With home prices substantially down from were they were more than half a decade ago and interest rates remaining low, consumers are starting to increase demand for housing. Strong secular trends in the market will drive appreciation for producers like Lennar (LEN), KB Home (KBH), M/I Homes (MHO), and Comstock Homebuilding (CHCI). Based on my review of the fundamentals and multiples analysis, I find favorable risk/reward. These value plays are only further magnified by the prospects of an inflection point from a housing recovery.
From a multiples perspective, Lennar and KB Home trade trade at a respective 17.4x and 29.3x forward earnings. The much smaller Comstock, however, trades at only 16.7x past earnings! As informational flow improves for Comstock, investors are poised to benefit from the discount being closed. M/I Homes has showcased its own strengths recently, gaining more than 26% for the year to date and 72.5% over the last six months. As Lennar and KB Home appreciate, it will naturally lift these smaller producers even more.
To elaborate on this point, consider the optimistic outlook for 2012 that Lennar's management recently expressed:
So 2 days ago on CNBC, Jamie Dimon of JPMorgan highlighted that he believed that housing was at or nearing the bottom of this downturn, and I believe he's correct. I previewed in our third quarter conference call 3 months ago that we were beginning to see evidence of a genuine turn in residential and the residential housing market, and that this could be a harbinger of market stability. Last quarter, I was not ready to conclude that a real trend had been identified. This quarter, I'm feeling somewhat more confident that the market is, in fact, changing.
As I noted earlier, we have just completed our 2-day review of all of operating divisions across the country. We've looked back at our 2011 results, and we've looked ahead to 2012 expectations. The consistent message is that the general environment is different this year than it has been in the past. There are discernible fundamental shifts appearing in the home market, and there are empirical compliments that are to date confirmatory that the market is showing signs of stability.
Lennar is the third biggest domestic home builder and I anticipate that it will more than double the homes sold to around 25K in 2014 - this being only half that achieved at the 2005 peak. Management has done a terrific job slashing building costs by one-third to $40 per square foot. With operations in just 14 states and comfortable financial shape, Lennar also has strong room for domestic, let alone international, expansion. The company also maintains a distressed real estate investment business, Rialto. Investors should recall that the last business of this kind that Lennar operated was eventually acquired for $4.2B in 2005 after being spun off.
Consensus estimates for Lennar's EPS forecast that it will grow by 60.4% to $0.77 in 2012 and then by 70.1% and 41.2% in the following two years. Assuming a multiple of 20x and a conservative 2013 EPS of $1.29, the rough intrinsic value o the stock is $25.80, implying 15.3% upside.
KB Home has made progress in its own rights. The company's liquidity, especially in light of litigation, was previously a major headwind to value creation. Having exited 2011 with $480M in cash - even after making a payment more than half that amount to resolve the South Edge Complaint - and issued $350M worth of debt financing, the company has improved its capital position. As we advance into the spring season inflection point, KB Home is carrying forward momentum from a backlog y-o-y gain of 74%. As selling prices improve while SG&A is trimmed, KB Home is further well positioned to improve margins.
Consensus estimates for KB Home's EPS forecast that it will improve to -$0.35 in 2012, turn positive at $0.38 in 2013, and then soar to $1.07 thereafter.
Disclosure: We have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. We seek IR business from all of the firms in our coverage, but research covered in this note is independent and prospectively commissioned. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence. Always discuss investments with a licensed professional before making any financial decision. Statements made within this report may include “forward-looking statements” as stipulated under Section 27A of the Securities Act of 1933, Section 21E of the Securities Act of 1934, and the Private Securities Litigation Reform Act of 1995. Since these statements are uncertain, actual results may be materially different from those expected.