Homebuilder ETFs Pricing In A Housing Rebound After Harsh Winter

|
Includes: DHI, FSHOX, ITB, SPY, XHB
by: Michael Passante

Summary

iShares U.S. Home Construction ETF (ITB) surged 11% this year through April 2, beating the SPDR S&P 500 ETF's (SPY) 1% return.

The major indexes surpassed their pre-recession peaks two years ago while homebuilder ETFs have yet to revisit their former highs, suggesting they have catching up to do.

Considering that home building was weak during the winter but their share prices have been outperforming, leads me to conclude that homebuilder ETFs are pricing in a comeback.

Housing supplies are tight and the rate of new orders should rise unless there’s an outsized hike in mortgage rates.

Homebuilder ETFs climbed to the top of the leaderboard in 2015 after underperforming most of the stock market last year. Their rebound is built on a foundation of low-interest rates, strong job growth driving consumer confidence and household formation, and pent-up demand from an extremely harsh winter. All of the while, the dive in oil prices has put extra money in consumers' pocketbooks and wage growth has been accelerating. The current savings rate of 5.7% is the highest rate since March 2012. Home price gains have been moderate and lending conditions are easier. All this means improvement in homebuilders should persist as we go into the April-to-August selling season, the busiest months for housing.

iShares U.S. Home Construction ETF (BATS:ITB) surged 11% this year through April 2, beating the SPDR S&P 500 ETF's (NYSEARCA:SPY) 1% return. ITB rebounded from a lackluster 2014, when it gained only 5% while the benchmark increased 14%. SPDR Homebuilders ETF (NYSEARCA:XHB) climbed 9% year-to-date after adding only 3% in 2014. The major indexes surpassed their pre-recession peaks two years ago while homebuilder ETFs have yet to revisit their former highs, suggesting they have catching up to do.

U.S. housing starts plunged 17% month on month in February to a seasonally-adjusted annual rate of 897,000 homes, in part because of snowstorms across the Northeast. Considering that homebuilding was weak during the winter, but their share prices have been outperforming, leads me to conclude that homebuilder ETFs are pricing in a comeback in the near future.

Improvements For Homebuilders

The homebuilding industry saw deliveries of new homes in calendar year 2014 climb 9% to 119,741 homes, from 109,659 homes the year before, according to S&P Capital IQ. In 2013, new home deliveries soared 24%, the heftiest growth rate since the crash of 2007-2009. For calendar year 2015, S&P Capital IQ forecasts more moderate unit growth of 6.3% to 127,300 homes.

Attractive property lots for future development are increasingly scarce, and homebuilders who have locked up several years supply of land, will be in a good position to develop communities and deliver homes," Erik Oja, a homebuilder analyst at S&P Capital IQ wrote in an equity report March 25. "Most publicly traded builders are in a stable competitive position after cutting costs, retiring debt and growing cash positions."

The largest U.S. homebuilder by market value, D.R. Horton (NYSE:DHI), raised the number of new homes delivered nearly 19% to 28,670 homes in fiscal year 2014. The average selling price climbed 11% while revenues vaulted 32%. Average selling prices rose 7% year over year in Q1 for FY 2015. New homes delivered increased 29% to 7,973 as revenue soared 37%.

S&P Capital IQ analysts project home deliveries to rise 14% in fiscal year 2015, to 32,675 homes as prices rise 3% and revenues spike 17%. S&P forecasts a 7% increase in homes delivered in fiscal year 2016 to 35,000 units with a 3% price improvement and 10% jump in revenue.

"Homebuilder industry revenues should grow by 12%-13% in the next two years, supported by both price hikes and higher unit sales volume," Todd Rosenbluth, director of ETF and mutual fund research at S&P Capital IQ Global Markets Intelligence, wrote in a report Jan. 29. "Meanwhile, home furnishing revenues should benefit from sustained economic growth and potentially new retail store openings, following peer-group consolidation, while home appliance shipments should increase at low to mid-single digit growth rates."

In January 2015, the S&P/Case-Shiller U.S. National Home Price Index logged a 4.5% year-over-year gain after a 4.6% uptick in December 2014. However, on a month-to-month basis, the index dropped for five months in a row, dipping 0.1% in January amid a frigid winter.

Multi-family housing starts have nearly bounced back to 2007 levels and are running at 97% of prerecession highs. But single-family housing starts are at just a third of the way to their former peak. Housing supplies are tight and the rate of new orders should rise unless there's an outsized hike in mortgage rates. There was 4.6 months of supply of homes for sale on the market as of February - about the same as January. That's considerably short of the six months of supply that's seen as a healthy balance between demand and supply.

Investing Risks

Homebuilder stock shares are extremely volatile. Homebuilding companies have very thin gross margins. Higher-than-expected rises in labor and materials, reluctance of banks to loan money and rising interest rates would decrease affordability, particularly for first-time buyers. And unfortunately, home prices are rising faster than wages.

Homebuilder ETFs and Mutual Funds

The homebuilding industry is very fragmented and has very low barriers to entry. According to Morningstar, the five largest homebuilders in the U.S. by revenue made up only 18% of the market in 2013. I suggest investing in homebuilders via iShares US Home Construction, SPDR Homebuilders ETF or Fidelity Select Construction & Housing Portfolio (MUTF:FSHOX), which is up 9% year to date. iShares US Home Construction overlaps XHB considerably with 37 names. The major difference between them is that ITB is market-cap weighted while XHB is equal weighted. XHB has greater exposure to home-improvement and home-furnishing retailers than ITB. XHB is a 35-stock portfolio with home-improvement and home-furnishing retailers, homebuilders and building-materials producers.

UBS launched in March some pure plays on the industry with ETRACS ISE Exclusively Homebuilders ETN (NYSEARCA:HOMX) and ETRACS Monthly Reset 2x Leveraged ISE Exclusively Homebuilders ETN (NYSEARCA:HOML). But because they're so new, they're thinly traded. I recommend seeing how they trade for a while before buying them.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in ITB, XHB, DHI over the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.