The U.S. housing recovery has helped a number of companies reach record highs, with the SPDR S&P Homebuilders ETF (XHB) trading up more than 40% over the past 52 weeks. With the Federal Reserve's threat of higher interest rates, these stocks have since moved off of their highs, underperforming the SPDR S&P 500 (SPY) by nearly 10% over the past three months.
But, investors would be ill advised to completely shun the homebuilding sector. Speculative buyers are being pushed out of the market by the prospects of higher interest rates, which will help normalize demand and pricing in the years ahead. With strong pent up demand remaining, the sector will likely stabilize and grow with the economy rather than leading it in the future.
So, where should investors seeking higher risk-adjusted returns turn?
Market Leader, Unique Product
PGT Inc. (PGTI) develops residential impact-resistant windows and doors for hurricane-prone regions of the United States and various international markets. Led by its widely known WinGuard® brand, these heavy-duty aluminum or vinyl frames are equipped with laminated glass to provide protection from hurricane-force winds and other wind-borne debris.
These windows and doors satisfy stringent building codes in U.S. coastal states and provide an alternative to shutters and other "active" forms of hurricane protection that requires installation and removal before and after each storm. Since these products were introduced, not a single one has shattered and caused any damage, according to an investor presentation.
The company's products are sold throughout numerous venues, ranging from its recently announced partnership with PulteGroup Inc. (PHM) to niche window replacement dealers and enclosure contractors. Its largest customer accounts for only 2.7% of net sales, with its top 10 customers accounting for about 17.8% of sales - meaning revenues are very diverse.
Focusing on Patches of Growth
Unlike many homebuilders, PGT targets a relatively small subset of the U.S. market with its impact-resistant windows. Florida accounted for approximately 85% of its revenues in FY2012, while the vast majority of its remaining sales occurred in hurricane-prone regions of the U.S. As a result, investors should look at the state's growth instead of the nation's growth.
Florida's housing market was one of the hardest hit during the recession, but it's now enjoying one of the strongest comebacks during the recovery. In June, the state's governor also signed a new foreclosure bill that could accelerate this recovery by enacting a series of provisions aimed at speeding up the default process in the state and cleaning out the inventory glut.
The state also remains well below its historical averages with strong growth potential:
Figure 1 - Florida Housing Starts (Source: PGTI Investor Presentation)
Figure 1 shows that the growth in Florida's single-family housing starts between 2012 and 2015 is expected to be significantly higher than the U.S. average. Meanwhile, impact-resistant window installations in this market have grown from just 3% of homes in 1999 to 26% of homes in 2007, after a series of hurricanes have helped raise awareness of the product.
Aside from its core Florida market, the company has enormous potential to expand across other hurricane-prone regions, particularly as active storm cycles drive greater awareness. International markets in the Caribbean and other regions represent additional potential areas of growth for the company's impact-resistant windows over the long-term.
Looking at a Fair Valuation
Investors should now be fairly confident that PGT has additional growth potential, after having looked beyond the broad U.S. homebuilding industry. Now, let's address some valuation concerns that may have arisen from a stock that has soared more than 200%, including a 12% move over the past week or so after its positive second quarter earnings.
Indeed, PGT trades with a high valuation by many standards:
PGTI 5Y Average
Figure 2 - Valuation Comparisons (Source: Morningstar)
While it's tempting to quickly draw conclusions based on Figure 2, investors should take a closer look below the surface. The most important thing to consider would be the company's projected growth moving forward, as this could justify its existing multiples and the premiums to the company's 5-year historical multiples, peer multiples, and the S&P 500 comparisons.
According to Yahoo! Finance, the company's 5-year expected price-earnings to growth ratio stands at just 0.59x, which suggests that the stock may actually be undervalued given its expected growth. Meanwhile, the forward price-earnings multiple from the same source clocks in at 23.05x, suggesting that investors are really only paying a little more than the S&P 500's.
Entry Points, Risks & More
PGT's stock price trades at 52-week highs following its favorable second quarter earnings results, which included 35.2% sales growth, reduced long-term debt, and an improved balance sheet. While gross margins declined by about 2%, the drop was due to increased labor costs and scrap resulting from the hiring and training of 274 new employees to cope with rising demand.
As a result, investors may want to wait for a retracement before purchasing the stock, particularly after the post-earnings rise. Investors should also consider some key risks associated with the stock, including its above-average 1.35 beta co-efficient, significant exposure to Florida's homebuilding market, and rising market expectations for its earnings.