Memories of the U.S. housing crash in the mid-to-late 2000s are still fresh for a lot of people.
So there would be an understandable skepticism to the forecast that the current U.S. housing boom could last another decade.
But there’s a convincing case to be made based on lack of supply, favourable demographics, and stronger business models for homebuilders to suggest that the strength in the housing market could last for several years.
Here are the hi-lights of a Barron’s feature providing an overview of the housing market and a look at six different types of homebuilder companies that could benefit from this trend.
Housing is booming. Just take a look at Century Communities ’ development in Tumwater, Wash., where more than 140 homes, at prices as high as $500,000, have been sold this year.
Tumwater is viewed as a suburb of Seattle—even at 60 miles away. It’s a scene that has been repeated over the past two years in markets all across the country.
Are we nearing a peak?
No, say the housing bulls on Wall Street, who argue that this is an upturn that could last for a decade.
Millions of millennials are now at a point in their lives when they are seeking single-family homes in the suburbs and exurbs.
They are entering a market still chastened by an unprecedented collapse in housing more than a decade ago.
“This market is primarily driven by a lack of supply, not excess demand,” says Stephen Kim, a housing analyst at Evercore ISI.
“The supply shortage built up over 10 years, and it won’t go away quickly.”
The numbers support Kim’s assertion. Inventories of existing homes remain near historically low levels.
Construction starts on new single-family housing, meanwhile, will finally top one million this year after averaging fewer than 750,000 in the previous 10 years.
That would still be below the 1.6 million annual starts from 2004 to 2006, the peak years of the housing bubble.
“The industry would need to sustain a two-million-starts pace for a decade to bring the industry out of its current under-built situation,” Kim argues.
With that as the backdrop, here are six homebuilder ideas to capitalize to consider:
D.R. Horton (NYSE:DHI)
The industry leader constructs roughly one in 10 new homes in the country—over 80,000 in its latest fiscal year.
It has the industry’s largest market value at $37 billion and one of the highest returns on equity at 31%.
Entry-level homes account for about half of its business.
“Horton has done a superb job bringing down debt levels while at the same time growing the business and positioning itself for the future,” says Wedbush’s McCanless.
Horton now controls over 500,000 lots—enough for more than five years of building at 2022’s expected pace.
Its shares, at a recent $103, trade for about seven times the current earnings consensus of $14.22 a share for the company’s fiscal year ending in September.
The shares yield 1%.
Kim of Evercore ISI sees earnings of about $18 a share, arguing that Horton’s gross margins, now about 27%, can hit 30%.
He has an Outperform rating and a price target of $163.
The No. 2 home builder in terms of market value has done the best job among its peers of developing related businesses.
These include multifamily and single-family rental housing ventures and investments like a stake in Opendoor Technologies (OPEN), the online home buyer.
Lennar plans to spin off a group of noncore businesses, although it hasn’t yet provided details. Shares, at about $113, trade for 7.7 times projected 2022 earnings of almost $15 a share.
Chairman Stuart Miller says that “the best of times” for home builders still have a way to go.
“Since new-home construction cannot ramp quickly enough to fill the void of the production deficit that persisted over the past decade, short supply is likely to remain for some time to come,” he said on the company’s latest earnings conference call.
Investors can invest alongside Miller in the company’s super-voting B shares, which trade at $92, a big discount to the more-liquid Class A shares.
GoodHaven’s Pitkowsky also favours the B shares, and they are probably the best way for retail investors to play Lennar, given the possibility that the share classes combine.
Toll Brothers (NYSE:TOL)
With its luxury focus, Toll is the most differentiated of the major home builders, and its competitive position is probably the strongest, since it competes primarily with smaller private builders.
Toll shares, at about $68, trade for 7.6 times projected earnings of $9 a share in the company’s fiscal year ending in October 2022.
“The higher end of the market has seen the biggest reversal of fortune—in a good way,” says Kim, noting weakness before the pandemic.
Toll is benefiting from a larger pre-pandemic land position than peers. He has an Outperform rating and a price target of $86.
Higher-income white-collar workers—Toll’s core customer base—tend to have more work-from-home flexibility, and that is translating into strong demand, with the average buyer spending $160,000 on extras like home offices and multigenerational suites.
And with longer construction periods than peers on its homes that can stretch a year or more, Toll’s earnings gains could play out deep into 2022.
The company has developed what it calls “affordable luxury” homes in less expensive markets like South Carolina, with homes that sell on average for about $740,000 and make up about 40% of its business.
The No. 3 U.S. home builder caters mainly to first-time and move-up buyers.
Through its Del Webb and DiVosta brands, it builds “active adult” communities catering to those near, and in, retirement.
Its shares, at about $52, are among the cheapest of its large-cap peers at under six times projected 2022 earnings.
As more of a build-to-order company than D.R. Horton and Lennar, Pulte’s earnings have more upside potential, since its current closings reflect older orders.
And sales prices on new orders were up 26% year over year in the third quarter, pointing to higher 2022 earnings.
The company has one of the best balance sheets among its peers, with minimal net debt.
J.P. Morgan’s Rehaut is bullish on the company, citing its financial strength and a return on equity of more than 25%.
He has a price target of $71.
Century Communities (NYSE:CCS)
Since going public seven years ago, the Colorado home builder has expanded to 17 states and become the country’s ninth-largest builder.
The bulk of Century’s sales go to entry-level buyers. Its Century Complete brand offers low-price homes with no options—the average selling price is just $207,000—around smaller cities like Jacksonville, Fla., and Louisville, Ky.
“Century is leveraging its buying power to enter smaller markets where it can build homes to be competitive with the local resale market,” says Wedbush’s McCanless.
Shares, at about $72, trade for five times projected 2022 earnings of about $15 a share.
McCanless has an Outperform rating and a $110 price target on the stock.
Meritage Homes (NYSE:MTH)
The high-growth Arizona-based builder is focused on the entry-level market in the Southeast and Southwest U.S., with an average selling price of about $400,000.
“We’re in the affordable part of the market,” Phillippe Lord, Meritage’s CEO, tells Barron’s.
“Our part of the market will be more resilient” if interest rates rise, he says, adding that Meritage homes offer higher quality and better design than other entry-level rivals.
Meritage, whose shares trade for about $118, is expected to generate nearly 75% growth in earnings this year to $19 a share, and a 21% gain in 2022 to $23 a share.
The stock trades for just five times projected 2022 earnings.
After its third-quarter results, the company “executed extremely well,” despite materials shortages, Kim said.
He has an Outperform rating and a price target of $190 a share.
U.S. home builders have never been in better shape.
Even after a strong 2021, their stocks could be poised for many years of gains.
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