Homebuilding Recovery? Not Yet

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 |  Includes: BZH, CAA, DHI, KBH, LEN, MDC, MTH, NVR, PHM, RYL, TOL, XHB
by: Consumer Contrarian

The favorable recent uptick in homebuilding stocks – unsupported by key demand drivers – is likely to be short-lived. I think it is best to stay selective in equity purchases, until at least two of the following three events occur:

1) growth in jobs

2) improved consumer confidence

3) stable home prices

Investment Thesis

The relatively modest recent improvement in the labor market, by itself, is insufficient to materially lift home-buying demand and the shares. Wobbly consumer confidence along with falling prices on existing homes, are likely to push back any sustainable rebound in the shares until fall, at the earliest. Favorable near term trends among the builders themselves (e.g., firmer average selling prices, positive order data) could disappoint investors seeking real signs of a rebound.

Labor Markets Slowly Improving

Rising employment is the most important prerequisite for a favorable turn in housing. The housing downturn preceded the employment crisis – uncharacteristically – yet the next upturn demands more robust hiring.

Over the past year, the economy has added more than one million jobs, with year to date gains around 750k positions. Indeed, a more favorable employment trend over the last several months is one of the few bright spots for housing.

Yet in the context of unemployment at elevated levels (9%), rising payrolls alone should only serve to mitigate weaker demand – even from current lows.

Consumer Confidence Soft

Consumer sentiment is bouncing along at low levels. The University of Michigan’s survey rose back above 70 in May (to 74.3), following two months of readings below 70. The Conference Board, meanwhile, showed a reading of 61 in the most recent month, the lowest level since last fall. Confidence, tied to high unemployment and, to a lesser extent high gas prices, will remain a drag on demand.

Mixed Picture For Home Prices

Buying demand (and loan supply) is curtailed by potential further declines in home prices.

Prices on existing homes, which make up more than 90% of today’s market, have fallen 2% to 5% over the past year. According to the National Association of Realtors, existing home sale prices fell 5% in April 2011 from the prior year. Meanwhhile, Case Shiller’s 20 market index, with a median price of $138K in March 2011, had a 3.5% drop from March 2010.

Note that these figures include sales of distressed homes (including foreclosure, short sale, real estate owned by the lender), priced at 20% – 40% discounts versus non-distressed properties. Adjusting for an increase in distressed transactions, to 39% from 33% in the first quarter of 2010, prices still appear to be down by as much as 3%.

Prices for new home contracts and those in backlog, in the March quarter, are higher for about three-quarters of the builders I follow, when compared to this time last year. However, the first-time buyer tax credit that ended April 2010 probably had a dampening effect on prices in the comparison period.

This year, absent the tax credit, most builders have shifted toward the move-up market, and away from first-time buyers. According to Freddie Mac, sales into the move-up market, which also benefits from higher FICO scores, account for half of all sales this spring, versus 36% in the same period last year. This demographic shift should boost this year’s average closing prices by at least 2% to 3%, in my estimation. (Please see table below).

Average Selling Price

11E

10

09

08

07

06

Beazer Homes (NYSE:BZH)

205

215

231

253

287

285

DR Horton (NYSE:DHI)

211

206

213

234

259

274

K Hovnanian (NYSE:HOV)

283

290

289

305

343

329

KB Home (NYSE:KBH)

221

215

207

236

262

278

Lennar (NYSE:LEN)

258

246

247

271

292

300

M.D.C. (NYSE:MDC)

291

284

278

303

338

354

Meritage (NYSE:MTH)

259

254

238

268

304

324

NVR Inc. (NYSE:NVR)

306

297

296

338

373

399

Pulte Homes (NYSE:PHM)

259

259

258

284

322

337

Ryland (NYSE:RYL)

242

242

245

201

235

295

Standard Pacific (SPF)

348

346

313

336

390

380

Toll Brothers (NYSE:TOL)

552

566

592

655

672

692

Average

286

285

284

307

340

354

Click to enlarge

Source: SEC filings and company reports.

Orders for New Homes Could Rise in June Q, But…

Contracts for new home sales – which precede closing by two to three months – could rise in the June quarter. But, any increases would result from a combination of the following:

1) Easy comparisons to Q2 2010 – the first period after the tax credit-fueled surge. (please see table below.)

2) A jump in community counts industry-wide: Ryland and MDC, with 23% and 21% more selling neighborhoods to start the period, illustrate the point.

Unit Orders (Y/Y)

Q111

Q110

Q210

Q310

Q410

Beazer Homes

-27%

49%

-32%

-21%

-24%

DR Horton

-23%

55%

-3%

-21%

-17%

K Hovnanian

8-Jun

-15%

-35%

-10%

-12%

KB Home

-32%

5%

-23%

-39%

-25%

Lennar

-12%

18%

-10%

-15%

-5%

MDC

-24%

38%

4%

-22%

-19%

Meritage

-21%

8%

-22%

-36%

15%

NVR Inc.

-18%

21%

-6%

-5%

-12%

Pulte Homes

-9%

43%

55%

-12%

-19%

Ryland

-17%

-13%

-44%

-37%

-20%

Standard Pacific

-14%

3%

-38%

-39%

-21%

Toll Brothers

7%

41%

-16%

-27%

4%

Average

-17%

19%

-21%

-24%

-13%

Click to enlarge

Source: SEC filings and company reports.

*Pulte's Q110 and Q210 figure includes CTX, acquired 8/09.

There will be a time when all three macro signals flash buy, but that’s at least two or three quarters away. Meantime, in my next report, I highlight three builder stocks most apt to perform in the current environment.

Disclosure: I am long TOL, DHI.