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Bull of the Day: DR Horton Inc.

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DR Horton (DHI - Free Report) is America’s biggest homebuilder by volume and has held that position for the last 16 years. They operate in 26 states across the country and now build about 50,000 new homes per year in a wide range of prices from $100,000 to over $1,000,000. Homebuilding stocks have been sluggish in 2018, as fears of increased costs - as a result of lumber tariffs - and higher interest rates have had investors concerned about both margin and demand for new homes. Neither problem has actually materialized however, and earnings are as strong as ever.


The iShares U.S. Home Construction ETF (ITB - Free Report) has fallen over 14% year-to date and shares of DR Horton are down nearly 8%.


Double -Whammy in Lumber Prices and Interest Rates


In May of 2018, Lumber prices at the Chicago Mercantile Exchange reached all-time highs of $655/per 1000 board feet, due primarily to U.S. Tariffs on Canadian lumber imports. Shares in homebuilder shares took a hit as the average price of a new home was expected to rise as much as $9000 as a result of higher costs on their most important raw material.

In June, the leadership of the National Association of Home Builders (NAHB) met with U.S. Commerce Secretary Wilbur Ross and came away satisfied that the U.S. would continue negotiating with Canada on trade issues with an eye on ensuring a “stable supply of lumber at reasonable price to keep housing affordable for hard-working American families.”


Source: CME Globex

Lumber prices have fallen precipitiously in the past two months and are currently at $460, just slightly above their multi-year average.


Simultaneous with the spike in lumber prices, expectations of rising long-term interest rates threatened demand for new homes. The benchmark 10-year treasury yield briefly topped 3% for the first time since 2014, but has since fallen back to 2.85% as the yield curve flattened. 30-year mortgages remain near historic lows.


Shrugging off the Negative News


In the midst of what once appeared to be a perfect storm for homebuilders, DR Horton continued to post impressive results, most recently beating the Zacks Consensus Estimate for fiscal Q3 by almost 10%.


Thanks to positive guidance in the earnings presentation, analyst expectations are on the rise - with 16 upward revisions for full year 2018 in the past 30 days. DHI is a Zacks Rank #1 (Strong Buy).


Contrary to the idea that demand for new homes would soften, DHI management reported that orders for new homes in the quarter increased 12% to 14,650 homes and 13% in value to $4.4 billion while cancellation rates remained unchanged, suggesting continued growth on the horizon.


Chairman Donald R. Horton commented, “We continue to grow our revenues and pre-tax profits at a double-digit annual pace, while generating increasing annual operating cash flows and returns. With 29,800 homes in inventory at the end of June and 277,700 lots owned and controlled, we are well-positioned for the fourth quarter and fiscal 2019.”


Attractive Valuation


With the recent decline in share price and upward revisions, DHI is now trading at a 12 month forward P/E ratio of just 9.8X, near its historical lows.



When an otherwise solid company has its shares battered amid negative expectations for the entire industry yet continues to perform, it can represent a true value opportunity. If the reasons for the negative expectations fail to materialize, it’s time to buy.
 

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