The housing slowdown that began in the second half of 2013 was
aggravated by a harsh winter. This took a toll on the homebuilders
in the December quarter, delaying construction and raising serious
doubts as to the strength of the housing market.
The weather has no doubt been a major spoilsport for the sector in
the past quarter. However, there are other pressing issues for the
builders as well. Shortage of lots and skilled labor, rising cost
of materials and a declining level of new homes in inventory are
not making things easier for these builders. Moreover, the recent
spike in mortgage rates and rising home prices are hurting demand.
As a result, many companies saw declining order trends in the last
Orders declined around 18% at
), 6% at
Toll Brothers, Inc.
) and 4% at
Ryland Group, Inc.
) in the last reported quarter. Though order trends improved year
over year for others like
), it slowed down from the past quarter.
A slew of data released recently clearly shows that the housing
sector has had it tough in the recent past.
Homebuilder confidence, as indicated by the National Association of
Home Builders (NAHB)/Wells Fargo housing market index, dropped to
47 in both April and March and 46 in February from 56 in January
indicating increasing builder concerns about meeting ongoing and
future demand thanks to a shortage of lots and labor.
Further, housing starts declined 0.2% to an annualized rate of
907,000 in February from the prior month, weighed down by lower
multi-family starts. Meanwhile, single-family homes and apartments
rose only slightly. The February data was a continuation of the
January trend when starts dropped 16%. New home sales also dipped
3.3% in February as the weather remained bitter and supply
constraints continued to plague homebuilders.
However, as the winter chill subsides and builders prepare for the
upcoming spring selling season, improving trends may well be in the
cards. Builders are increasing their inventories of homes as
they anticipate a relatively strong spring buying season. This
might propel homebuilder stocks higher in the months ahead as
demand for new homes rise.
Although interest rates are rising, they are currently doing so
below historical levels; housing is still affordable. In addition,
accelerating job growth, an improving economy and unlocking pent-up
demand will likely boost demand for new homes for the rest of the
Building permits, a measure of future construction, rose 7.7% in
February, the highest rate since October last year and, more
importantly, the second highest rate since the middle of 2009. The
strong permits show that we can expect steady gains in construction
activities over the spring and summer months. NAHB also expects
2014 to be a strong year for housing, expecting a big increase in
Land as Native Strength
Homebuilders like Lennar and Toll Brothers with a solid land
position have been able to better capitalize on the rising demand
for homes during the upturn. This gave these companies a
competitive edge over peers like Pulte which faced land
During the downturn, Lennar strategically focused on acquiring new
home sites in well-positioned markets. The company thus has enough
land in all major markets to satisfy deliveries well into 2015.
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 has been more focused on driving
price and margin in most communities. This strategy hurt net order
growth significantly, with orders declining around 10% in fiscal
2013 -- a stark contrast to the increase enjoyed by most of its
) is also emphasizing on price and margin improvement to optimize
returns from its land assets. This slowed down its sales pace and
resulted in lower order growth in 2013. Though the price
optimization initiatives of Pulte and KB Home have boosted profits
in the past, the companies need to increase their volumes
consistently to boost long-term top-line growth.
Other homebuilders have realized the importance of land
investments. Ryland Group has spent $689 million on land
acquisition and $257 million on site development in 2013.
D.R. Horton, Inc.
) invested $2.6 billion in land, lots and development in 2013,
positioning it well to meet demand for fiscal years 2014 and
2015. KB Home spent $1.14 billion in land investment in
fiscal 2013, significantly more than $564.9 million spent in 2012.
In fact, aggressive land investments helped KB Home record better
order trends in its last reported quarter, Q1 of fiscal 2014.
High-End Homes Driving Prices
Despite the softness in the market, pricing remained strong in the
back half of the year. Home prices began moving up sharply from
2013 with market demand gaining momentum and supply remaining
Many homebuilders like Lennar, KB Home and Toll Brothers have
shifted their focus on high-end communities, primarily in
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. Also, Pulte is building some
new commonly-managed communities that represent homes that have
been constructed under the company's more efficient design, cost
and build processes and thus generate better margins and volumes
than the non-commonly-managed communities.
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
Margins Remain Strong
Despite slowing volumes in the second half, pricing remained
strong, which along with tight cost control and improved
efficiencies boosted the overall margins for many 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 continue to boost profitability in 2014.
Ancillary Companies Seeing Strong Momentum
Construction material companies
Vulcan Materials Company
Eagle Materials Inc.
), and building product makers
), have gained momentum from improving new home demand. These
companies also saw a concomitant rise in demand and volume for
In fact, Vulcan Materials' second-half revenues and profits
improved significantly from the first half as improving private
construction activity and better weather conditions markedly raised
volumes. Positive trends in new home construction activity and
improvement in repair/remodel activity in North America
significantly improved Masco's top line in the second half of 2013.
