Every spring, the same headline flashes across the screen: "The
housing sector is perking up and it's time to buy." As time passed,
the newfound momentum invariably petered out, leading to the
follow-up refrain "wait 'til next year."
The fact that housing stocks posted solid gains in the past few
quarters led me to think investors were setting up for another
false dawn. Yet after parsing a range of data points coming out of
the housing sector in recent weeks, it indeed looks as if housing
has finally embarked on the long-awaited rebound that many have
been hoping for.
Make no mistake: it's still a sickly sector. The fact that
shares
of many major players are already up solidly from their lows means
that housing stocks hold little appeal to value investors. But for
growth-oriented investors, these stocks may be shaping up to be one
of the better opportunities of the next 24-36 months.
Such a bargain
Many Americans have opted to rent rather than own their homes, but
that could change quickly if the
economy
gets a bit stronger in the next year or two. That's because homes
have not been this good a deal since 1970. That's the last time the
National Association of Realtors' Housing Affordability
Index
surged above 200. In the first quarter of 2012, it hit
205.9.
Low inventories create scarcity
One thing is for sure: there are a lot fewer existing homes for
sale in almost every major
market
. According to housingtracker.com, the number of listings in the
country's 20 largest metropolitan areas fell roughly 25% in the 12
months ended March, led by drops of 40% or more in Phoenix,
Sacramento, Calif., and Tampa, Fla. Meanwhile, falling inventories
appear to be spurring consumers into action: the markets that have
had the greatest glut of unsold existing homes in the past are now
showing some of the greatest gains. From March 2011 to March 2012,
sales of existing homes shot up 35% in Phoenix, 16% in Denver, 15%
in Miami and 11% in Dallas. On a nationwide basis, home sales rose
another 3.4% sequentially in April, on a seasonally-adjusted
basis.
As the supply of existing homes falls, home builders are in a
better position to lure in buyers to get a closer look at
newly-built homes. It helps that home builders have shown a lot of
restraint in the past few years, keeping construction activity at a
low boil. Even as demand for new homes has been weak, the supply
has been even weaker. From March, 2011 to March 2012, the supply of
new homes for sale by the nation's 25 largest homebuilders fell
28%. And the low
inventory
has finally helped spur price increases in certain
markets.
For example, on recent conference calls,
Ryland Group (
RYL
)
said that prices have been boosted in 25% of the 200 housing
communities it serves.
PulteGroup (NYSE:
PHM
)
said it has stopped discounting homes to expedite sales, and
Meritage Homes (NYSE:
MTH
)
has pushed through price increases on roughly two-thirds of its
available homes.
The long climb back for prices
Housing prices have fallen so sharply in the last half-decade that
it could take many years to return to previous peaks (and even
longer to return to inflation-adjusted levels). If history is any
guide, then housing prices will only slowly creep up during the
next few years, and it will be the middle of the decade before more
robust pricing gains will be seen. Analysts at Guggenheim Partners
expect home prices to rise just 3% this year and again in
2013.
Yet even that modest figure can help
profit
margins for home builders. Coupled with forecasts of 15% more new
homes being sold this year, analysts at Guggenheim anticipate
revenue for publicly-traded home builders to rise nearly 20% this
year -- and in many instances, even greater profit growth.
Lastly, it's unclear how the glut of foreclosed homes will
affect the market once banks have worked through their current set
of legal challenges and put homes up for sale. Currently, banks
appear to be working more closely with homeowners, adjusting loans
to keep them in their homes, which may limit any future
foreclosure-related glut. Importantly, the number of homes going
into
foreclosure
is now falling rapidly, as April 2012 figures represent a five-year
low.
Valuations: taking it on faith
For investors, waiting around tospot value plays in housing stocks
may be futile. These stocks are up sharply from their 52-week lows
and won't look like bargains based on near-term results. Instead,
investors will need to believe that 2012 and 2013 results are just
the start of even better days to come as we head into the middle of
the decade.
Guggenheim Partners, for example, recently upgraded many stocks
with new price targets that reflect P/E (price-to-earnings) ratios
of around 25 times projected 2013 profits. They see shares of
D.R. Horton (NYSE:
DHI
)
rising from a recent $17 to $27 by that math. They also say
Lennar (NYSE:
LEN
)
could rise from the current $28 to $37, and predict Ryland Group
could rise from $23 to $34.
Goldman Sachs recommends
MDC Holdings (NYSE:
MDC
)
, which has 30% upside to its $36
price target
. It notes MDC is seeing solid demand in its markets, sports a very
strong
balance sheet
, and offers an attractive 3.5%
dividend yield
.
Analysts at UBS prefer
Beazer Homes (NYSE:
BZH
)
, spotting more than 100% upside to their $5.50 price target. They
say Beazer has the makings of a solid
turnaround
under new
CEO
Allan Merrill, who took the reins a year ago. Their target price
implies a move up to just 1.1 times
book value
.
Risks to Consider:
Further gains in housing will be tied to employment trends. The
economy likely needs to create an average of 150,000 jobs a month
in order to provide a tailwind to housing. This Friday's monthly
employment report should be closely watched by investors who are
interested in home building stocks.
Action to Take -->
These stocks are best pursued with 1-2 year time horizons because
their outperformance relative to the S&P 500 thus far in 2012
makes them vulnerable to profit-taking if the market slumps
further. Despite recent gains, sector share prices don't begin to
reflect the profit potential of these companies if housing demand
is truly solid by mid-decade. The housing stocks I mentioned
earlier should all be on your watchlist.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.