The housing prices in US are experiencing a strong upward trend. As expected, a number of viewpoints have emerged regarding the source and impacts of this increase in housing prices over the last year. According to yesterday's reports on Case-Shiller index, the home prices in the US have experienced the strongest upward surge since FY06. The report posted a 10.9% increase in home prices in March on YoY basis. A few analysts have suggested that this increase in prices has not occurred because of an increase in demand for housing but because of increase in investing activity in the housing industry. It is a fact that a number of institutional investors have shown signs of increasing their exposure to the housing market in expectation of further improvement. However, when we consider the report in a holistic economic perspective, the proponents of increased housing activity from actual consumers make a stronger case. The consumer confidence is growing strong through an increase in disposable income and spending trends. The overall economic activity is showing signs of recovery through these changes in the behavior of US consumers. The housing companies, which have been subject to a very slow performance in the three years following the crisis, are expected to benefit the most from this surge in prices. In this situation, we are considering D.R. Horton Inc. (NYSE:DHI) as a prospective investment in the industry. The company is among the larger players in the industry with a market capitalization of $8.3 billion and net sales revenue of $5.2 billion in FY12.
The stock price for D.R. Horton remained fairly stagnated before initiating an upswing in early October of FY11. The upward trend has persisted since then and the increase in housing prices suggests that it is far from over.
The above chart shows the stock price of D.R. Horton and the Case-Shiller Home Price Index (Composite 20) since the beginning of FY12. The chart shows that the home price index and the stock price of the company are strongly correlated and both have shown a substantial improvement over the reference period. At the same time, in comparison with the company's competitors, its stock price has not shown a substantial gain.
The above chart shows the change in stock prices of D.R. Horton as compared with its peers which include KB Home (NYSE:KBH), Lennar Corp. (NYSE:LEN) and Pulte Group Inc. (NYSE:PHM). The chart clearly represents that over this period the company's stock price has increased by 97.9% whereas other similar stocks have managed to post an increase of more than 200% over this period.
Growth and Financial Stability
In the past few years, the company has been subject to strong deterioration in terms of its growth prospects due to the adverse impacts of the crisis. The housing industry as a whole went through a difficult period and has to suffer tough consequences before looking at a hopeful future outlook. In FY12, the situation started to change. This reversal of expectations with the regards to the company and the overall industry is clearly visible in the financial performance of the company.
Data Source: Morningstar
The above chart shows the total assets of the company over the last five years. The assets demonstrate a consistent deterioration over the period of four years since FY08 but in FY12, a strong recovery has occurred. Going forward, we should expect the recovery to continue as the growth prospects of the housing industry will begin to take momentum.
The above charts show the EPS of the company and its debt to equity proportion as compared to its peers since FY10. In the upper portion of the chart, we see that the company has shown stronger per share earnings but these results have not been fully reflected in the stock price of the company as compared to other similar companies. At the same time, the second part of the chart shows that the company's financial risk is limited and much more manageable than its competitors. Out of these four companies, D.R. Horton is the only one with most of its capital based on equity whereas all the other three companies have their capital structure highly levered.
Keeping in view the financial performance and the stock performance of these companies, I suspect that the company will be undervalued as compared to its peers providing a substantial upside potential to investors.
Data Source: Morningstar
The above table shows some key valuation metrics for the four companies, their average and the industry average. The table shows that the industry as a whole is not a high dividend paying industry. More importantly, the table shows that the D.R. Horton is undervalued across all most valuation indicators which allows for a sizable upside potential for the investors.
The housing prices are improving and it is my perspective that the upward surge in prices will continue. Given D.R. Horton's financial performance as compared to its competitors, the company is strategically well positioned to benefit from this improvement in industry outlook. Also, the undervaluation of the stock provides an upside potential to investors; therefore, my recommendation for the stock is 'buy'.