Homebuilding has arguably been the worst hit industry of the Great Recession. New home sales fell from over 1,000,000 per year at the height of the housing bubble to approximately 300,000 in 2011. This equates to an over 70% drop in the industry's annualized volume. Add to this drop a fall in the median selling price, and the collapse in the share prices of the large publicly traded homebuilders is understandable. For equity investors looking past this calamitous change there is potentially a generational opportunity to buy into an essential industry of the United States economy. The most intriguing of the homebuilders are Toll Brothers (NYSE:TOL), Pulte (NYSE:PHM), Lennar (NYSE:LEN) and KB Homes (NYSE:KBH).
Toll Brothers is a homebuilder that focuses on the luxury segment of homebuilding. This segment historically has allowed Toll Brothers to post stronger margins than its competitors with pre-2007 gross margins in excess of 25%. Like all homebuilders, Toll Brothers has suffered from the lack of demand for new houses since 2006; however the company's conservative credit culture has allowed the company to maintain a relatively strong balance sheet with approximately $1.65 billion in funded debt supported by over $1.1 billion in cash. The recent increase in share price from under $20 per share three months ago to over $23 recently has reduced the buying opportunity, but long term investors should take any pull back in price as an opportunity to buy. Toll Brothers may offer good value to long term investors at a market to book below 1.30x, which equates to a share price of $20.
Pulte is a national homebuilder that runs three of the best known brands in the industry: Del Webb, Centex, and Pulte. Its stock price has fallen from over $30 a share in 2007 to near $9 recently. The drop in share price has been recently muted due to a rapid rise in price since the autumn of 2011 when the price was near $4 a share. The rise was due primarily to investors believing that new home sales had finally bottomed out. The evidence has turned slightly more bullish with the latest Census Bureau estimate showing new home sales essentially unchanged in 2011 from 2010 at approximately 300,000 homes. Investors should continue to be wary as home prices continue to fall and any increase in interest rate likely reducing buyer demand. Assuming forward earnings of $1.50 and a price to earnings ratio of 6 times the fair value, Pulte is $9 a share. Currently, the stock is trading near there and the equity appears to be near fully valued by the market. Without a significant pull back in share price, investors should avoid purchasing the stock.
Lennar is a homebuilder with a focus on first time buyers. The company currently sells new homes in 14 states. The company has seen its backlog of orders fall from over 15,000 homes in the mid-2000s to approximately 2,100 per its latest 10-K filing. The latest backlog estimate is still over 35% higher than the 2010 estimate. 2011 earnings per share were .48 versus .51 for 2010. The last two years of positive earnings stands in contrast to much of the industry that continues to endure losses. Lennar's share price has responded by rallying from near $14 a share in October 2011 to recently over $22 a share. Forward price to earnings is approximately 19x, which appears to be fairly rich compared to historical valuation levels closer to 10x. Lennar's performance has been impressive given the unprecedented volume declines faced by the industry; however its share price does not appear to be an attractive purchase at these levels. Investors should continue to monitor the stock and look for buying opportunities on any pullback that brings forward earnings closer to historical averages.
KB Homes builds homes for first time buyers. This focus has allowed KB Homes to become very customer oriented within its niche market. Unfortunately, this strong marketing prowess has been undercut by weak financial discipline. KB Homes had approximately $1.9 billion of outstanding debt at 2011 year-end. Using an average price of a 70 cent on the dollar valuation for outstanding debt, the current debt to the market value of equity is close to 1.44. This high level of leverage has characteristically impacted stock performance with the share price falling from near $50 in 2007 to below $6 in 2011. KB Homes will be highly dependent on the capital markets' willingness to refinance debt as maturities come due. The company is proactively working to manage this potential risk, but a dilutive equity raise cannot be excluded from likely solutions. On a positive note, operating performance has been improving with the backlog in units continuing to increase. The 2011 final backlog in units ended at the highest level since 2008. KB Homes likely has the greatest potential for equity appreciation, but also the highest degree of risk. Equity investors should steer clear of this stock unless they are willing to take a long-term view. Additionally, the recent run-up in share price has eroded the margin of safety and investors may want to wait until prices have returned to below $9 a share before considering a purchase.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.