After the tough years 2006-2007, the housing market is now
recovering steadily. The stability in the home buying market,
combined with low interest rates and increased rentals, have
increased the affordability of homes. Improvement in employment
and consumer confidence is also contributing to a rise in demand
for new homes.
Inventory of foreclosed homes and short sale homes is declining,
thus stabilizing prices of new homes. Additionally, buyers are
selecting larger and upscale homes with energy-efficient
features, which are increasing average sale prices.
Thus, homebuilders are 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. Home prices have started moving up
lately with market demand gaining momentum.
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 and an
oversupply situation are gradually being rolled back.
Overall, the U.S. housing market has seen significant upside in
new home sales volume for the first nine months of 2012 with
industry-wide sales increasing roughly 25% from prior-year
levels. The improving housing outlook thus has been a solitary
bright spot on the economic horizon.
The National Association of Home Builders/Wells Fargo Housing
Market Index (HMI), known as the homebuilder sentiment index,
rose for the eight consecutive month in December, improving by 2
points to 47. This is a significant improvement from the depths
of the housing downturn and is the index's highest level since
April 2006. The improvement in this index suggests an increased
demand for housing and better sales prospects for the next few
Focus on High-End Communities
Most homebuilders are focusing on the 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
Given the scenario, large builders are eating into the shares of
other undercapitalized small/medium-sized private builders on the
back of overall housing demand, stronger capital and better land
) strategically focuses on acquiring new home sites that would
boost margins and benefit 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.
) is also shifting its focus toward 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
) has started rolling out communities in highly desirable
submarkets, primarily in the Central and West Coast regions,
which allows it to sell larger, higher-priced homes, driving up
the ASP. The company is also reallocating resources to focus on
core preferred markets with strong growth prospects like those of
California and Texas. 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 foreclosure.
Another small homebuilder,
Meritage Homes Corporation
) is investing in well-positioned and high-priced land and new
communities in the most desirable submarkets, which should ensure
profits as the market gets stronger.
Increased Investments in Land Positions
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 and at a relatively lower
The pace of D.R. Horton's investments in homes under
construction, land development and finished lots has increased
following the improved liquidity position from solid sales growth
in the first nine months of 2012. In the first nine months of
2012, the company invested $938 million on land developments
versus total investment of more than $800 million over the past
couple of years.
Pulte is also investing in acquiring land positions and expects
to spend $1 billion on land and land development in 2012. 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
its operating strategy, thus freeing up cash to invest in other
potential opportunities, which could generate higher returns.
Pulte is also using its existing land assets more efficiently and
lowering unsold inventory levels more aggressively, which in turn
are benefiting its working capital and margins.
Most housing companies resorted to cost reduction initiatives in
order to cope with the housing downturn and raw material cost
Pulte has made significant workforce reductions and is also
aggressively working to reduce overhead costs. In 2011, the
company consolidated its field organization and certain corporate
functions. It also consolidated its regional operations in
Arizona, Florida, New York and New Jersey and merged its West and
Home improvement products-maker
) cost-saving initiatives included business consolidations,
system implementations, plant closures, improvement in the global
supply chain and headcount reductions. The restructuring
initiatives are expected to result in about $175 million of gross
cost reduction in 2012.
Construction aggregates maker
Vulcan Materials Company
) has invested in a new Oracle-based ERP and Shared Services
platform, which allowed the consolidation of the company's eight
divisions into four regions. The system also streamlined its
support functions, thereby reducing related positions and
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, the company 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 earnings.
Other smaller homebuilders like KB Home significantly reduced its
overhead, inventory and community count levels to better align
operations with the reduced housing activity. Consequently, the
company exited underperforming markets like South Carolina,
downsized operations in Arizona and Charlotte, North Carolina,
lowered production costs, disposed of unnecessary land and
reduced exposure to risky joint ventures.
Most homebuilders are expecting these restructuring and cost
savings initiatives to help them achieve profitability as the
housing dynamics continue to improve.
Performance of Key Players in the Past Quarter
Gaining from the improving housing dynamics, key housing
companies like Pulte, Lennar and D.R. Horton delivered
stronger-than-expected results in the third quarter. However,
other operators like Vulcan Materials and
) either missed or could only meet expectations. While Fastenal,
a national distributor of industrial and construction supplies,
faces uncertainty in the growth outlook for some of non-housing
end markets, Vulcan Materials is facing volume headwinds in its
largest segment, Aggregates.
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)
shows that Pulte could beat the Zacks Consensus Estimate in the
fourth quarter of 2012. Pulte management is also expecting better
profitability in the future quarters.
Overall the earnings picture for the group as a whole remains
very robust. Total fourth quarter 2012 earnings for the
homebuilder sector are expected to be the highest of all 16 Zacks
sectors at 33.3% from the same period last year, reflecting a
combination of strong revenue growth and margin expansion. This
follows the group's strong performance in the third quarter, when
total earnings increased 56.6%.
