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Homebuilding Industry Outlook: Margin Woes to Continue

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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.

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

  • The operating backdrop has been tough for the U.S. homebuilding space this year, thanks to rising mortgage rates, higher construction costs, shortage of skilled labor and a dearth of buildable lots. Lower supply of homes has already pushed home prices higher in several parts of the country. This, along with rising mortgage rates, is making houses less affordable for buyers (mostly the first time ones). On the other hand, rising land and labor costs are eating into homebuilders’ margins.
     
  • Homebuilders are also distressed by higher aluminum and steel costs as a consequence of the newly imposed tariffs on these inputs. This, coupled with increased lumber prices owing to an import tariff, is denting builders’ margins.
     
  • Improving economic conditions, rising disposable income and favorable demographic changes are continuing to support demand. The U.S. economy is clearly on a solid footing buoyed by impressive labor market, unemployment at a 49-year low, rising wages and modest inflation.


Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Building Products - Home Builders Industry is a 16-stock group within the broader Zacks Construction Sector. The industry currently carries a Zacks Industry Rank #239, which places it at the bottom 7% 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 dismal near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since the beginning of June this year, the industry’s earnings estimate for the current year has gone down by approximately 3.2%.

Despite the industry’s dull near-term prospects, we will present a few homebuilding stocks that one can hold on to. But it’s worth taking a look at the industry’s shareholder return and current valuation.


Industry Lags on Stock Market Performance

The Zacks Building Products - Home Builders industry has lagged the broader Zacks Construction Sector as well as the S&P 500 index over the past year.

Over this period, the industry has declined 27.8% versus the broader sector’s decline of 21.8% and the S&P 500 Index gain of 3.7%.

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 6.8X compared with the S&P 500’s 15.77X and the sector’s 10.86X.

Over the last five years, the industry has traded as high as 16.06X, as low as 6.8X, with the median at 11.87X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)


 

Bottom Line

While concerns surrounding limited supply, rising mortgage rates and higher material costs have been plaguing the industry of late, homebuilders remain positive on ongoing traffic trends that indicate higher inclination of buyers.

Currently, the Zacks Building Products - Home Builders industry doesn’t have any stocks carrying a Zacks Rank #1 (Strong Buy) or 2 (Buy). However, below we have discussed four stocks that have solid earnings growth prospect and investors may want to hold on to for the time being. You can see the complete list of today’s Zacks #1 Rank stocks here.

Lennar Corporation (LEN - Free Report) : For this Miami, FL based homebuilding company, the Zacks Consensus Estimate for 2018 EPS indicates year-over-year growth of 29.7%. The company, a Zacks Rank #3 (Hold) stock, has an estimated long-term earnings growth rate of 18.2%. It came up with an average positive surprise of 68.9% in the trailing four quarters.

PulteGroup Inc. (PHM - Free Report) : This Atlanta, GA based homebuilder has solid expected earnings growth of 64.4% for the current year. The company carries a Zacks Rank #3 and has an estimated long-term earnings growth rate of 18%. It has an average positive earnings surprise of 15.5% for the trailing four quarters.

D.R. Horton, Inc. (DHI - Free Report) : This TX-based homebuilder has solid expected earnings growth of 42% for the current year. The company carries a Zacks Rank #3 and has an estimated long-term earnings growth rate of 10%. It has an average positive earnings surprise of 8.9% for the trailing four quarters.

Toll Brothers Inc. (TOL - Free Report) : This Horsham, PA-based homebuilding company has a solid expected earnings growth of 44.2% for the current year. The company carries a Zacks Rank #3 and has an estimated long-term earnings growth rate of 15.6%. It has an average positive earnings surprise of 10.3% for the trailing four quarters.

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Toll Brothers Inc. (TOL) - free report >>

PulteGroup, Inc. (PHM) - free report >>

Lennar Corporation (LEN) - free report >>

D.R. Horton, Inc. (DHI) - free report >>

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