OPPORTUNITIES
Land as Native Strength
High-End Homes Driving Prices
Margins Remain Strong
Ancillary Companies Seeing Strong Momentum
Fed to Keep Interest Rates Low
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.
WEAKNESSES
Supply Constraints
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 purchase decisions.
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 interest rate.
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. HOV 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 year-ago comparisons.
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.
Earnings Trends
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 ‘Earnings Trends.'
Bottom Line
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 bearish.
Stocks which will likely outperform the broader market and currently hold a favorable Zacks Rank #1 (Strong Buy) include William Lyon Homes WLH, while Taylor Morrison Home Corporation TMHC and NVR, Inc. NVR carry a Zacks Rank #2 (Buy). We are currently not enthusiastic on Zacks Ranked #5 (Strong Sell) MDC Holdings Inc. MDC 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 Report
HOVNANIAN ENTRP HOV: Free Stock Analysis Report
LENNAR CORP -A LEN: Free Stock Analysis Report
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 Report
NVR INC NVR: Free Stock Analysis Report
PULTE GROUP ONC PHM: Free Stock Analysis Report
RYLAND GRP INC RYL: Free Stock Analysis Report
TAYLOR MORRISON TMHC: Free Stock Analysis Report
TOLL BROTHERS TOL: Free Stock Analysis Report
VULCAN MATLS CO VMC: Free Stock Analysis Report
WILLIAM LYON HM WLH: Get Free Report
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