After Chilly Winter, Homebuilders To Share Earnings With High Hopes Ahead

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Includes: DHI, HD, KBH, LEN, LOW, TOL
by: JJ Kinahan
Summary

Weather might have taken a hammer to the home-building business in Q1.

Lower mortgage rates now seen as possible lift for sector in Q2.

High labor and material costs could continue to provide challenges.

By most accounts, homebuilders didn’t exactly get much hammer time in Q1.

The weather—always a dubious affair for outside framing and brick-laying at any time—wasn’t just unseasonably chilly this winter, it was downright nasty. The polar vortex hit and then created a ripple effect with extreme climate blasts throughout much of the country.

As some homebuilders and home-improvement retailers start to roll out Q1 earnings results, we might see the soft numbers in housing starts and residential building permits over the first months of the year coming home to roost as weak housing market trends persist.

Remember that housing starts tumbled 8.7% in February, and building permits were down 1.6% as well, according to the Commerce Department. On the positive side, new home sales did rise 4.5% in March, but that was with a 9.7% drop in the median price.

Unfortunately, we’re not sure yet how accurate those February housing starts and building permit numbers were. The Commerce Department warned last month that the 35-day government shutdown beginning Dec. 22 could have been a culprit behind soft numbers.

“Delays in data collection for December and January could make it more difficult to determine exact start and completion dates,” the Commerce Department said. That could lead to significant revisions that are yet to be seen, so hold tight.

Warmer weather appears to be just around the corner, and many investors could be looking ahead at the start of the busiest time of the homebuilding, home-improvement and home-buying year. Warm weather, for example, tends to prompt homeowners to start thinking about repairing that fence that the snowplows knocked over, or repainting the house. The question is what home-building and supply industry executives might say about their perspectives on this activity.

The Mortgage Rate Catalyst

If mortgage rates are any indication, looking ahead might be a rosier picture than looking behind, judging from some analysts’ housing market predictions. Mortgage rates bounced up a bit recently after four straight weeks of falling, but 30-year fixed-rate mortgage rates are still a good 25 basis points below where they were a year ago. Lower rates often give potential home buyers a push to step up to the plate.

It might help, too, that it appears the Federal Reserve is in no hurry to get back to the business of upping rates any time soon, according to the minutes from its March meeting. Those minutes appeared to be helping mortgage rates stabilize a bit. Even with concerns surfacing about consumer spending and housing activity slowing, most Fed officials said during the meeting they didn’t see it trickling into Q2.

“A majority of participants expected that the evolution of the economic outlook and risks to the outlook would likely warrant leaving the target range unchanged for the remainder of the year,” according to the minutes.

Add then there’s the Mortgage Bankers Association’s outlook for spring that was recently released. The MBA reported that building applications rose 7% on a year-over-year basis in March, which marked a 19% gain over February.

"With a strong job market, rising wages and lower mortgage rates, housing demand remains strong, as shown by the solid 7% growth in new home purchase applications in March," Mike Fratantoni, MBA’s Chief Economist, said in a statement.

"The confluence of declining mortgage rates with the spring buying season is supporting stronger housing demand and activity,” he added. “Additionally, the drop in average loan size suggests that builders are tilting production to lower-priced homes, which continues to see the tightest inventories and strongest home-price growth."

We need to consider taking a wait-and-see approach on the housing market forecast, and let’s never forget that borrowers and buyers are a rate-sensitive bunch.

Builders' market: After slumping in March as economic concerns grew and word came in of a chilly start to the year, home builder stocks (candlestick) got a wind at their back in April and are now keeping close pace with the S&P 500 Index (purple line). Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Optimism Grows, But Not For Q1

Still, it might be worth noting that analysts like those at CFRA are sounding a little more positive about homebuilders. Rates could be a catalyst for higher demand with improved prospective homebuyer affordability, CFRA recently said in a research note.

That doesn’t help the quarter that was. Revenues for Q1 are expected to show single-digit declines compared with a year ago, CFRA said. And higher land prices, coupled with rising costs of labor and materials, are expected to saw right into gross margins by a range of 50-100 basis points, the research firm predicted.

Some of the biggest home-building companies saw strength in their stocks so far this year (through the end of last week), and that might partly reflect falling rates and the dovish Fed. KB Homes (KBH) has advanced nearly 36%, Lennar (LEN) is up 35%, Toll Brothers (TOL) by 19% and D.R. Horton (DHI) almost 34%. On the home-improvement side of the equation, Home Depot (HD) has gained 19% and Lowe’s (LOW) is tracking higher by 23%.

KB Homes and Lennar may already have set the tone, reporting their latest quarterly earnings late last month. Overall, they were better than the year-ago period, but mostly short of analyst expectations.

“We continued to see choppiness in the marketplace during our first quarter,” Lennar Executive Chairman Stuart Miller said in a statement. “However, during the quarter, mortgage interest rates subsided and ultimately pulled back and home prices moderated providing a catalyst for the new home market to correct itself.”

Earnings Calendar

D.R. Horton said it will release its Q2 earnings on Thursday, April 25, ahead of the market open.

Home Depot expects to release its Q1 earnings before the open on Tuesday, May 21.

Lowe’s said it will report before the open on Wednesday, May 22.

TD Ameritrade commentary for educational purposes only. Member SIPC.

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