.”
Analysts had only anticipated earnings growth around 7% for the next two years at Wells Fargo, but what will they project if rates rise and mortgages slow?
Considering Wells Fargo's current price ($35/$36), even if the bank hits all its estimates the upside is limited. Let’s pretend Wells Fargo hit expectations for next year (EPS of $3.65)--a reasonable multiple of 12x would still only put the stock would be at about $43.
It’s a great bank, but the short-term downside outweighs the long-term upside at its current price. Lennar works better for you with a forward P/E of just 16; it’s both reasonably safe and has room to roar, if housing does.
Speculative Winners and Losers
With an evolving housing market that is unlikely to continue rising in a straight line, investors should exercise caution before investing in a speculative play like USG Corp (NYSE: USG). USG is a company that will be profitable one day, when housing lifts all boats, simply because its products are needed in new home development. I love that the company has few competitors, but it hasn’t managed to earn a profit in 5 years and is currently trading near multi-year highs—danger!
USG recently missed earning again (by $0.20), and considering how so many other housing plays are actually delivering a profit, there’s safer ways to win big than USG--at least for now.
In fact, if you hold USG you probably believe that new home demand will soar, causing building material demand to skyrocket—so why not just buy shares of Beacon Roofing Supply (NASDAQ: BECN)?
Beacon has grown EPS by 22.95% annually over the past five years—through the truly dark days. You have to like the fact that its revenues (5%) have grown slower than earnings, a sign of stability.
The most bullish factor for Beacon is that it doesn't need a strong housing market to thrive--it just helps. Yes, roofing demand explodes with new home sales, but it also does pretty well when “super storms” hit and people need to replace existing roofs. Say what you want about discretionary spending, but people will definitely part with a few sheckles to keep a (literal) roof over their head.
With low debt (unlike USG), and a market cap under $2 billion, Beacon makes a pretty good buy-out candidate to boot.
10 Second Takeaway: the Market vs. the Minutes
With strong new home demand coupled with surging sales of distressed properties, the housing rally still has long legs to it. As foreclosures are absorbed and banks like Wells Fargo continue to ease lending restrictions, long-term demand will be strong.
The comments from the Fed were really just a timely reminder that stock picking still matters in housing, and that the recovery won’t happen without a few setbacks. That’s why you should arm your watch list with companies like Lennar and Beacon, companies that have one of the following characteristics:
1). The company has proven to be profitable in down housing markets, or
2). The company doesn’t rely solely on a robust housing market for profits
There will certainly be a time and a place for less-proven performers, but today's market comes with great fluctuation and enormous potential for headline risk.
Lennar and Beacon have thrived in the absolute worst of times--even as a home builder Lennar only reported a few quarters without profit ( in 08/09).
They both deserve your consideration should any reasonable pull-back occur--I know they have mine.
mrrightside has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo. 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!
