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Monday, 10/03/2016 11:59:43 PM

Monday, October 03, 2016 11:59:43 PM

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Two Home Builders in the Hottest Markets
CalAtlantic and KB Home have the most exposure to the top 10 new-construction housing markets in the U.S.


Oct. 3, 2016 4:30 p.m. ET
MKM Partners

We are introducing a new monthly housing report wherein we will focus on the health of the top 10 new-construction housing markets in the U.S., which we estimate represent roughly 26% of total new-home sales.

We rely mostly on publicly available real estate data -- this is primarily resale data, but we think it can still provide us a good look into the health of the markets. In this first of our series, we would describe the aggregate health of the top 10 markets in August as relatively strong, with a total heat index market score of 70.6 (out of 100). Seattle was our strongest market in August, with Houston the weakest, albeit improving a bit.

We score each market between 0 and 100 individually using a rating system based on 10 housing and macro metrics, including sales, pending sales, inventory levels, price appreciation, permit growth, employment statistics, GDP growth, population growth and construction spending.

For August data, Seattle was the highest-scoring market (84.3), followed by Orlando (75.7) and San Antonio (74.5). The lowest-scoring markets in August were Houston (52.0), Washington D.C. (61.7) and Dallas (70.2). We note that even our slowest-growing markets scored above a 50 in August, as trends generally improved across most cities and inventory levels remain low.

Total home sales (mostly resale) in the top 10 markets in the U.S. were up 10% year-over-year in August. This was a marked improvement from a very weak July, with sequential growth improvements noted in nine of the 10 housing markets tracked (Atlanta being the exception). Total sales on a 3-month rolling average basis are up 1.6% for the 10 markets. This is closer to the national existing home sales rate that has been reported over the past few months.

Total inventory in the top 10 markets fell slightly year-over-year in August, after having risen slightly in the previous few months. Monthly supply in aggregate was roughly 2.5 months of supply for these markets and fell slightly sequentially. Houston inventory continues to rise, but is at 4.0 months of supply.

Pending home sales were up 1% year-over-year for the seven markets that report this metric, an improvement over flattish sales in the prior two months.

Based on the relative exposure of each of the builders in our coverage universe, we created a ranking of each builder, which takes into account overall presence in each top 10 markets and the health of that market. For this ranking, CalAtlantic Group (CAA) (rated at Buy) ($45 price target) garners the top spot, followed by KB Home (KBH) (rated at Neutral) ($13 estimated fair value). NVR (NVR) (rated at Neutral) ($1,600 estimated fair value) comes in last (due to its limited exposure to the top 10 markets).

Hovnanian Enterprises (HOV) (rated at Neutral) ($1.75 estimated fair value) has the highest relative exposure to the top 10 markets (we estimate at 53% of its total communities), but its overall score was hurt by the company’s large exposure to the Houston market.

We were pleasantly surprised to see the improvement in sales in many of the markets in August and given that the data came from 10 different data sources, we are inclined to believe it wasn’t coincidence. The low supply in these markets should be conducive to a positive environment for homebuilders, as long as the macro data remains constructive. We continue to believe that CalAtlantic provides good value in this space, trading at 1.3 times book value, especially given the strong relative score it receives in our analysis. The stock may be in a holding pattern for a little while, however, until it can address what we believe may be some company-specific issues in its Southwest region. We continue to also like Toll Brothers (TOL) (rated at Buy) ($38 price target), with our thesis having less to do with its positioning in the top 10 markets and more to do with the potential margin growth we see next year due to improved mix in California and New York City.
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