The housing market has steadily made a comeback from the lows
witnessed from the severe and widespread downturn. However, the
housing momentum seen in 2012 and in the first half of 2013 seems
to have moderated somewhat with the recent spike in mortgage rates,
tight credit availability and a limited supply of land and labor.
In spite of the recently rising interest rates, they are still
below historical levels and housing is still very much affordable.
Thus, high affordability levels, increased rentals and historically
low interest rates are driving the housing momentum. In addition,
accelerating job growth and increasing consumer confidence are
boosting demand for new homes.
Supply, however, is constrained by low home inventories, both for
new and existing 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. In fact, rising home prices and
thinning home inventories have created a sense of urgency among
homebuyers who are now more anxious to buy a house before prices
shoot up further.
Most homebuilding companies are resultantly witnessing a
significant growth in both volumes and average selling prices
(ASPs). New home orders, backlogs (number of homes under sales
contracts at the end of the year) and homes delivered continue to
climb year over year.
Moreover, improving homebuilding revenues combined with tight
cost control and better overhead leverage (as volumes improve) are
boosting margins for most homebuilders. Most homebuilders believe
the housing momentum will continue into 2014.
The National Association of Home Builders/Wells Fargo Housing
Market Index (HMI), known as the homebuilder sentiment index,
jumped 3 points to 59 in August from 56 in July. This was the
fourth consecutive monthly increase in the index and was also the
strongest increase in almost eight years. The jump in the index
shows that the recent interest rate hikes have not dampened the
How Did the Big Players Perform This Quarter?
It was a mixed Q2 for the homebuilders. Among the big homebuilders
Meritage Homes Corp.
) beat the Zacks Consensus Estimate for both revenues and earnings;
) beat on revenues and incurred a narrower loss. All the three
companies saw increasing demand and pricing in most housing markets
despite rising interest rates.
D.R. Horton, Inc.
The Ryland Group Inc.
) beat the Zacks Consensus Estimate for earnings on the back of
pricing and margin gains, they missed the expectations for revenue.
Rising interest rates slowed down the order growth for DHI in the
latter half of the quarter, which we believe hurt the top line.
) was the worst performer this quarter, missing the Zacks Consensus
Estimate for both earnings and revenues due to declining net order
Land as Native Strength
Homebuilders like Lennar which have a solid land position are
better placed to meet the rising demand for homes during the
upturn. This gives these companies a competitive edge over peers
like Pulte which are facing land availability constraints.
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 till through 2014 and is now
pursuing land opportunities for 2015 and beyond. Its net orders
jumped 27% in the second quarter.
However, net orders at Pulte declined 12% in the quarter. Pulte's
net orders were weak due to a decline in the number of communities.
The company has been intentionally slowing down sales in the face
of land development constraints and a scarcity of finished lots.
The company is focusing more on driving price and margins rather
than pushing up unit volumes. Such a strategy we believe has
affected net order growth in the quarter.
Other homebuilders are speeding up their land investments. Ryland
Group has spent $269 million on land acquisition and $108 million
on site development in the first half of 2013. California-based
homebuilder KB Home invested $575 million in land and land
development in the first half, nearly three times the investment
made in the year-ago period. The company plans to shell out $1.2
billion and more in land investment in fiscal 2013.
Texas-based D.R. Horton's investments in homes under construction,
land development and finished lots have increased by more than $1.1
billion during the first half of fiscal 2013 following the improved
liquidity position from solid sales growth in 2012.
High End Homes Driving Prices
Most homebuilders like Lennar, KB Home and
Toll Brothers, Inc.
) 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, 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 raising the
quality and the luxury quotient of its homes, thus giving it a
Strategic Restructuring & Cost Saving
Most housing companies are striving to improve their operating and
financial performance through strategic and restructuring
initiatives. The initiatives taken include workforce reductions,
improving overhead leverage, managing inventory tightly and
implementing new pricing strategies. Most homebuilders expect these
cost reduction and operating efficiency improvement plans combined
with positive housing demand to further boost profitability in the
second half of 2013 and 2014.
Ancillary Companies Also Stand to Gain
Construction material companies,
Vulcan Materials Company
Eagle Materials Inc.
