With a gradual recovery in the overall economy, the homebuilding
industry is finally seeing signs of stabilization in 2012. The
downturn during 2006-2007 had hit the homebuilding sector
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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We believe that the housing market is improving at a moderate
pace, benefiting from an increase in employment rates, higher
consumer confidence and several years of pent-up demand. Houses are
more affordable now as home prices stabilize, mortgage loans come
with relatively low interest rates and renting becomes more
Thus, homebuilders are witnessing increasing traffic levels due to
heightened consumer demand. Inventory of foreclosed homes and short
sale homes is declining, thus stabilizing prices of new homes.
Additionally, buyers are selecting larger and much more upgraded
homes with energy-efficient features, which will eventually help
increase average sale prices.
Thus, most homebuilding companies are witnessing better
year-over-year growth in revenues, driven by an increase in new
home orders and average selling prices. Backlogs (number of homes
under sales contracts at the end of the year) and homes delivered
are also climbing year over year.
Moreover, improving homebuilding revenues combined with tight cost
control by most homebuilders are boosting margins. The large
discounts and incentives offered in response to declining demand
and an oversupply glut are gradually being called back.
The National Association of Home Builders/Wells Fargo Housing
Market Index (HMI) rose for the fourth consecutive month in August,
improving by 2 points to 37. This is a significant improvement from
the depths of the housing downturn and is the index's highest level
since February 2007. The improvement in this index suggests an
increased demand for housing and better sales prospects for the
next few months.
Housing Recovery Slow
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
As discussed above, there have been signs of a gradual
strengthening in the housing market in the first half of 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, homebuilders are still facing impediments
in raising prices in some markets. The overall demand remains
constrained due to tight credit standards, which make it difficult
to obtain home loans. A speedy housing recovery is unlikely and it
will take some time before the markets fully recover.
Progress in 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 Corporation ( LEN )
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.
PulteGroup, Inc. ( PHM ) 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
Small homebuilders like KB Home ( KBH )
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. 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 ( MTH ) 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
Cost Saving and Strategic Initiatives
Most housing companies resorted to cost reduction and other
strategic initiatives in order to cope with the housing downturn
and raw material cost inflation. Most of these companies have been
taking action to improve their operating and financial
Pulte is continuously evaluating its assets and prioritizing
markets and projects in order to allocate capital appropriately and
invest selectively in high-return projects. The company is
divesting lower-margin projects and exiting non-performing
communities and lower margin land lots, which no longer fit into
their operating strategy.
Subsequently, the company is 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 its unsold inventory levels more aggressively, which in
turn are benefiting the working capital and margins.
In addition, Pulte 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 Central
Home improvement products-maker Masco Corporation
) took initiatives to improve underperforming businesses like
Installation and Cabinet, leveraging its brands and continued
innovation, and reducing costs. The company's 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 total cost reduction of about $150 million in
Construction aggregates maker Vulcan Materials
Company ( VMC ) 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 overhead costs.
The company has also announced two other 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. The
plan is expected to improve EBITDA by $100 million on an annual
basis by 2014 at current volumes.
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 and are expected to generate after-tax net proceeds of
$500 million by mid-2013.
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, NC, disposed of
unnecessary land and reduced exposure to risky joint
Further, KB Home is activating communities in stabilizing markets,
increasing revenues per community, redesigning products to make
them more affordable to cash-constrained consumers, lowering
production costs and strengthening management teams with additional
resources to improve its operating performance in the second
Most homebuilders are expecting these restructuring and strategic
initiatives, combined with the housing recovery, to help them
achieve profitability in the second half of 2012.
The improved business backdrop is showing up in positive earnings
momentum for homebuilders, resulting in Zacks #2 Rank (Buy) for
Toll Brothers ( TOL ),
Zacks #1 Rank (Strong Buy) for Lennar ( LEN ),
Zacks #2 Rank for Hovnanian ( HOV ),
and Zacks #2 Rank for Meritage Homes ( MTH ).
trend in earnings estimates revisions for
Louisiana-Pacific Corporation ( LPX ) is
also positive, as reflected in its Zacks #2 Rank.