Fed to Keep Interest Rates Low
For most of 2013, the Federal Reserve bought $85 billion in
government bonds and mortgage backed securities a month, known as
quantitative easing, to keep interest rates low and boost economic
growth. However, the Fed scaled back the bond buying program thrice
by $10 billion each as economic growth picked up.
At present, the Fed is buying $55 billion in bonds per month.
Ideally, tapering of the bond-buying plan would have put pressure
on interest/mortgage rates. However, the Fed has maintained tight
control on interest rates and they have been kept low, irrespective
of the reduction in the bond buying program. This has removed a
major overhang for homebuilders.
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 leave alone pent-up
demand. If the supply picture does not improve, home prices could
shoot up further, causing many homebuyers to hold back on their
Rising Interest Rates
Since the middle of 2012, homebuilders have largely benefited from
historically low interest rates, eventually leading to the sharp
increase in home buying activity. However, 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 4.34% as of Apr 10.
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 since the second half of 2013. But the
homebuilders are also convinced that sluggish demand is only a
fleeting phenomenon and buyers would soon return to the market
overcoming their inhibitions of rising rates and climbing home
prices. As discussed above, the Fed has also assured of a stable
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 a full-fledged recovery. Until there is a more robust economic
recovery, new home sales would continue to lag historical levels.
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 future margins.
Latest Performance of Key Players
Despite rising interest rates and harsh weather, important housing
companies like D.R. Horton and Pulte beat the Zacks Consensus
Estimate for both revenue and earnings in the December quarter.
This was largely due to aggressive pricing and margin growth, which
made up for slowing order growth.
However, New Jersey based
Hovnanian Enterprises Inc.
) missed expectations on both counts due to delays in deliveries
caused by severe weather, interruption of cabinet supply and
construction labor shortages. Others like Toll Brothers beat
earnings expectations on the back of strong margins, while missing
out on the revenue consensus due to soft order growth and difficult
Among those which have already reported their results for the March
quarter, Lennar and KB Home beat the Zacks Consensus Estimates for
both revenue and earnings helped by better order trends, price
increases and strong gross margins.
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
at #141. This is in the middle 1/3rd of all industries ranked,
highlighting the group's near-term neutral outlook. The cautious
stance reflects an albeit temporary pause after a harsh winter and
the threat of rising interest rates before demand picks up in the
upcoming spring selling season.
Looking at the overall results of the Construction sector, earnings
shot up 13.9% in the December quarter, due mostly to pricing gains
and strong margins -- a major decline from a 32.1% rise in the
September quarter due to slower volumes. Total revenues were up
6.3% in the quarter versus a 9.2% rise a quarter ago. The sector
racked up an earnings beat ratio (the percentage of companies
coming out with positive surprises) of 63.6% and revenue beat ratio
of 72.7% in the December quarter.
In the first quarter, earnings and revenues are expected to grow
2.5% and 4.9%, respectively, with better growth rates expected in
quarters thereafter as the sector regains momentum.
For 2014, earnings are expected to show a 12.3% increase. Revenues
are forecast to expand 8.1%.
For more details about earnings for this sector and others, please
read our latest '
Though the harsh winter and rising home prices did put the brakes
on a housing recovery last quarter, homebuilders are increasingly
optimistic of improving demand in the upcoming spring selling
season. Many homebuilders noticed that both traffic and sales
volume showed a steady improvement in January and February as they
left the seasonally slowest months behind them.
Our proprietary Zacks Ranks indicate the movement of stocks over
the short term (1 to 3 months). At present, 16% of the stocks sport
a bullish outlook while 62% are neutral. The remaining 22% are
Stocks which will likely outperform the broader market and
currently hold a favorable Zacks Rank #1 (Strong Buy) include
William Lyon Homes
Taylor Morrison Home Corporation
) carry a Zacks Rank #2 (Buy). We are currently not enthusiastic on
Zacks Ranked #5 (Strong Sell)
MDC Holdings Inc.
) and Zacks Rank #4 (Sell) Hovnanian Enterprises and Ryland Group,
due to weak order trends in the last reported quarter.
EAGLE MATERIALS (EXP): Free Stock Analysis
HOVNANIAN ENTRP (HOV): Free Stock Analysis
LENNAR CORP -A (LEN): Free Stock Analysis
LOUISIANA PAC (LPX): Free Stock Analysis Report
MASCO (MAS): Free Stock Analysis Report
MDC HLDGS (MDC): Free Stock Analysis Report
MERITAGE HOMES (MTH): Free Stock Analysis
NVR INC (NVR): Free Stock Analysis Report
PULTE GROUP ONC (PHM): Free Stock Analysis
RYLAND GRP INC (RYL): Free Stock Analysis
TAYLOR MORRISON (TMHC): Free Stock Analysis
TOLL BROTHERS (TOL): Free Stock Analysis Report
VULCAN MATLS CO (VMC): Free Stock Analysis
WILLIAM LYON HM (WLH): Get Free Report
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