The housing momentum seen in 2012 and in the first half of 2013
has slowed down a bit in the past 3-4 months due to the recent
spike in mortgage rates, rising home prices, tight credit
availability and the political uncertainty in Washington. While
interest rates are rising, they are still below historical levels
and housing is still affordable. In addition, accelerating job
growth and increasing consumer confidence are also boosting demand
for new homes.
Supply, however, is constrained by low home inventories, both of
new single-family and multi-family homes. A shortage of land and
labor is restricting the construction of homes, both single and
multifamily. Home prices have thus started to move up with market
demand gaining momentum and supply remaining limited.
Rising home prices and the spike in interest/mortgage rates since
May this year slowed down the pace of orders and traffic.
Buyers were taken unawares by the sudden increase in rates and a
few put off their purchase decision, thereby increasing
cancellation rates and lowering orders for most homebuilders in the
last reported quarter.
Orders declined around 17% at
), 2% at
D.R. Horton, Inc.
) and around 9% at
Hovnanian Enterprises, Inc.
). Though order trends improved year over year for others like
Toll Brothers, Inc.
), they slowed down from the past quarter.
However, most homebuilders believe that this is only a temporary
factor and are confident of demand picking up in the forthcoming
quarters. These builders expect buyers to adjust to rising prices
and interest rates and return to the market. Also, Federal
Reserve's promise to keep interest rates low for some time despite
tapering its $85 billion stimulus plan by $10 billion from Jan 2014
removes a major overhang for the homebuilders.
A slew of housing data released lately clearly shows that the
housing recovery is still very much intact. Data released by the
U.S. Department of Housing and Urban Development and the U.S.
Census Bureau showed that sales of newly built, single-family homes
rose 25.4% in October. Another data release by the department
showed that November housing starts surged to their highest in
nearly six years.
The National Association of Home Builders (NAHB)/Wells Fargo
Housing Market Index (HMI), known as the homebuilder sentiment
index, jumped 4 points to 58 in December from 54 in July. This was
the seventh consecutive monthly increase in the index showing that
the recent interest rate hikes have not dampened the housing
Land as Native Strength
Homebuilders like Lennar and Toll Brothers who boast of a solid
land position have been able to better capitalize the rising demand
for homes during the upturn. This gives these companies a
competitive edge over peers like Pulte which are facing land
During the downturn, Lennar strategically focused on acquiring new
home sites in well-positioned markets. The company thus has enough
land now to satisfy deliveries through 2014 and is now pursuing
land opportunities for 2015 and beyond.
However, others like Pulte have intentionally slowed down the sales
pace across some of their communities (thus lowering the community
count) due to a lack of land development and scarcity of finished
lots. Housing inventory, both existing and new homes, remains tight
in most markets. Instead, Pulte is focusing more on driving price
and margin in most communities. This strategy has hurt net order
growth significantly year to date, with orders declining 12% in the
second and almost 17% in the third.
) is also emphasizing more on price and margin improvement to
optimize returns from its land assets and slowing down its sales
pace leading to lower order growth. Though the price optimization
initiatives of Pulte and KB Home have boosted profits so far, the
companies need to increase their volumes to boost long-term top
Some homebuilders are speeding up their land investments. Ryland
Group has spent $498 million on land acquisition and $184 million
on site development in the first nine months of 2013. Texas-based
D.R. invested $2.6 billion in land, lots and development in 2013
and seems well positioned to meet demand for fiscal 2014 and 2015.
High-End Homes Driving Prices
Most homebuilders like Lennar, KB Home and Toll Brothers have
shifted their focus on high-end communities, primarily of
California, Arizona, Colorado and Florida, which allow them to sell
larger, higher-priced homes, driving the ASPs up.
Homebuilders like KB Home also target the higher income, move-up
buyers who are more likely to qualify for home loans. Pulte is
shifting its focus towards its high-priced Pulte-branded, move-up
homes, which improve the overall ASP.
