The housing market has steadily made a comeback from the lows
witnessed in mid-2006 from the severe and widespread downturn. The
stability in the home buying market, combined with low interest
rates and increased rentals, has increased the affordability of
Moderate job growth and slowly increasing consumer confidence are
also contributing to a rise in demand for new homes. Inventory of
foreclosed homes and short-sale homes are declining, thus
stabilizing prices of new homes. Home prices have started moving up
with market demand gathering momentum.
As the housing market returns to its pre-downturn level, it will
drive employment upward and build consumer confidence, thus
providing stimulus to the overall economy. In fact, the health of
the housing market is often an indicator of the health of an
economy at large.
Homebuilders are thus witnessing increasing traffic levels due to
heightened consumer demand. Most homebuilding companies are
witnessing significant growth in both volumes and average selling
prices (ASP). New home orders, backlogs (number of homes under
sales contracts at the end of the year) and homes delivered are
climbing 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. The large discounts and
incentives offered in response to declining demand during the
housing downturn have mostly been called back.
Overall, the U.S. housing market has seen significant upside in new
home sales volume for 2012 with industry-wide sales increasing
roughly 25% from prior-year levels. New home construction activity
improved 25% in 2012. Faced with the fiscal cliff at 2012 end, and
the threat of sequestration and a mounting national debt, the
recovery of the housing market was one bright spot on the U.S.
Increased Investments in Land Positions
With sales and profitability improving, most housing companies have
strategically focused on acquiring new home sites in high demand
areas, which will further improve revenues and profits. In addition
to purchasing finished home sites, companies like
D.R. Horton, Inc.
) also acquire early stage raw lands in A-plus locations, on which
finished home sites can be built faster at a relatively lower cost.
D.R. Horton has indeed stepped up investments in homes under
construction, land development and finished lots on the strength of
its improved liquidity position from solid sales growth in 2012.
The company's land and lot position is now the strongest in its
) spent $925 million on land and land development in 2012 and plans
to spend another $1.2 billion on land and related development in
fiscal 2013 and 2014. While the company is disciplined in adding
land positions, it is also divesting lower-margin projects and
exiting underperforming communities and lower-margin land lots
which no longer fit into their operating strategy. This would free
up cash to invest in other potential opportunities, generating
KB Home has also exited underperforming markets like South
Carolina, downsized operations in Arizona and Charlotte, disposed
of unnecessary land and reduced exposure to risky joint ventures.
Focus on High-End Communities
Most homebuilders are shifting their focus on high-end communities.
The average selling prices (ASPs) are improving for most large-cap
homebuilders due to changes in the community/product mix. ASPs have
gained from increased sales in high-end communities of California,
Arizona, Colorado and Florida, where home prices are generally
Given the scenario, large builders are eating into the share of
other undercapitalized/small/medium-sized private builders on the
back of overall housing demand, stronger capital and better land
Lennar strategically focuses on acquiring new home sites that would
boost margins and percolate down to the bottom line. The company
focuses on high-margin, well-positioned communities and avoids
fringe or tertiary markets where price is the only driver. The
company's focus on quality instead of quantity is benefiting
margins and boosting new sales orders.
Pulte is also shifting its focus towards high-priced Pulte-branded
move-up homes, which improve the overall ASP. A better mix of
sales, particularly Pulte-branded move-up homes, as well as
addition of new higher margin communities, is consistently boosting
the company's margins.
Small homebuilders like KB Home has started rolling out communities
in highly desirable submarkets primarily in the Central and West
Coast regions, which allow it to sell larger, higher-priced homes,
driving up the ASP. KB Home in the fourth quarter 2012 has been
able to drive up ASPs for 10 consecutive quarters. KB Home is also
targeting higher income, first-time and move-up buyers -- all of
whom are more inclined toward buying a new home rather than buying
a foreclosed one.
Another small homebuilder,
Meritage Homes Corp.
