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A Backdoor Way To Profit From The Housing Recovery -- With 60% Upside

By: StreetAuthority
Posted: 6/25/2014 11:00:00 AM
Referenced Stocks:

Americans will never forget the real estate market crash. After 50-plus years of appreciating real estate assets, the bottom finally fell out, surprising nearly everyone. Foreclosures were rampant as homeowners were unable or unwilling to make payments as home prices rapidly depreciated.

The plunging housing prices forced the entire economy into a deep recessionary period. However, no sectors were more damaged than the businesses that depend on a thriving housing market to survive.

I am talking about builders, contractors, landscapers and a host of other businesses that provide services, products and create value for homeowners. These businesses depend directly upon rising or at least steady home prices.

One such company is the Dixie Group (NYSE: DXYN ) . This company specializes in manufacturing and selling rugs and carpets to residential and commercial customers. Dixie sells under the brand names Fabrica International, Masland Carpets and Dixie Home.

The real estate crash decimated Dixie's stock, sending shares of DXYN plunging below $2 during the real estate crash. Price has slowly worked its way back to as high as $18 at the start of 2014 as the real estate market improved.

However, DXYN has fallen from its recent highs, aided by a slowdown in real estate growth in the first quarter. This pullback has set up an ideal buying opportunity.

Residential housing is back on the growth track after struggling in the first quarter. The latest data from the S&P/Case-Shiller Home Price Index indicates housing prices have posted increases in all 20 cities that are tracked.

In addition, purchases of pre-owned homes rose nearly 5% in May, marking the largest gain since August 2011. Borrowing costs have fallen since the start of this year, which should also help spur purchases.

David Blitzer, a real estate dealmaker at private equity giant Blackstone Group and chairman of the Case-Shiller index committee, told Bloomberg : "Near-term economic factors favor further gains in housing: Mortgage rates are lower than a year ago, the (Federal Reserve) is expected to keep interest rates steady until mid 2015 and the labor market is improving." However, he added a caveat: "Housing is not back to normal."

Blitzer's statement is particularly encouraging as it reduces worries of the potential of another real estate market bubble and implies that housing is still bouncing back to just the normal level.

Internationally, the housing market is also bouncing higher from the recession lows. The most recent data from the International Monetary Fund indicates that global housing prices have climbed seven consecutive quarters.

As you can see in this IMF graphic, the United States stacks up well against the rest of the world in the housing recovery:

On top of this bullish data, U.S. consumer confidence soared to its highest level in over six years in June. In addition the Commerce Department just reported that new-home sales exploded by 18.6% in May to a seasonally adjusted annual rate of 504,000 units, the highest level since May 2008 and the biggest increase in sales since 1992.

Markets, real estate included, rarely go in a straight line higher. What happened in the first quarter, when the Fed spooked the market by intimating that it may cut back on its monetary easing, is perfectly natural in a bullish market. Profit-taking and fears stemming from short-term news are inherent parts of every financial market and should cause little concerns.

However, these pullbacks can be used by savvy traders to purchase related stocks -- like DXYN -- at a discount.

The Dixie Group is well entrenched in the carpet and rug business with a vertical manufacturing model (meaning that it's involved at every step of the manufacturing process, from raw material to finished product). It boasts a market cap of just under $144 million but annual revenue of nearly $355 million and gross profit of $85.6 million. The quarterly revenue growth is just over 13%. However, the operating cash flow comes in at a negative $6.8 million over the past 12 months.

Clearly, the company was hurt by the real estate crash and has been fighting its way higher ever since. A recent stock offering of 2.5 million shares at $10.65 certainly didn't help to keep prices near the recent highs.

The good news is Dixie's domestic carpet sales have grown 69% since the bottom of the recession in 2009. In addition, the company's focus on the high end of the carpet market has helped increase profits and earn a valuable niche in the industry. As the housing market continues to improve, Dixie should revisit its recent highs in the not-too-distant future.

The technical picture is extraordinarily bullish. A triple bottom is evident on the daily chart at the $10.50 level. Price has pushed into the mid-$11 level and appears to be building another support level at $11.

Risks to Consider: Carpet is slowly losing its popularity with homeowners. What was once considered a must has given way to wood and other hard flooring materials. However, this sea change in consumer tastes will likely take years to show up in Dixie's sales.

Action to Take --> Buy DXYN between $11 and $11.50 with stops at $10.40. I expect price to climb the ladder back up to the $18 range within the next 52 weeks, which represents upside of better than 60%.