Homebuilding on Solid Footing: Low Mortgage Rates Hold Key

Shrabana Mukherjee

The Zacks Building Products - Home Builders industry comprises manufacturers of residential and commercial buildings. Some of the industry players are involved in providing financial services that include selling mortgages and collecting fees for title insurance agency and closing services.

Notable companies in the industry include Lennar Corporation (LEN), NVR, Inc. (NVR), D.R. Horton, Inc. (DHI), PulteGroup, Inc. (PHM) and Toll Brothers, Inc. (TOL).

Let’s take a look at the industry’s three major themes:

  • The U.S. housing industry has been reaping benefits from the U.S. Federal Reserve’s dovish monetary stance. Lower mortgage rates have been spurring demand in this rate-sensitive housing market. This, along with a stable economy, rising disposable income and favorable demographic changes are continuing to support demand.
     
  • Raw material prices — which have been increasing over the past few months due to the initial effects of tariffs on items like steel, aluminum and softwood lumber — are now decreasing. This should provide a meaningful boost to margins in the near term. According to an Associated Builders and Contractors' analysis of information provided by the U.S. Bureau of Labor Statistics, construction material prices dropped 2.2% on a yearly basis in October 2019.
     
  • However, despite the fact that declining mortgage rates and lower housing prices have been driving traffic after a tough second half of 2018, the conversion of that traffic into signing of purchase contracts slowed down in the high-end housing market. Softness in home purchases in this particular segment, in response to affordability challenges and general market uncertainty, are impacting the order flow of luxury homebuilders like Toll Brothers. Again, shortage of skilled labor is a pressing concern. Homebuilders continue to be cautiously optimistic about the industry’s prospects owing to rising land and labor costs. Again, rising incentives to drive sales are eating into margins.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Building Products - Home Builders industry is an 18-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #35, which places it at the top 14% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates upbeat near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s earnings growth potential. Since June 2019, the industry’s earnings estimates for 2019 and 2020 have gone up approximately 5.7% and 7.1%, respectively.

Given the solid near-term prospects, we will present a few stocks that have the potential to outperform the market. But before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Outperforms Sector and S&P 500

The Zacks Building Products - Home Builders industry has outperformed the S&P 500 Index and the broader Zacks Construction sector in the past year.

Over this period, the industry has gained 47.4% compared with the S&P 500’s increase of 15.4% and the broader sector’s 28.7% growth.

One-Year Price Performance

 

Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings (P/E) ratio, which is commonly used for valuing homebuilding stocks, the industry is currently trading at 10.7X compared with the S&P 500’s 18.1X and the sector’s 15.8X.

Over the last five years, the industry has traded as high as 15.1X and as low as 7.3X, with the median at 11.1X, as the chart below shows.

Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500



Bottom Line

Indeed, the U.S. housing space continues to grapple with labor shortage and a dearth of buildable lots. That said, the recent softening in home price appreciation, low mortgage rates and the Fed’s dovish stance should spur home buying activity in the near term.

Currently, there are five top-ranked stocks in the Zacks Building Products - Home Builders industry that are cashing in on the solid industry fundamentals.

Meritage Homes Corporation (MTH): This Scottsdale, AZ-based company designs and builds single-family homes in the United States. This stock also sports a Zacks Rank #1 (Strong Buy) and has a trailing four-quarter positive earnings surprise of 19.2%, on average. The Zacks Consensus Estimate for its 2019 and 2020 earnings has gone up 4.4% and 7.1%, respectively, over the past 60 days. You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: MTH



PulteGroup Inc.: This Atlanta, GA-based homebuilder currently sports a Zacks Rank #1. The company has a trailing four-quarter positive earnings surprise of 10.5%, on average. The Zacks Consensus Estimate for its 2019 and 2020 earnings has moved up 3.5% and 4.8%, respectively, over the past 60 days.

Price and Consensus: PHM



M/I Homes, Inc. (MHO): Based in Columbus, OH, this homebuilding company builds single-family homes in Ohio, Indiana, Illinois, Minnesota, Maryland, Virginia, North Carolina, Florida, and Texas in the United States. The Zacks Consensus Estimate for this Zacks Rank #1 company’s 2019 earnings has gone up 14.6% over the past 60 days. It has a trailing four-quarter positive earnings surprise of 16.2%, on average.

Price and Consensus: MHO




D.R. Horton, Inc.: This Texas-based homebuilder currently carries a Zacks Rank #2 (Buy). The Zacks Consensus Estimate for its fiscal 2020 earnings has moved 6.3% north over the past 60 days. It has an expected earnings growth of 13.8% for the current fiscal year.

Price and Consensus: DHI


NVR, Inc.: Headquartered in Reston, VA, this homebuilder currently carries a Zacks Rank #2. The Zacks Consensus Estimate for its 2019 and 2020 earnings has gone up 2.1% and 0.9%, respectively, over the past 60 days. It has a trailing four-quarter positive earnings surprise of 22.2%, on average.

Price and Consensus: NVR



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Toll Brothers Inc. (TOL) : Free Stock Analysis Report
 
PulteGroup, Inc. (PHM) : Free Stock Analysis Report
 
NVR, Inc. (NVR) : Free Stock Analysis Report
 
Meritage Homes Corporation (MTH) : Free Stock Analysis Report
 
M/I Homes, Inc. (MHO) : Free Stock Analysis Report
 
Lennar Corporation (LEN) : Free Stock Analysis Report
 
D.R. Horton, Inc. (DHI) : Free Stock Analysis Report
 
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