Homebuilders Continue To Confound The Bears

by: John Gilluly

Yesterday the market rewarded D. R. Horton (NYSE:DHI) with a nice 10% rise after its Q4 earnings:

  • Net income increased 86% to $123.2 million
  • Diluted EPS increased 80% to $0.36 per share
  • Pre-tax income increased 76% to $189.7 million
  • Pre-tax income margin increased 290 basis points to 11.4% of revenues
  • Home sales gross margin increased 350 basis points to 22.3%
  • Net sales orders increased 14% in value to $1.5 billion and 4% in homes to 5,454
  • Homes closed increased 33% in value to $1.6 billion and 19% in homes to 6,188
  • Sales order backlog increased 20% in value to $2.1 billion and 5% in homes to 7,684

But at the same time, I'd have to go back to early 2012 to read the kind of bearish sentiment that's come across the wires recently, (January 2014): The Housing Slowdown Has Already Begun; New Home Sales Freeze Up; The Housing Bear Market is Back; An Early Real Estate Warning Signal May Have Just Sounded; Real Estate 2014 - the Stealth Bubble.

Somebody should probably tell the companies building and selling new homes just how BAD it is out there. Maybe they don't know (yet)? Or maybe they'd be amused. What if the financial writers threw a bear market party and nobody came?

Meanwhile the builders will keep building (and selling, by the way) in land-constrained geographies where employment is improving and the ratio of starts to jobs is underserved. And the Fed's tapering this year will probably cap the top end of mortgage interest rates at about 4.5%.

Why is this so hard to see? Is sentiment from the past skewing the bears' facts in the present?

A homebuilder builds homes where it can make a profit. It does not build homes where it cannot make a profit. Why would a company build homes where and when it could not make a profit, and thus lose money?

Maybe that made "sense" during the bubble days of 2005-2006, when a mortgage broker could walk up to you on the street and say, "Hey dude, want to buy a $300K home? I got money to burn." But it doesn't make sense in today's credit-constrained environment. No one in the industry is doing that kind of thing now. No one.

The bears would have you believe that they are one-step-ahead of the publicly-traded builders who have unlimited access to capital, and who can pay the best researchers in the business to data-crunch their business.

I don't think so.

In 2014, the homebuilders will:

  • Sell every home they could possibly build;
  • At moderately higher selling prices;
  • On rising volumes;
  • With margins stabilizing around 20%;
  • And demand remaining constant throughout the year

What will this continued profitability do for the share prices of the housing stocks this year? That's an unknown. We may have another long year of consolidation, we may not.

But the price to book value (P/B) of homebuilders will continue to compress toward 1.5 as their land values, community count and back-log of homes rise.

I fully expect the builders with the most leverage (land under control and developed lots) to lead the pack this Spring. DHI's earnings announcement yesterday is just the first shot across the bow.

Which builders do I recommend? DR Horton (DHI), Brookfield Residential (NYSE:BRP), Pulte Homes (NYSE:PHM), Toll Brothers (NYSE:TOL), Meritage (NYSE:MTH), Tri-Pointe (NYSE:TPH), Lennar (NYSE:LEN), KB Homes (NYSE:KBH) and Standard Pacific (SPF). As an aside, these are also dominant CA builders.

Finally, Brookfield will be reporting its Q4 and full-year results on Wednesday, February 12th. Q4 has always been the company's biggest quarter of the year. At yesterday's lows, Brookfield shares were down 15% YTD, but it was one of the top performers of 2013 (+38%).

Brookfield is somewhat of a special situation, and it occupies a unique niche in the land-development market. The company has $5B in largely unrecognized legacy land assets (109,000 lots) which it judiciously sells-through annually to other builders at 29% margins.

When I first began listening in on their conference calls two years ago, there was not a single housing analyst in the States who covered them. Today they are followed by Credit Suisse, Wells Fargo and RBC.

Disclosure: I am long BRP, NLY, WMC. 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.