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Overview

The U.S. housing market has created quite a bit of news throughout 2012 and thus far in 2013. Its continuing uptrend over this time period, along with recent macro data, suggests that publicly listed housing stocks are back on track. The below graph displays the share price growth of some of the major players in this industry; specifically, Meritage Homes (MTH), DF Horton (DHI), Lennar (LEN) and Pulte Homes (PHM).

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We'll take a look at Meritage Home Corporation as an example of being one among the numerous players that have scooped up profits for last 5 continuous quarters. Since its incorporation in 1988, Meritage has managed to acquire a market cap of just under $2 billion by designing and building single-family homes across the Southwest, West and Southern U.S - all growth regions. With the economy looking better, single family homes are, and will continue to be, preferred in the housing sector run. The current share price correction of Meritage, along with the industry as a whole, has largely been attributed to a slightly more pessimistic market sentiments and risk averse investors. However, Meritage Homes Corporation reported better than expected earnings in its 2nd quarter results declared on July 24th which saw home closing revenue jump 55% year over year. The average sale price rose 23% to $350,000, the highest in the last 8 years. Company management has hinted at better than expected earnings for the coming Q3 results to be announced on 21-Oct-13.

Continuing with our example of Meritage Homes, a quick look at the financials reveals that gross margin grew to 21.5% from 18.5% in the second quarter (versus a year ago) due to both home price appreciation and the cutting of costs, and 2013 expected earnings growth of 117%.

(click to enlarge)

Analyst recommendations (collected by Yahoo Finance) are expecting Meritage to earn revenue of $504.89 million in Q3, with further growth in Q4 by 6%. Investors that hold Meritage shares through 2014 are expecting continued growth. Estimates are that Meritage will grow by 34% in 2014, compared to 2013. Strong operating and financial results during the first half of 2013 are reflected in both the strengthening balance sheet and improved profitability.

Economy

Throughout the first half of 2013, the positive housing market momentum has continued, largely driven by excellent housing affordability, decreasing levels of home inventory in many markets, increasing consumer confidence levels and an improving economy. The market outlook for the current summer period, as indicated by today's permit numbers, is expected to be phenomenal.

This is confirmed by the recent Case-Shiller Home Price Index data for April, which further suggested bullishness in the housing market. Non-seasonally adjusted data for the 20 city index showed a 10.9% increase in home prices, compared to a prior reading of 9.3%, and a consensus forecast of 10.2%. Clearly, housing still has plenty of room to run so investors may still have time to make a play on homebuilders for solid gains this summer.

The elephant in the room is, obviously, the inevitable end of record low interest rates. We have already seen rates increase distinctly in anticipation. No one is certain when the Fed will make a move. However, it is a certainty that it will reduce home affordability. Historic data have indicated that there may be a burst of home buying prior to a rate hike as purchasers feel the pressure to make a move (as indicated earlier this spring). So, while the outlook is rosy, no one is of the belief that it will continue indefinitely.

Home Builder Initiatives

Some trends can be identified across nearly all the home builders mentioned above; specifically:

  • Acquiring and developing lots in high-performing markets
  • Utilizing enhanced market research to capitalize on the knowledge of buyers' demands in each community, tailoring pricing, product and amenities offered
  • Continued innovation and promotion of energy efficiency programs
  • Adapting sales and marketing efforts to generate additional traffic and successfully compete with resale homes
  • Focusing on purchasing efforts to manage costs as homebuilding recovers and demand rises
  • Growing inventory balances while ensuring sufficient liquidity

Unfortunately, with most home builders focusing on the same set of initiatives, it will be difficult for one particular company to pull away from the pack.

Conclusion

Clearly, expectations are high. The boom in home prices, and demand for housing, suggests that homebuilders could still be a great pick as strong earnings are expected through next year. However, this is not an investment without risk as it is an incredibly volatile market. I'm still of the opinion that the spring correction, followed by more recent declines at companies such as Meritage, created an opportunity for savvy value investors. For those who are afraid they missed out on the run-up in homebuilder stocks, now's your chance to buy in a lower valuations. You may not get another attractive discount for quite some time.

Source: Housing Stocks: More Room For Growth