Raymond James Downgrades US Homebuilders On Mortgage Rate Hike

  • Raymond James analyst Buck Horne lowered the rating on the shares of KB Home KBHLennar Corp LENM.D.C. Holdings Inc MDCPulteGroup Inc PHM, and Toll Brothers Inc TOL to Market Perform.
  • He downgraded the shares of D R Horton Inc DHI to Outperform rating from Strong Buy. 
  • The move comes after a 200 basis point increase in thirty-year mortgage rates over the past 2.5 months. 
  • With average effective mortgage rates now north of 7%, virtually all housing affordability metrics tracked are now in unprecedented territory, said the analyst.
  • Horne calculated the monthly finance for a median existing home would be almost 42% of a median family's gross income at current prices, topping the prior 40% record that marked the 2006 housing peak.
  • With the Federal Reserve ready to raise rates further, "we cannot predict when/if credit spreads will begin to normalize," he added.
  • As such, he noted the housing sector and homebuilders must now brace for a Fed-assured hard landing, with significantly lower absorption rates and downward pressure on new home prices. 
  • With assumptions now embedded in his new Street-low EPS estimates, including, Absorption rates (orders per community per month) dropping to 2011 levelsNew home average order prices dropping 20-25% by FY23, and gross margins declining y/y between 650-1,000 basis points from 4Q22 to 4Q23.
  • Horne thinks it would take a sustained and severe economic recession throughout next year to put any prospective 2024 estimates in the red.
  • He anticipates another surge of elevated cancellation rates in the upcoming homebuilders' earnings, both due to qualification issues and buyers' remorse. 
  • He said that one bright spot could be some homebuilders' pivot to building homes specifically for the single-family rental sector.
  • Though the analyst expects the unprecedented interest rate surges to stall out near-term housing demand, he continues to believe the U.S. housing market remains structurally undersupplied.
  • Price Action: PHM shares are trading higher by 1.65% at $37.19 on the last check Friday.
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