Opportunities in the Residential Housing Sector

Includes: DHI, KBH, MTH
by: The Wall Street Transcript

On July 31st, The Wall Street Transcript published a roundtable forum on residential housing. Below are excerpts from two of the analysts' buy recommendations in the space:

STEPHEN EAST, Susquehanna Financial Group

On the larger cap side, we like KB Home (NYSE:KBH). We love how they aggressively switched from land acquisition to share repurchases with their free cash flow. Our guess is that they will repurchase 10%-11% of their shares this year. They have a big equity stake in their France operations. Quite frankly, there has never been this level of discrepancy in valuation between France's equity and KBH's equity here in the US. If they could monetize that, they could acquire another 10% or so of their equity, in addition to their other free cash flow. So you're looking at a story over the next three years where they would (and I am not sure that they would actually do it) legitimately have the opportunity to repurchase 30% of their shares outstanding. I think that gives them a great opportunity to battle this slowdown. They have also expanded away from California geographically. They have a decent presence in Texas. They also have a growing presence in Florida. Even though Florida is rough, they are growing. They've got a budding presence in the DC market, which is not a great market right now, but they are really not impacted by that. They are growing it geographically...having nice geographic diversity helps. In addition, they are also diversifying their price points a bit with their Martha Stewart product and that type of thing. I think that makes sense.

We also like D.R. Horton, and I know that everybody likes D.R. Horton (NYSE:DHI). They are the Wal-Mart of the industry, so to speak, though we'll see if they can truly operate in a tough environment. But if you're going to bet on one or two, I think that this one has to be a part of that bet.

And then on the small cap side, there is Meritage (NYSE:MTH), which is fairly controversial because of their big exposure in Phoenix and in California. But they have had a great ability to grow. I think that they will continue to grow through acquisitions and through greenfield. When it trades at a meaningful discount to the rest of the group, to me that is a story where, if you've got that 18-month plus time horizon, you are going to be very happy from these levels.

ALEX BARRON, Director and Senior Analyst, Housing at JMP Securities

Generally speaking, we are telling people to stay on the sidelines. But for those who do want exposure to the group, we have two buy-rated names at this point: D.R. Horton (DHI) and Meritage (MTH). The primary reason is that the price point that they offer is much lower than that at other companies. So, in an environment where affordability is getting tougher as the days go by, we think that they will be more likely to attract buyers because of the price points that they serve. The other reason is that, historically speaking, these two management teams have the longest track records for performing better, even through downturns.

Horton is almost finishing up their 29th year, and I believe that Meritage is on their 18th year. So if investors want exposure, those are the two names that we would recommend, although generally speaking, we would advise them to wait a little longer.