) 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 competitive advantage.
Ancillary Companies also Stand to Gain
Construction material companies,
Vulcan Materials Company
Eagle Materials Inc.
), and building product makers
) are also slowly gaining momentum from improving new home demand.
These companies are also seeing a concomitant rise in demand and
With both residential housing starts as well as non-residential
contract awards showing a steady improvement, Vulcan is seeing some
improvement in demand for its aggregates as well as non-aggregates
businesses. Its aggregates business, which was sluggish in 2012, is
expected to see solid demand growth in 2013 as private construction
Masco is seeing improving North American sales on the back of
increasing new home construction activity, which is driving demand
for its home improvement products.
Strategic Restructuring & Cost Saving
Most housing companies are striving to improve their operating and
financial performance. The initiatives taken include steps to
expand margins, improve overhead leverage, manage inventory tightly
and implement new pricing strategies.
As part of its cost reduction program, Pulte has made significant
workforce reductions and is also aggressively working to reduce
overhead costs. In addition, the company had effectively managed
its business during the downturn that led to positive cash flows,
which in turn could be used to pay back outstanding debt. The
company is also adjusting contents of its homes and building
smaller floor plans to curtail construction costs.
Masco's strategic initiatives include improvement of
underperforming businesses like Installation and Cabinet,
solidifying its market position and leveraging its brands, new
product introductions and product innovation, reducing costs,
paying off debt and strengthening its balance sheet. The company's
cost-saving initiatives included business consolidations, system
implementations, plant closures, branch closures, improvement in
the global supply chain and headcount reductions.
Over the last 4-5 years, Masco has reduced its gross fixed costs by
approximately $600 million by closing around 33 facilities and
reducing headcount by more than 30,000.
Construction aggregates maker Vulcan's aggressive cost saving
actions resulted in improved per-ton margins in 2012. In addition,
the company re-organized its structure (consolidated eight
divisions into four regions) in 2012, which lowered its selling,
general & administration costs by 11% in 2012.
The company also has two other ongoing initiatives -- a Profit
Enhancement Plan and planned asset sales -- in order to improve
earnings and cash flows, pay off debts and thereby strengthen its
overall credit profile.
The Profit Enhancement Plan is designed to reduce costs as well as
enhance profitability by streamlining the management structure.
Under the planned asset sale, Vulcan plans to divest its non-core
assets in order to focus on the higher-growth Aggregates business.
These sales will improve the company's liquidity position and
KB Home is improving and refining its products, activating
communities (which were held for future development) in stabilizing
markets, increasing revenues per community with intense focus on
sales performance, and strengthening management teams with
additional resources to improve its operating performance while
carefully managing costs.
Most homebuilders expect these cost reduction and operating
efficiency improvement plans combined with reinvigorated housing
demand to boost profitability in 2013.
How Will the Big Players Perform this Quarter?
A look at the Earnings ESP (
Expected Surprise Prediction
- Zacks' proprietary methodology for determining which stocks have
the best chance to surprise with their next earnings announcement)
in the table below shows that Louisiana-Pacific could beat the
Zacks Consensus Estimate in its first quarter 2013. The company is
expected to outperform on the back of solid performance in its
Oriental Strand Board (OSB) and Sliding segments driven by the
housing market recovery. Masco is also expected to beat earnings
this quarter driven by continued improving trends in the North
American and the company's turnaround efforts and profit
Among those which have already reported their results for this
quarter, Lennar beat the Zacks Consensus Estimates for both revenue
and earnings; KB Home beat on revenues and incurred a narrower
) delivered in line earnings and missed on revenues. While Lennar
and KB Home gained from improving housing fundamentals, Fastenal
continues to see sluggish sales of its fasteners product line (hurt
by end-market slowdown and a broader economic uncertainty).
