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We maintain our Neutral recommendation on D.R. Horton Inc. (DHI - Analyst Report) following appraisal of the third quarter of fiscal 2012 results.

D.R. Horton’s adjusted earnings of 23 cents per share in the third quarter of fiscal 2012 beat the Zacks Consensus Estimate by 15% and the prior-year quarter earnings by 155% driven by an increase in homebuilding revenues as overall demand for new homes improves. Homebuilding revenues climbed 14.0% to $1.12 billion, driven by growth in net sales orders, homes closed and sales order backlog as the housing market recovers.

Management expects home closings and pre-tax income to increase both yearly and sequentially in the fourth quarter of fiscal 2012 following the solid backlog position at the third quarter end and increased pace of sales, even in July. In fact, pre-tax income is expected to grow in upcoming years also, driven by a solid balance sheet, lower debt and resultant interest costs, improved liquidity position and rising inventory.

With a gradual recovery in the overall economy, the homebuilding industry is finally seeing signs of stabilization in 2012. The downturn during 2006-2008 had hurt the homebuilding sector hard. The housing market is benefiting from an increase in employment rates, higher consumer confidence and several years of pent-up demand. D.R. Horton is witnessing better year-over-year growth in revenues, driven by an increase in new home orders and average selling prices. Backlogs and homes delivered are also climbing year over year.

D.R. Horton’s strong cash position and low debt/capital ratio allows it to make opportunistic land purchases, thus giving it a significant competitive advantage. The pace of the D.R. Horton’s investments in homes under construction, land development and finished lots has increased following the improved liquidity position from solid sales growth in the first nine months of 2012. The company also aims to shift its product mix toward higher margin move up homes to improve profitability. D.R. Horton also continuously evaluates new submarkets.

Moreover, D.R. Horton’s strong cash flows are being used to pay back its outstanding debts. Diligent debt-payback policies have helped lower interest costs and spur profitability. In addition to lower interest costs, management is also making an effort to reduce other costs. Selling, general & administrative (SG&A) expense has declined as a percentage of sales in first nine months of 2012, driven by cost control and better fixed cost leverage. SG&A as a percentage of revenue is expected to improve further in the fourth quarter due to strong home closings and better fixed cost leverage.

Though demand trends for new homes are slowly stabilizing, management expects the overall demand for new homes to remain at low levels for some time. The housing market improvement has been uneven across the company’s operating markets. Most of the gains have, by and large, been observed in high-end communities. In addition, homebuilders are still facing impediments in raising prices in some markets. The overall demand still remains constrained due to tight credit standards, which make it difficult to obtain home loans. A speedy housing recovery is unlikely and it will take some time before the markets fully recover. We would thus prefer to remain on the sidelines until we witness a speedy recovery in the overall housing market.

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