With mortgage rates hovering around record lows, housing starts rallying to four-year highs, an increase in residential construction spending, and augmenting home prices, we feel that the housing sector has gained traction and is one of the rare bright spots in the gloomy U.S. economy. Goldman Sachs (GS) is also expecting a strong recovery in the housing sector, further corroborating our bullish thesis on homebuilders. Like GS, we continue to recommend KB Homes (KBH) and Toll Brothers (TOL) as potential candidates for taking long positions in. While GS is neutral on Lennar Corp (LEN) and DR Horton (DHI), we are also bullish on these stocks because of an increase in their number of new orders and quarterly backlogs, coupled with a decrease in their order cancellation rates.
LEN's new orders and quarterly backlogs have shown a year-over-year appreciation of 40% and 61% respectively, and a quarter-over-quarter decrease in order cancellation rate of 2%. Likewise, DHI's new orders and quarterly backlogs have increased by 19% and 17% respectively, while its cancellation rate dropped by 4%. DHI will report its 3Q earnings on Friday, July 27.
Increase in # of new orders (% YoY)
Increase in Quarterly backlogs (% YoY)
Decrease in order Cancellation rate (% QoQ)
In a client note yesterday, GS upgraded its view on the housing sector from Neutral to Attractive, as a result of its "Housing's Long List of Positives." The key components of that list were:
- Home price appreciation - In 2Q2012, home prices increased (by 0.2%) for the first time since 2007, on a YoY basis. GS analysts attributed this increase as the main driving force behind the "20%-30% growth CAGR forecast in new home sales and housing starts over the next four years."
- Even without additional growth in jobs, the analysts forecasted a "50% growth in new home sales."
- Declining shadow supply and low inventory - Shadow inventory i.e. "homes projected to hit the market through foreclosures and short sales," have declined by 15% in five important new home markets (Arizona, Florida, Texas, Nevada, and California). In addition, the median age of inventory listed for sale dropped by 10% relative to the previous year, implying that it takes relatively less time for a seller to find a buyer. The analysts wrote, "We expect any further decline in inventory as a platform for price appreciation, further aiding sales."
- Supportive housing policies - Focus on supply instead of demand, as according to GS analysts, has resulted in an improvement in government policies, which is expected to continue in future.
- Increasing market shares of Public U.S. Homebuilders.
The analysts added MDC Holdings Inc. (MDC) to Goldman Sachs' "Conviction Buy List," upgraded KB Homes and Ryland Group Inc. (RYL) from neutral to buy and from sell to neutral respectively, and demoted NVR Inc. (NVR) from neutral to sell. Toll Brothers and Pulte Group Inc. (PHM) remained a buy, while the firm was neutral on all other homebuilders.
The following table summarizes some important valuation ratios for four of these homebuilders: LEN, TOL, DHI, and KBH.
Forward P/E (1 year)
PEG Ratio (5 year expected)
Price / Book (MRQ)