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The housing market is gradually trying to make a comeback after witnessing the lows during the recent downturn. Although, generally higher mortgage rates, tightening credit availability and a limited supply of land and labor hamper the growth of this industry, including home sales, housing starts and new purchase mortgage applications, the reaction of households has been quite opposite this time. In fact, this has created hype among the households that fear a further increase in the mortgage rates and are opting to buy now.

However, supply is limited due to the low home inventories. A shortage of land and labor is restricting the construction of new housing starts, both for single and multi-family. Thus, home prices have started to move up due to the mismatch in market demand and supply.

This situation provides a favorable growth opportunity for the house construction companies that continue to witness a significant growth in their sales volumes and average selling prices. New home orders, backlogs and homes delivered continue to rise year over year. D.R. Horton (NYSE:DHI) is one of the leading homebuilding companies in the U.S. It constructs and sells homes in the U.S. It also provides mortgage financing and title agency services to home buyers through its financial services segment.

Financial Performance

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The above graph exhibits long-term revenue growth of the company. Over the years, the company has experienced a consistent growth in its revenue at a CAGR of 11.9%, with an exception of 2011. During the fiscal year 2012, demand for new homes improved in most of the markets. The number of Horton's net sales orders increased by 21% compared with the prior year. Revenues from home sales increased by 19% to $4.2 billion in fiscal 2012 compared with $3.5 billion in fiscal 2011. The average selling prices of homes closed increased by 5%. Pre-tax income was $242.9 million in 2012 compared with $12.1 million in the prior year. Sales order backlog stood at $1.7 billion on September 30, 2012, an increase of 61% from last year. These orders provided a healthy basis for a strong start in 2013.

The company's performance in the third quarter of 2013 was way better as compared with the same period last year. Third-quarter home sales revenue increased by 46% to $1.6 billion with 6,464 homes closed compared with $1.1 billion with 4,957 homes closed in the third quarter last year. Average closing price for the quarter was $252,300, an increase of 12% as compared with the prior year due to the larger average home size. The value of its net sales orders increased by 30% compared with the same quarter in the previous year due to a 12% increase in the number of houses sold and a 15% increase in its average selling price to $268,000. The cancellation rate for the third quarter was 24%. The value of its backlog increased by 56% to $2.6 billion with an average sales price per home of $260,700 and the number of homes in backlog increased by 36% to 9,911 homes compared with last year. The increase in its average sales price reflects Horton's ability to continually raise prices due to the shift in its current buyer mix as buyers move up from apartments to single-family homes.

Key Statistics

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Holistically, the key statistics of Horton are depicting it to be a cut above the industry. To begin with, the company's operating margin of 9.7% and net margin of 7.4% are far better than the industry. A strong ROA and ROE elucidates the fact that the company is utilizing its resources with additional efficacy. Moreover, Horton has a lower D/E ratio compared with the industry, which indicates that the company has less financial risk. This could be a positive point for risk-averse investors. Besides its outstanding performance, the key valuation metrics indicate that the company is currently undervalued.

Multiple Based valuation

The above table hints at the undervaluation of the company, but it does not tell you the extent of upside potential. Hence, I have used a multiples-based approach to calculate the expected return of the stock.

The multiples-based valuation reveals quite an optimistic picture of the company. In order to calculate stock price using a multiple approach, I have used the company's trailing 12-month per share Earnings, Book Value and Sales figures. I have ignored the P/CF ratio as currently both the industry and company's cash flows are negative. Moreover, the weight to P/E, P/B and P/S has been assigned on the basis of my assumptions. On the grounds of the given multiples of this industry and Horton, I have derived a target price of $21.66 with an upside potential of 8.55%.

Conclusion

I believe that Horton's business is well-positioned to benefit from the housing recovery due to its strong balance sheet, finished lot position, inventory of available homes and broad geographic operating base. These factors have and will continue to support the company's growth under the current market conditions. The short-term outlook is quite unclear due to the Fed's pending decision regarding the reduction in bond buybacks, which has resulted in an upsurge in mortgage rates. Despite the prevailing uncertain economic environment, the company has bright future prospects. Hence, I give a buy recommendation for this stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: D.R. Horton Bringing Housing Sector's Recovery Effects To Your Portfolio