Fastenal is a national distributor of industrial and construction
In terms of composite growth expectations (combining the reports
that have come out with those still to come), total earnings for
companies in the construction sector are expected to increase 80.5%
(year over year) in the first quarter after the +90.3% gain in the
fourth quarter of 2012, thus continuing its positive momentum. This
reflects 10.9% increase in revenue and a modest margin contraction.
DHI's fiscal year ends in September while that of all other
companies end in December.
Will the Housing Momentum Continue?
Notwithstanding the improving trend, the U.S. new home demand
remains at historically low levels due to the currently weak U.S.
economic conditions and tight mortgage lending standards.
Sustainable increases in housing and housing demand for the long
term will require the overall economy to strengthen, including
further job growth.
Consumers will remain cautious until the employment scenario
improves, home prices appreciate further and access to the credit
markets ease. A sustainable housing recovery in the long term can
be achieved only through a broad-based recovery in the overall
economy, which we believe will take time.
Rising input costs are also 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.
The National Association of Home Builders/Wells Fargo Housing
Market Index (HMI), known as the homebuilder sentiment index,
dropped by 2 points to 45 in April due to rising building materials
costs and shortage of developed lots and labor supply. Moreover,
difficulty in obtaining construction loans and tightened lending
standards are making it tough for homebuilders, especially the
smaller ones to effectively respond to increasing demand.
That said, the earnings momentum for homebuilders has remained
positive for the near term, resulting in a Zacks #1 Rank (Strong
Buy) for D.R. Horton, Louisiana-Pacific and
The Ryland Group, Inc.
), and a Zacks #2 Rank (Buy) for Pulte, Masco, Lennar, KB Home and
Hovnanian Enterprises, Inc.
D.R. Horton has beaten Zacks earnings estimates in all the quarters
of fiscal 2012 (ended Sep 2012) as well as in the first quarter of
fiscal 2013 driven by growth in net sales orders, homes closed and
sales order backlog. The company is expected to see continuous
improvement in profitability on the back of geographic diversity,
solid cost discipline, sound balance sheet, improved liquidity
position, better pricing power, and rising home inventories and
Lennar has witnessed solid year-over-year growth in new home
orders, average selling prices and home closings in all quarters of
2012. Margins have also been above average, despite rising costs,
driven by strong operating leverage. The company expects to
continue to achieve further profitability in fiscal 2013 on the
back of rising home prices, strong liquidity positions, solid
backlog, strategic land acquisitions and new community openings.
Pulte has beaten Zacks earnings estimates in the last three
quarters of 2012. Improving homebuilding revenues combined with the
company's cost control initiatives and solid operating leverage to
boost margins. We believe that homebuilders like Pulte, who have
significant land positions, broad geographic and product diversity,
and better capital positions, are expected to benefit the most as
market conditions recover.
Masco's had a solid fourth quarter as both top and bottom line
results surpassed the Zacks Consensus Estimate. The strong
quarterly results were driven by strong performance in North
America and Masco's profit improvement initiatives. We are
encouraged by Masco's continued focus on product innovation and
cost improvements. In general, management expects improved
profitability in 2013 as both the new home construction and repair
and remodel activities continue to recover.
With the housing market on a recovery path, we are not generally
bearish on any housing company. However, we advise investors to
avoid Fastenal. Fastenal's daily sales growth rates in the last
three quarters of 2012 were lower than the first quarter as well as
the year-ago comparable periods. Daily sales growth rates to
manufacturing customers have declined sharply due to lower sales of
fasteners. We believe that the shift of resources to vending may
also be hurting fastener sales. The stock carries a Zacks #3 Rank
D R HORTON INC (DHI): Free Stock Analysis
FASTENAL (FAST): Free Stock Analysis Report
HOVNANIAN ENTRP (HOV): Free Stock Analysis
KB HOME (KBH): Free Stock Analysis Report
LENNAR CORP -A (LEN): Free Stock Analysis
MASCO (MAS): Free Stock Analysis Report
VULCAN MATLS CO (VMC): Free Stock Analysis
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