Another small homebuilder,
Meritage Homes Corporation
), is also seeing improving selling prices from a mix shift towards
move-up homes in higher priced communities and states. Luxury
home-builder Toll Brothers is focused on improving the quality and
the luxury quotient of its homes, thus giving it a competitive
Strategic Restructuring & Cost Saving
Improving homebuilding revenues combined with tight cost control
and better overhead leverage (as volumes improve) continue to boost
margins for most homebuilders.
Most housing companies are striving to improve their operating and
financial performance through strategic restructuring initiatives.
The initiatives taken include workforce reductions, improving
overhead leverage, managing inventory tightly and implementing new
pricing strategies. The homebuilders expect these cost reduction
and operating efficiency improvement plans combined with positive
housing demand to further boost profitability in 2014.
Ancillary Companies also Gain from Housing
Construction material companies,
Vulcan Materials Company
Eagle Materials Inc.
), and building product makers
) are fast gaining momentum from improving new home demand. These
companies are also seeing a concomitant rise in demand and volume
for their products.
Fed to Keep Interest Rates Low
In mid December, the Federal Reserve announced plans to scale back
its currency $85-billion-a-month bond buying program by $10 billion
to $75 billion. The Fed has been buying $85 billion in government
bonds and mortgage backed securities a month, known as quantitative
easing, to keep interest rates low and boost economic growth.
Ideally, tapering of the bond-buying plan would have led to
adoption of a tighter monetary policy, which would have increased
interest rates further. However, the Fed said that the interest
rates will be kept low for even longer than previously promised,
irrespective of the reduction in the bond buying program; thus
removing a major overhang for homebuilders.
Rising Interest Rates
Since mid-2012, homebuilders have largely benefited from
historically low interest rates, eventually leading to the sharp
increase in home buying activity. With the recent improvement in
economic conditions and the housing market in general,
mortgage/interest rates are edging upwards to more normalized
levels since May 2013. According to the Freddie Mac mortgage
survey, the 30-year fixed mortgage rate has risen from 3.59% on May
23 to 4.42% as of Dec 12.
High interest rates dilute demand for new homes, as mortgage loans
become expensive. This lowers a buyer's purchasing power. This can
hurt volumes, revenues and profits at the homebuilders.
Homebuilders at large admitted that higher interest rates have
eaten into volumes in the last reported quarter. But the
homebuilders are also convinced that sluggish demand in the past
quarter is only a fleeting phenomenon and buyers would soon return
to the market overcoming their inhibitions of rising rates and
climbing home prices.
In fact, while interest rates are an important part of the home
buying business, sustainable increases in housing and housing
demand for the long term will require the overall economy to
strengthen. This means further job growth, improving household
incomes, rising consumer confidence and easing of credit
availability. The economy, while still improving slowly, is far
from experiencing a full-fledged recovery. Until there is more
robust economic activity, new home sales will continue to lag
Interestingly, with the rise in mortgage rates, lenders are
beginning to ease credit standards to more normalized levels which
could, in fact, have a modest positive impact on demand.
Rising Input Costs
Rising input costs are a concern due to increasing costs of
building material and labor. As housing starts accelerate, both
labor and construction material costs would continue to experience
upward pricing pressure, impeding margins in the future.
A shortage of approved home sites, labor constraints in some
markets and a lack of available capital for smaller builders are
lowering the supply of homes, both new and existing. The supply of
homes is still not meeting current demand let alone the pent-up
demand. If the supply picture does not improve, home prices could
shoot up further, causing many homebuyers to hold back on their
Performance of Key Players in the Last Reported
Despite the rising interest rates, key housing companies like
Lennar and Toll Brothers delivered stronger-than-expected results
in the last reported quarter driven by volume growth and aggressive
pricing. Pulte beat the Zacks Consensus Estimate for both earnings
and revenues driven by margin growth and pricing power which made
up for the order shortfall.
