Home builders continue to log gains in new orders, and earnings continue to grow, with many companies in double digits. But stock prices aren’t reflecting those fundamentals.
“You have to believe the economy is going to expand to own a homebuilder (stock),” said Citigroup analyst Will Randow. “Investors are fearful. Everyone, including me, is looking for the canary in the coal mine. I don’t think we’ve seen it yet.”
Take a look at homebuilder share prices, which have fallen like dominoes since the start of the year. As of Thursday, big builders Toll Bros.
), D.R. Horton
) and PulteGroup
) are down 28%, 27%, 23% and 14%, respectively.
Smaller homebuilder LGI Homes
), which had been one of the best performers last year as it catered to first-time buyers in Texas and several other states in the Southwest and Southeast, has tumbled 16% this year.
There have been a number of headwinds, such as a shortage of workers, which means longer construction times and delayed deliveries; higher land costs; plunging oil prices that are impacting energy markets, most notably Houston; and the rising dollar, which is keeping once-active foreign buyers at bay.
But more than anything, stocks have been spooked by investors’ fears, analysts say. They’re fearful over a slowing economy and possible recession, and to a lesser extent the prospects of higher mortgage rates.
Homebuilder stocks are considered “high beta,” meaning they are highly sensitive to the economy and what’s going on in the overall stock market.
“When the stock market goes down, homebuilders go down even further. When the economy sneezes, the builder group catches a cold,” said Brad Hunter, chief economist at the Hanley Wood subsidiary Metrostudy, which studies the homebuilding industry.
‘A Mild Stimulant’Economic recoveries are usually led by housing. And in this long running post-Great Recession recovery, housing also has led to a degree, Hunter says.
“The recovery in housing has been so gradual I would say it was a mild stimulant,” he said. “If there is a recession, it won’t be because of a downturn in housing. Housing will be the victim, not the culprit.”
It’s true that job growth – an important stimulus for home buying — slowed in January to 151,000 newly created jobs, down from last year’s average of 228,000 a month. But that number is still high enough to be considered economic expansion, Randow says.
Plus, wages grew 2.5% in January from a year ago, which he sees as a positive. And housing supply is still tight, keeping prices on an upward trajectory.
Builders’ confidence held steady at 60 in January, according to the National Association of Home Builders/Wells Fargo Housing Market Index. A number over 50 indicates that more builders view conditions as good than poor.
“We’re all looking for reasons that something bad is happening and I’m not seeing it,” Randow said. He says builder surveys that Citigroup ran in early February show January orders were still growing and cancellation rates were not trending higher, either.
“That is a bit of a surprise considering what the market reflected,” he said. “There are going to be bumps in the road through the earnings season but we don’t have any evidence that demand is slowing.”
Earnings Growth SlowingBut while demand isn’t slowing, builders report slowing growth. D.R. Horton’s quarterly earnings growth has tumbled from 88% to 36% to 8% in the last few quarters. Sales gains have cooled for the last three quarters. Lennar, another major builder, has seen EPS increases decelerate for the last four quarters. Toll Bros.’ has reported lower earnings in the last two quarters.
For the current year, D.R. Horton’s earnings are seen rising 16%, Lennar 10% and PulteGroup 14%.
Toll’s are expected to rebound 32% in the fiscal year ending in October. LGI Homes’ earnings are forecast to catapult by 83% in 2015 and surge another 27% in 2016. But CalAtlantic Group
) — the name that resulted from last year’s merger of Standard Pacific and Ryland Group — is seen rising only 3% this year. Its shares have plunged 24% this year.
New orders will be watched closely as builders report. The spring selling season traditionally kicks off after the Super Bowl.
“If we see continued strength in March, I think you’ll see the (homebuilder) group pick up,” Randow said.
Homebuilder stocks “are starting to get cheap,” he added. “If you’re a value investor, it’s probably a good time to invest in the homebuilders.”
Still, concerns over a global slowdown as China sputters are real. The U.S., while still holding up relatively well, isn’t immune to trading partners’ woes, Hunter says.
“The economy is okay. It’s not super strong. There is growing risk worldwide of an economic slowdown and growing risk of recession at some point in the next two or three years,” Hunter said. “That weighs on people’s minds: Maybe I shouldn’t buy that home I had my eye on. Maybe I should wait.”
Housing Cycle AgingHousing starts are running at an annualized pace of 1.1 million, still below the 1.5 million that is considered normal. Analysts consider the housing market in the middle of the cycle, if not later than that.
Barclays warned investors in the fall, before homebuilder stocks started sliding, that they were “perilously Pollyannish” to view the U.S. housing market as still early in the cycle, especially when the economy wasn’t. In a more recent research report, Barclays’ analyst Stephen Kim said housing is in the “third inning of a five-inning ball game.”
“The housing cycle isn’t as young as it once was,” he wrote.
While he is encouraged by a recent pickup in first-time buyers, new-home supply constraints will push excess demand into the existing-home resale market, he noted. Meanwhile, noting that a growing number of former homeowners are moving into rentals, offsetting first-time buyer moves into the market, Kim figures housing starts won’t grow faster than last year’s 10% rate.
He calls the situation “housing cycle’s midlife crisis.”
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