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What’s the ultimate contrarian bet? Homebuilders.As a group, homebuilder stocks are in the sixth year of a deep slump, with a 15% average annual loss over the past five years versus the S&P 500 Index’s 2.8% average annual gain.
Some industry analysts even view current conditions as indicative of a “double-dip” depression, since the expiration of the first-time-homebuyer credit last year and the hyperactive-foreclosure market have combined to stifle growth just as there were early signs of recovery last year.
The industry has slimmed down to about 10 national homebuilders, and at least half are expected to regain their strength when the economy and the credit markets come to life. Just when that might be is anyone’s guess. Potential investors will need patience and fortitude before they start seeing returns in this industry.
Kenneth Leon, a Standard & Poor’s equity analyst who follows homebuilder stocks, told TheStreet that companies in the sector are highly cyclical investments that tend to do well at the beginning of an economic recovery, so as a group, their prospects are not good now, despite some positive signs last year.
“They might be interesting from a trading perspective for a long-term investment, but we have a ‘neutral’ (rating) view on the group, and we feel homebuilders are not likely to see sustained recovery and growth until late 2012 or 2013,” he said.
But he said in a June 17 research note that most of the homebuilders are sitting on hefty cash balances which, in some cases, exceed $1 billion.
Indicative of the still-dormant new-home market, a few are looking to make money in diversified businesses. For example, Lennar is investing in distressed government mortgage securities, while Beazer Homes(BZH_), another top 10 homebuilder, has formed a business unit that will buy, improve and rent relatively new but previously owned homes.
Leon said those strategies give an insight to the homebuilders’ own view of their industry. “The gist of the story is that if you’re diversifying, you’re not positive on the growth (potential) of your core business, which in this case is building homes.”
Here are five new homebuilders’ stocks that are seen as recovering with the industry and have significant institutional investor backing:
D.R. Horton(DHI), with a market value of only $3.7 billion, has almost 91% institutional ownership, half of that from the top 10 institutional investors and led by Fidelity’s almost 15% stake. General Electric(GE), in contrast, has 60% institutional ownership.
The company is one of the largest new-home builders and operates in 72 markets across 26 states. D.R. Horton targets entry-level and first-time home buyers. It also offers finance and closing services to its buyers.
According to a FactSet survey of analysts’ ratings, it earned nine “buy” ratings, 11 “holds” and one “underperform.”
Morningstar analysts wrote in an April 7 report that “we believe the firm now sits near a trough in sales performance” and it has the potential to “drive years of double-digit sales and earnings growth going forward as the housing market recovers from a generational low realised in the last few years.
“Horton holds the financial solvency to withstand any setbacks in the recovery as well as the operational tenacity to profit from the eventual major rebound in demand,” raves Morningstar.
The company’s shares are off 4% this year, but up 9% over the past 12 months.
Toll Brothers(TOL), which focuses on high-end new homes, gets a “buy” recommendation and a four-star corporate rating from Standard & Poor’s.
And Morningstar glows about it, saying that it is “one of the most attractive long-term business opportunities in homebuilding, in our view, represented in part by its narrow economic moat.
“The firm’s well-managed indebtedness, lean operations and disciplined entrepreneurial style stemming from material inside ownership provide high visibility on the realisation of this opportunity,” said Morningstar.
Almost 85% of its shares are owned by institutional investors, about half that by the 10 largest ones, including a 15% stake by Fidelity.
Toll Brothers’ shares are up 8% this year and 16% over the past 12 months, giving the company a market value of $3.5 billion.
But Morningstar gives the company a five-star rating, its highest, and has a $21 “fair value” price target on its shares.
KB Home had $735 million in cash on the books at the end of February.
Morningstar says “KB Home operates as one of the more forward-thinking and pragmatic firms in our homebuilder coverage. The firm holds a deep-rooted merchant-like approach to its business, a differentiated strategy in an industry often dominated by more maverick, real-estate-centric mindsets.”
But Standard & Poor’s has a “sell” rating and a $10 price target. S&P forecasts that “revenues will decrease 32% (in fiscal 2011, which ends in November) as we assume the housing market will take longer to recover.”
The company has tried to differentiate itself by building new-style, smaller homes.
Despite all the negativity, 53% of the company’s shares are owned by the top 10 institutional investors, led by Fidelity with 14.7%.
Standard & Poor’s has a “buy” recommendation and gives the company a four-star rating out of a possible five. S&P reports that “we see the company benefiting from its size relative to many of its homebuilder peers, and we forecast 18% revenue growth in (fiscal) 2012 in the housing recovery we expect.”
S&P adds that “we believe return on equity will begin to improve in (fiscal) 2011. We expect profitability to be sustainable in (fiscal) 2012, largely reflecting the increased demand we foresee for new homes and more stable pricing as market conditions likely improve.”
According to Morningstar, 89% of its shares are owned by institutional investors and the top 10 own 43%, led by Fidelity with a 15% stake.
Pulte Group(PHM) is the nation’s largest new homebuilder after the company acquired Centex for $1.3 billion in 2009.
Standard & Poor’s has Pulte rated “hold” and forecasts that revenue will decline 15% in 2011 after a 21% drop in the first quarter. Net orders were flat, despite a 16% cancellation rate on total contracts.
But S&P adds that “we believe (Pulte) will be able to gain market share as the housing market slowly recovers, providing we see better execution of its post-merger plan.”
Morningstar is also upbeat, saying in an April 28 research note that “the first-quarter earnings provide some evidence that the company may finally be turning the corner.”
And it notes that Pulte held $1.4 billion in cash at the end of the first quarter, against $3.4 billion of debt.
Morningstar has a $12 “fair value” target on its shares, which is a 60% premium to its current price.
Institutional investors own 83% of its shares, while the top 10 firms hold 37%. Fidelity leads the pack at 10%.
Pulte’s shares are down 0.8% this year and off 19% over the past 12 months, giving the company a market value of $2.9 billion.
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