Toll Brothers 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 both
the second and third quarters of fiscal 2012 (ended July 31). The
company has delivered double-digit growth in net orders in every
quarter of fiscal 2012 so far and provided an optimistic outlook
for the fourth quarter.
We believe this luxury homebuilder will be able to outperform the
market, given its well-located communities and strong land
positions, along with stabilizing home prices, improving consumer
confidence and the overall economic recovery. The stock carries a
Zacks #2 Rank (short-term Buy rating).
Lennar's first half results have been impressive, driven by price
increases and improved net order growth with the housing market
stabilizing. We believe the company is performing better than its
peers by increasing sales prices, reducing incentives, improving
volumes and investing in well-positioned, high-margin
The company offers a diversified line of homes for first-time,
move-up and active adult homebuyers which can be availed in a
variety of environments ranging from urban infill communities to
golf course communities. The stock carries a Zacks #2 Rank
(short-term Buy rating).
Regarding Pulte Group, we are encouraged by its solid second
quarter results and bullish growth projection for the second half,
backed by the gradually recovering homebuilding market. Pulte Group
rebounded from a loss in the first quarter to post an earnings
surprise of 160% in the second quarter. Improved homebuilding
revenues, expanded margins, and the company's cost reduction and
operating efficiency initiatives boosted earnings in the
We believe that homebuilders like Pulte, which have significant
land positions, broad geographic and product diversity, and better
capital positions will benefit the most as market conditions
Louisiana-Pacific delivered impressive earnings and revenue growth
in the first half of 2012, driven by strong performance of its two
segments, Oriental Strand Board (OSB) and Siding. Both segments
benefited from volume growth as overall housing activity improved.
Management believes that Louisiana-Pacific's excess manufacturing
capacity in each of the business segments will allow it to cash in
on the opportunity provided by growing demand while the market
Meritage Homes delivered solid first half results, 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 the second quarter. Its new order
growth in the second quarter was the strongest since the second
quarter of 2008. We believe the company's focus on acquiring new
communities in the most desirable submarkets will generate profit
in the long run.
With the housing market showing recovery, we are not generally
bearish on any housing company. However, we advise investors to
avoid names that have reported lower-than-expected results in the
Fastenal Company ( FAST ),
a national distributor of industrial and construction supplies,
witnessed a slowdown in sales to manufacturing customers who
represent almost 50% of revenues in the second quarter of 2012.
Daily sales growth rates declined sharply in the quarter due to
sluggish end markets as well as foreign currency headwinds. The
sequential change in daily sales for the first half of 2012 was
also below historical averages, highlighting the rising uncertainty
in the growth outlook of Fastenal's end markets.
Moreover, Fastenal's 'pathway to profit' strategy has failed to
achieve the desired results. The strategy called for a slowdown in
the pace of store openings and instead uses the resultant
savings to increase the headcount in stores. Other than that, the
company's strategy of new store openings significantly hurt
near-term profitability due to the start-up costs involved in
opening a new store. The stock carries a Zacks #3 Rank (Hold),
reflecting its lack of earnings momentum.
Another company which announced unimpressive results this quarter
was Masco ( MAS ).
Masco's second quarter 2012 earnings as well as revenue missed the
Zacks Consensus Estimates due to currency headwinds and a sluggish
global economy. Overall, the company anticipates
weaker-than-expected growth in the second half of 2012, owing to
slower-than-expected recovery of the U.S economy and Euro-zone
crisis. The stock carries a Zacks #3 Rank (short-term Hold
Vulcan ( VMC )
reported lackluster earnings in the second quarter 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.
Vulcan expects the second half results to be better than the first
half banking upon cost reduction efforts and better earnings in the
Aggregates, Concrete and Asphalt segments. We, however, prefer to
wait and see if the company actually meets the bullish second half
outlook. The stock carries a Zacks #3 Rank (short-term Hold