Barron's article on the homebuilders, the cheapest sector of the market at around 4x 2022 analyst estimates -
The housing market is still robust, but home-building stocks have been rocked this year as investors worry that surging mortgage rates will dampen activity later in 2022 and in 2023.
The result is that the industry now has the lowest price-to-earnings ratio in the stock market at around four times projected 2022 earnings.
With the sector so inexpensive, the risk-reward equation looks favorable given that many stocks are trading at, or near, book value.
Thirty-year mortgage rates have risen to about 4.5%, from 3% in late 2021. Should they start to slide back, the stocks could rally. And the stocks could gain even if rates hold at current levels — should favorable industry trends continue.
Home-building stocks are the second-worst performing group in the S&P 500 index this year—only home furnishing stocks have done worse. The iShares U.S. Home Construction exchange-traded fund (ticker: ITB) is off 25%, to around $62. Industry leader D.R. Horton (DHI) is off 28%, to $78.
Barron’s wrote favorably on the group in late 2021 in what appears today to be a badly timed article. The stocks are off sharply since then.
Housing bull Stephen Kim, an analyst at Evercore ISI, says the stocks are cheap and that their land values should help put a floor under them. Demographics also look favorable as millennials move out of city apartments in search of more space in the suburbs.
“But while industry fundamentals are incredibly strong, housing bears are quick to add the rejoinder ‘so far!’ and turn a blind eye to all the positive data,” he noted in a report a month ago.
Book value has often underpinned the stocks in the past, and book value could now be understated industrywide because of older, lower-priced land carried on company balance sheets. Kim wrote that the stocks “are trading well below their implied liquidation value.”
Toll Brothers (TOL), KB Home (KBH), Tri Pointe Homes (TPH), and Taylor Morrison Home (TMHC) trade near book value, while Lennar (LEN), one of the two industry leaders, now trades for 1.2 times book.
D.R. Horton, the No. 1 home builder in the country, trades for 1.8 times book and PulteGroup (PHM) at around 1.5 times, according to FactSet.
The industry is probably in its best shape ever, with strong balance sheets and increasing capital returns to shareholders, mostly stock repurchases. Lennar bought back more than 2% of its stock in the latest quarter. Dividend yields generally are under 2%.
So what’s the problem?
“Investors are understandably skittish given the combination of higher rates and elevated prices makes homes less affordable,” J.P. Morgan analyst Michael Rehaut wrote in a recent note. “While the current fundamental backdrop remains healthy, at the same time, we believe investor concerns regarding rising interest rates and the sustainability of earnings are likely to persist over the near to medium term.”
The J.P. Morgan analyst is “less constructive” and more selective on the stocks, favoring Horton, Lennar, and Pulte. Home builders are contending with shortages of materials like garage doors.
Lennar stock could benefit from the company’s plans to separate non-core businesses including multifamily rental operations later this year. Kim has written that the spinoff value could be over $20 a share.
Lennar has two classes of stock. Its less-liquid, supervoting class B shares trade at a 15% discount to the more liquid A shares. The class B stock ended at $69.50 Monday, against $82.51 for the A stock.
The B stock, largely held by Lennar Chairman Stuart Miller, could ultimately be merged into the A shares, benefiting B share holders. Barron’s has written that the B shares are a good alternative to the A stock for individual investors. The B shares trade below book value and for just four times projected earnings in Lennar’s fiscal year ending in November.
Toll shares, which ended Monday around $49, trade for less than 1.1 times the company’s book value of nearly $45 in its quarter ending in January. Toll is differentiated from its peers thanks to its luxury focus. The affluent buyers of its high-end homes — whose average price is close to $1 million — tend to be selling homes that have appreciated and are thus less sensitive to changes in mortgage rates.
If Toll CEO Doug Yearley is accurately describing the housing market as he did in the company’s earnings press release in February, the industry could be on a multiyear run.
“This market is being propelled by strong demographics, the substantial imbalance between the tight supply of homes and continued pent-up demand, growing equity in existing homes, migration trends, and the greater appreciation for home,” he said then. “We believe these long-term tailwinds will continue to support demand for new homes well into the future. With our significant and well-located land holdings and our unique niche in the luxury market, we are well positioned for continued growth.”
Write to Andrew Bary at andrew.bary@barrons.com
CCS, MHO
