D.R. Horton: Undervalued As The Leader Of The Industry

Summary

• The company has performed very well in the last 2 years.
• Minimal weakness seen in fundamentals.
• Economic risks need to be monitored closely if initiating a position.
• Technicals allow for low-risk entry with significant upside potential.

D.R. Horton, Inc. (NYSE:DHI) is the largest homebuilding company in the United States in terms of number of homes closed and revenues. As unemployment continues lower and wages continue higher, U.S. homebuilder sentiment sits near 18-year highs. After shares gained about 82% in 2017, despite the company still performing well fundamentally, they are down 15.5% YTD and are now testing the 200-day moving average. This gives investors a low-risk opportunity to buy off of support should the momentum of price action correct itself.

Performance

With the housing market remaining on cruise control, DHI is showing steady revenue growth YoY. The company finished 2017 with $14.09B, a 15.9% increase, which is slightly lower than the increase in 2016 of 16.12%. They seem to have kept this pace coming into 2018 by posting a Q1 increase of 14.75% from the same quarter in 2017. The rest of the year looks promising as well as 2018 FYE estimates are currently $16.20B, a 15% increase.

The company has started 2018 strong across the rest of the board as well. Gross profits came in 16.10% higher than expected at $752.6M, an 18.28% increase YoY. They also dominated their net income estimates, beating by 45.36% and their EPS estimates by 56.85%. They came in at $298M and $0.77 per share consecutively, which are YoY increases of 44.03% and 40%.

Strengths and weaknesses

The company has posted strong numbers throughout 2017 and 2018 is also shaping up to be more of the same. As I stated earlier, homebuilder sentiment is near 18-year highs and this is reflected in DHI's revenue. Strong top-line growth and consistent estimate beats are some of many strong points going for this company. By improving on most of the other key metrics as well, DHI is all around, a fundamentally sound business.

But the company isn't without their flaws. Despite consistent growth, the company's gross profit and gross profit margin are showing signs of slowing. In 2017, the company grew gross profits by 14.82%, which is slower than the 27.89% posted in 2016 and the 24.63% posted in 2015. Margins were also lower as they actually decreased YoY by -0.47% in 2017, compared to the 2.27% growth in 2016. Gross profit margins are expected to continue shrinking as estimates for 2018 are -0.46%.

Possibilities and risks

The main risk to homebuilders is the fact that their business is cyclical and heavily affected by the economic conditions of the country. Any negative changes in employment levels, consumer confidence, housing starts, homebuilder confidence, credit availability, etc. could have a significant impact on the profitability of DHI. Although I don't believe we will see any negative impacts anytime soon, it is something that needs to be monitored if pulling the trigger on this company.

Keep in mind that economic conditions are not the only risk factor when dealing with homebuilders. Natural disasters also pose a significant threat to profitability and should be watched closely.

Looking forward

Despite the risks mentioned, the positives that DHI delivers to shareholders outweigh any cons. Analysts tend to agree. Of the 22 covering the stock, 100% of them are positive with 10 ranking it a Hold, 7 have a Buy rating, and 5 have a Strong Buy for DHI. The average price target among them is $56.55, which leaves an attractive 30% upside to the current share price of $43.45.

(Source: Thomson Reuters Eikon)

I agree with analysts as my price target for the company is $56. Shares are trading at a P/E of 14.6 and a forward P/E of 11.0. Compared to the industry average of 17.7, they are undervalued, especially for a company that is the leader in one of the hottest industries in the market right now. Factor in the fact that the company has a PEG ratio of only 0.76 and there is clearly a lot of upside potential here.

Technicals

Towards the end of 2017, share prices got extremely extended off the key moving averages. But since the start of 2018, prices have pulled back quite a bit and seem to have found support at the key 200-day moving average. With the company being so fundamentally sound, the drop in share price is mostly attributed to the political uncertainty that has wreaked havoc on the market this year. I'll be watching the technicals very closely in the coming weeks for a sign that momentum has turned and shares are ready to make new highs.

(Source: ThinkorSwim/TD Ameritrade)

The key levels I'm watching are the 200-day moving average for support and the $46-46.50 area for resistance. A break of these levels in either direction will signify the direction of the near-term momentum.

Summary

DHI is a company that has performed outstandingly well as the leader of the homebuilder industry. The company leads their industry and is simultaneously undervalued. The positives outweigh the negatives and I expect the growth trend to continue for at least the next 12 months or until the economic conditions start to show weakness. But as of now, DHI seems to be a solid choice for anyone looking to add a homebuilder to their portfolios.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DHI over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.