Why Are JPMorgan And Qineqt Bullish On Homebuilders?

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 |  Includes: BZH, DHI, ITB, JPM, KBH, LEN, PHM, RYL, TOL, XHB
by: Bidness Etc

JPMorgan's (NYSE:JPM) recent note on homebuilding substantiated our previous bullish thesis on this sector. Like JPM, Lennar Corp. (NYSE:LEN), K.B. Home (NYSE:KBH), and Pulte Group, Inc. (NYSE:PHM) are our favorite picks in this sector. D.R. Horton (NYSE:DHI) can also be a potential buy, although it is currently trading at relatively expensive valuations, with its forward P/E ratio of 20x. Toll Brothers (NYSE:TOL) has also satisfied all our filters, as it has shown an increase in the number of new orders and quarterly backlogs, while its order cancellation rate has also declined. However, its forward P/E ratio of 32x is very high, and it is currently trading close to its 52-week high. We also recommend taking short positions in homebuilders ETFs, SPDR Homebuilders ETF (NYSEARCA:XHB) and iShares Dow Jones US Home Construction Index (NYSEARCA:ITB) so as to complete our portfolio and hedge our long positions.

JPM is expecting the industry's fundamentals to improve consistently for at least the next 18 months due to the "favorable demand/supply dynamics," "expected continued strengthening of the apartment market," and reasonable valuations. It has upgraded PulteGroup, Inc. , K.B. Home , and Beazer Homes USA Inc. (NYSE:BZH) to its 'Overweight' category, which already comprised of Lennar Corp. and Ryland Group Inc. (NYSE:RYL). Toll Brothers (TOL) has been downgraded to 'Underweight' because of its expensive valuations.

The primary reason for JPM being so bullish about homebuilders is the fact that it sees sustainable, in fact improving, demand over the next 12-18 months as a result of improving household formations, which is the primary demand driver for housing starts. In its viewpoint, "recent inconsistency of job growth" is not an impediment in homebuilding's continued progress, as historically speaking, "A rebound in housing starts has occurred 1-2 years ahead of a rebound in job growth."

JPM feels that the tightening of supply is expected to act as a "solid protection against a downside risk in the housing market in the event that demand slows or the macro-economy falters in the near term." The company also sees that in addition to single-family homes, the apartment market is also going to benefit from an increase in household formations and tighter supply, which will decrease vacancy rates and increase rents; thereby reducing costs to own versus rent ratios and further bolster home prices.

As a result of this positive commentary, homebuilders ETFs have surged to new 52-week highs. XHB and ITB are two of the best-performing ETFs this year, as they rallied by almost 31% and 46% respectively, as is evident from the following graph.

Click to enlarge

Source: Google Finance

The following table shows the trends in the most important key dimensions we look at when choosing among various homebuilders:

PHM

KBH

BZH

LEN

RYL

DHI

TOL

Increase in Quarterly Backlogs (% YoY)

31%

22%

39.50%

61%

47%

31%

37%

Increase in Number of New Orders (% YoY)

32%

3%

29%

40%

41.6%

25%

47%

Decrease in order cancellation rate (% QoQ)

1%

10%

-2.5%

2%

-2%

-1%

3.8%

Click to enlarge

Except BZH, RYL, and DHI, all other homebuilders have shown a QoQ decrease in cancellation rates, which is a healthy sign for the housing sector. In addition, quarterly backlogs and new orders have been on the incline for all these homebuilders. The following table shows the important multiples to look at from a valuation's perspective:

PHM

KBH

BZH

LEN

RYL

DHI

TOL

Forward P/E (1 year)

14.08x

214.8x

N/A

22.49x

15.32x

20.54x

31.75x

Price/Book (MRQ)

1.69x

2.24x

1.58x

1.88x

2.49x

1.69x

1.96x

Dividend Yield

N/A

1.1%

N/A

0.5%

0.5%

0.9%

N/A

Click to enlarge

The following graph shows the YTD appreciation in each of these stocks:

Click to enlarge

Source: Google Finance

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.