However, housing giant D.R. Horton missed the Zacks expectations
for both revenues and earnings due to slowing order trends. Others
like Hovnanian Enterprises beat earnings expectations on the back
of price increases and cost savings, while missing out on the
revenue consensus due to weak order trends.
A look at the Earnings ESP in the table below shows that KB Home
could beat the Zacks Consensus Estimate in the next quarter (first
quarter of fiscal 2014) due to pricing and margin improvement.
Note: For Pulte, the last reported quarter was Q313 while for
others it was Q413
Zacks Industry Rank
Within the Zacks Industry classification, we rank all the 260 plus
industries in the 16 Zacks sectors based on the earnings outlook
and fundamental strength of the constituent companies in each
industry. To learn more visit:
About Zacks Industry Rank
As a guideline, the outlook for industries in the top 1/3rd of all
Industry Ranks or a Zacks Industry Rank of #88 and lower is
'Positive,' the middle 1/3rd or industries with Zacks Industry Rank
between #89 and #176 is 'Neutral' and the bottom 1/3rd or Zacks
Industry Rank of #177 and higher is 'Negative.'
The Zacks Industry Rank for the construction industry is currently
#69. This is in the upper 1/3rd of all industries ranked,
highlighting the group's near-term positive outlook as the housing
recovery continues despite rising interest rates and increasing
The Construction sector depicts stable earnings trends. The
September quarter results for the sector have been average in terms
of both beat ratios (percentage of companies coming out with
positive surprises) and growth.
The earnings "beat ratio" was a strong 81.8%, while the revenue
"beat ratio" was 63.6%. Total earnings for this sector increased
32.1%, reflecting a sharp moderation from 53.6% growth registered
in the second quarter. We note that comparisons have become
difficult considering that the housing industry started to improve
steadily from the second quarter of 2012. Total revenues grew 9.2%
in the quarter versus a 10.1% jump in the previous quarter.
The consensus earnings expectations for the December quarter look
encouraging with earnings projected to grow 1.5% thereby pegging
the full-year 2013 growth outlook at 95.2%. For revenue, growth
will likely be 6.9% in the December quarter. Full-year revenue will
likely increase 9.8%.
For more details about earnings for this sector and others, please
read our '
Though the sudden jump in interest rates has brought a short-time
halt to housing recovery, we expect sales to continue to rise in
2014 as pent up demand is released and buyers return to the market.
Most homebuilders also expect the housing momentum to continue into
2014 with the gradual strengthening of the economy.
Our proprietary Zacks Ranks indicate the movement of the stocks
over the short term (1 to 3 months). At present, 16% stocks post a
positive outlook while 84% has a neutral outlook. None of the
stocks show a negative outlook.
Stocks which will likely outperform the broader market and
currently hold a favorable Zacks Rank #2 (Buy) include
MRV Engenharia e Participa
M/I Homes, Inc.
) and Meritage Homes. We are currently not too enthusiastic on
Zacks Ranked #3 (Hold)
) due to weak net order trends.
D R HORTON INC (DHI): Free Stock Analysis
EAGLE MATERIALS (EXP): Free Stock Analysis
GAFISA SA-ADR (GFA): Free Stock Analysis Report
HOVNANIAN ENTRP (HOV): Free Stock Analysis
KB FINL GRP-ADR (KB): Get Free Report
LENNAR CORP -A (LEN): Free Stock Analysis
LOUISIANA PAC (LPX): Free Stock Analysis Report
MASCO (MAS): Free Stock Analysis Report
M/I HOMES INC (MHO): Free Stock Analysis Report
MERITAGE HOMES (MTH): Free Stock Analysis
PULTE GROUP ONC (PHM): Free Stock Analysis
RYLAND GRP INC (RYL): Free Stock Analysis
TOLL BROTHERS (TOL): Free Stock Analysis Report
TRI POINTE HOME (TPH): Free Stock Analysis
VULCAN MATLS CO (VMC): Free Stock Analysis
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