A "Hard Landing For Housing": This Luxury Homebuilder Is 'Best' 'Risk-Reward' Stock

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  • Raymond James analyst Buck Horne said the seemingly perennial event known as the 'Hope Trade' for homebuilders has not disappointed, even amid mounting evidence of accelerating home price weakness, inventory growth, and buyer retrenchment.
  • Despite the growing optimism that the U.S. economy can thread the needle, the analyst still believes a hard landing for housing is still the most likely path forward in 2023.
  • The Fed's determination to tame inflation will create a difficult correction for home prices, as tight labor markets and cash-flush consumers set the stage for continued rate hikes near-term., the analyst cited.
  • Also ReadHomebuilder Confidence Continues To Fall, Analyst Expects Industry To 'Slow Further In 2023'
  • The analyst added that despite the recent pullback in mortgage rates (to ~6.5%), payment/income ratios remain uncomfortably above prior 2006 peaks.
  • Buck cited that the home sales activity and buyer traffic remain shellshocked entering 2023, and housing markets across the country remain in price discovery mode.
  • The analyst said that margins will be sacrificed to keep inventory moving and cash flows positive.
  • The analyst believes the market has now fairly discounted the industry's best-in-class homebuilder, bidding up shares of D.R. Horton Inc DHI by 32% in 4Q22 and taking its book value multiple up to a mid-cycle 1.7x valuation.
  • Given the unpredictability of interest rates near-term, the analyst still thinks it's important for investors to keep at least one "line in the water" with respect to homebuilders.
  • The analyst has downgraded D.R. Horton from Outperform to Market Perform with a price target of $61.00.
  • The analyst said the best most attractive risk/reward opportunity lies in moving up the price point curve towards Toll Brothers Inc TOL, which is still trading at just 1.0x tangible book value and 7.9x CY23 EPS despite its very encouraging 2023 guidance.
  • Horne upgraded Toll Brothers from Market Perform to Outperform with a price target of $61.
  • While most of its peers are only able to offer limited earnings visibility into 2023, TOL's high-end $8.9 billion backlog of ~8,100 homes provide ample clarity into its ability to deliver solid 2023 earnings.
  • The analyst expects less volatility around TOL's earnings estimates, with its more affluent buyers less sensitive to mortgage rate volatility, and with more readily available cash-on-hand.
  •  The analyst said that homebuilder balance sheets are better prepared for a downturn than at any other point in the sector's history.
  • Due to affordability pressure and economic uncertainty, young adults are increasingly staying with their parents or bundling up with roommates to wait out the economic downturn.
  • The analyst added that interest rate volatility and the resulting economic uncertainty are causing a broad-spectrum reduction in housing demand and household formation.
  • Also ReadUS Housing Starts: Single Family Permits Fall, But Completions Rise, Adding Supply
  • Price Action: TOL shares are up 1.32% at $53.81 on the last check Monday.
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