) and building product makers
) are slowly gaining momentum from improving new home demand. These
companies are also seeing a concomitant rise in demand and volume.
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. This has raised concerns among some
analysts. According to the Freddie Mac mortgage survey, the 30-year
fixed mortgage rate has risen from 3.59% on May 23 to 4.40% as of
High interest rates dilute demand for new homes, as mortgage loans
become expensive. This lowers a buyer's purchasing power. As a
result we found the share prices of most housing stocks after
having peaked in May consequently hurtling down. The
better-than-expected earnings at most homebuilders in the reported
quarter could not prevent the share slide.
Rising interest rates notwithstanding, some companies like Lennar
and KB Home witnessed increasing demand in all their housing
markets and were able to push pricing further. However, others
showed some concern. D.R. Horton noted at its fiscal third quarter
conference call that the spike in interest rates slowed orders in
the back half of its quarter. Meritage Homes said it saw a little
bit of cooling in July due to higher rates, but indicated that
demand remained stronger than July 2012.
We believe that 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. None of these factors have shown any substantial
improvement so far, putting in question the sustainability of the
Changes in Federal Lending Process
Any change in federal lending procedure could also hurt demand for
new homes. The Federal Reserve is currently buying $85 billion in
government bonds and mortgage-backed securities per month, known as
quantitative easing (QE), to keep interest rates low and boost
However, the Fed plans to scale back this bond-buying plan by next
year and instead adopt a tighter monetary policy to avoid
deflation. The U.S. markets tumbled on the news. Investor
confidence in the overall housing recovery was especially shaken
due to concerns of rising interest rates if a tighter monetary
policy were to have been implemented.
However, Fed Chairman, Ben Bernanke announced plans in July to keep
interest rates low for longer. The Fed plans to keep the short-term
interest rates at record lows even if the unemployment rate falls
below 6.5%, which is the Fed's current benchmark to consider a
tighter monetary policy. Though Bernanke's comments have put the
above concerns to rest, at least for some time, the overhang still
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.
Interestingly, though overall housing starts for multifamily
construction rose 5.9% in the month of July, those for
single-family construction declined 2.2%. Though unusually wet
weather in the South and West pulled down the single family starts,
rising interest rates, tight credit availability and a limited
supply of land and labor also had a role to play.
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
#185. This is in the bottom 1/3rd of all industries ranked,
highlighting the group's near-term Negative outlook given the
current market situation. Even though the housing sector is doing
well, the negative outlook highlights the increasing concerns over
the recent hike in interest/mortgage rates and the resultant
volatility in the housing sector.
The Construction sector depicts stable earnings trends. The second
quarter 2013 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 54.5%, while the revenue "beat ratio"
was 36.4%. Total earnings for this sector increased 53.3%,
reflecting a sharp moderation from 105.2% growth registered in the
first quarter. We note that comparisons have become difficult
considering that the housing industry started to improve steadily
from the second quarter of 2012. Total revenue grew 10.1% in the
quarter versus a 13.9% jump in the previous quarter.
The consensus earnings expectations for the rest of the year look
encouraging with earnings projected to grow 19.6% in the third
quarter of 2013 and 2.6% in the fourth quarter, thereby pegging the
full-year 2013 growth outlook at 38.3%. For revenue, growth will
likely be 10.0% in the September quarter, followed by 8.6% in the
fourth quarter. Full-year revenue will likely increase 10.9%.
For more details about earnings for this sector and others, please
read our '
Overall the performance of the housing sector was essentially
satisfactory. Our proprietary Zacks Ranks indicate the movement of
the stocks over the short term (1 to 3 months). At present,
respectively 21%, 58% and 21% stocks sport a positive, neutral and
Stocks which will likely outperform the broader market and
currently hold a favorable Zacks Rank #2 (Buy) include
Hovnanian Enterprises Inc.
), Ryland Group, Meritage Homes and
TRI Pointe Homes, Inc.
). We currently are not too enthusiastic on the four stocks in our
universe that hold a Zacks Rank #4 (Sell) or Zacks Rank #5 (Strong
Sell). These stocks include Pulte,
Consorcio ARA, S. A. B. de C. V.
), M/I Homes, Inc. (
CONSORCIO ARA (CNRFF): Get Free Report
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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