With overall earnings growth in the broader S&P 500
essentially flat in the third quarter and expected to be no
different in the fourth quarter, the housing group provides the
few areas of earnings growth in the present environment.
Importantly, the trend has only just started and still has plenty
of room to grow.
Full Housing Recovery Will Take Time
The last few years have seen a very fragile housing market. The
downturn in housing -- aggravated by an overall weak economy,
high unemployment rates, low consumer confidence, rising interest
rates and tightened mortgage-lending standards -- weighed on
Declining demand for new homes and an excess of supply in the
market in 2011 drove homebuilders to make large concessions in
prices, largely hurting profitability. Homebuilders' sales and
profit margins had dropped dramatically from peak levels in 2006.
As discussed above, there have been signs of a gradual
strengthening in the housing market in 2012. However,
homebuilders have cautioned that the process of stabilization is
erratic and not adequately broad-based.
The housing market improvement has been uneven across the
country. Most of the gains have, by and large, been observed in
high-end communities. In addition, some homebuilders are still
facing impediments in raising prices in some markets. Tight
credit standards and reduced credit availability for residential
consumer mortgage loans still remains a constraint.
Moreover, consumers will remain cautious until job growth,
continued home price appreciation and access to credit improve
their confidence. A speedy housing recovery is thus unlikely and
the timing of the markets to fully recover and return to a more
historically typical operating environment is uncertain.
KB HOME (KBH): Free Stock Analysis Report
LENNAR CORP -A (LEN): Free Stock Analysis
MASCO (MAS): Free Stock Analysis Report
MERITAGE HOMES (MTH): Free Stock Analysis
PULTE GROUP ONC (PHM): Free Stock Analysis
VULCAN MATLS CO (VMC): Free Stock Analysis
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The improved business backdrop is showing up in positive earnings
momentum for homebuilders, resulting in Zacks #1 Rank (Strong
Buy) for Lennar and Zacks #2 Rank (Buy)
Hovnanian Enterprises, Inc.
) and The Ryland Group, Inc. (
Lennar has witnessed solid year-over-year growth in new home
orders, average selling prices and home closings in all the three
quarters of 2012. Margins have also been above average, despite
rising costs, driven by strong operating leverage. Lennar appears
to be well positioned for growth in the future quarters as well.
We believe that the company is performing better than its peers
by increasing sales prices, reducing incentives, improving
volumes and by making opportunistic land acquisitions.
Pulte has beaten the Zacks Consensus Estimates in the second and
third quarters of 2012. Improving homebuilding revenues combined
with the company's cost control initiatives are boosting 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.
We are also optimistic that, despite a Zacks #3 Rank, these
companies have bright prospects going forward:
) enjoys the competitive advantage of being the largest luxury
home builder in the country with little competition in this niche
sector. Toll Brothers delivered solid results in the last three
quarters of fiscal 2012 (ended October 2012). The company has
delivered double-digit growth in net orders in every quarter of
fiscal 2012 and expects the momentum to continue in fiscal 2013
) strong cash flows, its geographic diversity and its solid cost
discipline encourage us. The company has beaten the Zacks
Consensus Estimate of earnings in all the quarters of fiscal 2013
(ended September 2012) driven by growth in net sales orders,
homes closed and sales order backlog as the housing market
) delivered solid results in the second and third quarter of
2012, owing to robust new order growth and improved pricing. The
company saw significant growth in closings, average sales prices,
revenue, orders, backlog, gross margin and net earnings in both
the quarters. The company has also started raising prices in most
of its communities. It is expecting revenues to increase at an
impressive growth rate of 20%-30% in fiscal 2013. We believe the
company's focus on acquiring new communities in the most
desirable submarkets will generate profits in the long run.
With the housing market showing a steady recovery, we are not
generally bearish on any housing company. However, we advise
investors to avoid names that have reported sluggish results in
the past 2-3 quarters.
) daily sales growth rates in the second and third quarters of
2012 were lower than the first quarter as well as year-ago
comparable periods. Daily sales growth rates to manufacturing
customers have declined sharply due to lower sales of its
fasteners product line, which are being hurt by end market
slowdown and broader economic uncertainty. We believe that the
shift of resources to vending may also hurt fastener sales. The
stock carries a Zacks #4 Rank (Sell), reflecting its lack of
) reported lackluster earnings in the second and third quarters
of 2012 due to a decline in revenue and volumes. Revenues
declined from the prior-year quarter levels mainly due to a
decline in shipments and an unfavorable geographic mix in its
flagship Aggregates segment, which produces construction
aggregates. The stock carries a Zacks #3 Rank (Hold). Despite
being a Zacks #3 Rank stock, we cannot rule out a downgrade in
the near future following back-to-back disappointing quarters.
) can also be avoided currently as it faces headwinds from weak
big ticket remodeling activity and slow European economies,
offsetting the benefit from an improving new home construction
environment in the U.S. The stock carries a Zacks #3 Rank.