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2 Homebuilding Stocks to Watch in a Challenging Industry
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The U.S. housing space continues to grapple with accelerating mortgage rates, and rising raw material and labor costs. Disruption in the supply chain has been impacting builders’ ability to deliver on time. That said, the rising need for more work-at-home space, lack of existing homes for sale, focus on cost control, increased operating leverage and important buyouts have been somewhat aiding the Zacks Building Products - Home Builders industry. Companies like D.R. Horton, Inc. (DHI - Free Report) and Toll Brothers Inc. (TOL - Free Report) have been gaining from their fundamental strength and the above-mentioned tailwinds.
Industry Description
The Zacks Building Products - Home Builders industry comprises manufacturers of residential and commercial buildings. Some industry players are involved in providing financial services that include selling mortgages and collecting fees for title insurance agencies as well as closing services. The industry players are involved in building single-family detached and attached home communities; townhouses, condominiums, duplexes and triplexes; master-planned luxury residential resort-style golf communities; and urban low, mid, and high-rise communities. The companies are also involved in the purchase, development and sale of residential land. Additionally, the companies build and own multi-family rental properties; residential real estate; and oil and gas assets.
3 Trends Shaping the Homebuilding Industry's Future
Higher Rates: The home affordability issue remains a headwind owing to accelerating home prices and mortgage rates this year. While remaining committed to combating inflation, the Fed has raised rates four times since March this year, with a 75-basis-point increment at each of its last two meetings. On Nov 2, 2022, the Fed raised the rates by 75 basis points so as to maintain the federal funds rate in a target range of 3.75 to 4%. Although Fed chairman Jerome Powell’s recent comment about lowering the magnitude of the rate hike from December 2022 has come as a breather, fears of a global slowdown and a recession loom over the stock market. This is less encouraging for this rate-sensitive market, which accounts for almost 3% of the economy. Rising borrowing costs and elevated risk of recession have been driving the single-family homebuilding market into recession.
Supply Chain Hurdles & Tight Labor Market: Supply-chain challenges are expected to continue to impact the level of housing starts and construction cycle times. Continuous supply-chain issues arising from the COVID-19 outbreak and response to the health crisis in various countries have been impacting builders’ ability to deliver on time. Rising material costs are quite challenging. According to Associated Builders and Contractors' latest analysis of information provided by the U.S. Bureau of Labor Statistics, although construction input prices declined 0.9% in November from October, the metric was up 11.9% from a year ago. With COVID-related lockdowns continuing in China and Europe facing severe energy crises, supply chain disruptions are likely to persist in the near term as well. Again, the shortage of skilled labor continues to be a pressing concern.
Cost-Control Efforts, Focus on Entry-Level Buyers & Acquisitions: Given the accelerated raw material prices, companies have been relying on effective cost control and focusing on making the homebuilding platform more efficient, which in turn is resulting in higher operating leverage. Homebuilders have been controlling construction costs by designing homes efficiently and obtaining construction materials and labor at competitive prices. Some homebuilders also follow a dynamic pricing model, which enables them to set the price according to the latest market conditions.
Also, the majority of companies are focused on growing the demand for entry-level homes and addressing the need for lower-priced homes, given affordability concerns prevailing in the U.S. housing market. Meanwhile, industry players have been acquiring other homebuilding companies in desirable markets, resulting in improved volumes, market share, revenues as well as profitability.
Zacks Industry Rank Indicates Dull Prospects
The Zacks Building Products - Home Builders industry is a 19-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #210, which places it in the bottom 15% 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 bleak 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 positioning in the bottom 50% of the Zacks-ranked industries is a result of bleak 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 October 2022, the industry’s earnings estimates for 2022 and 2023 have decreased approximately 3.2% and 13.3%, respectively.
Despite the industry’s blurred near-term view, we will present a few stocks that one may consider adding to their portfolio. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.
Industry Lags Sector and S&P 500
The Zacks Building Products - Home Builders industry has lagged the S&P 500 Index and the broader Zacks Construction sector in the past year.
Over this period, the industry has lost 22% compared with the S&P 500’s decline of 16.7% and the broader sector’s 19.4% decline.
One-Year Price Performance
Industry's Current Valuation
On the basis of the forward 12-month price-to-earnings ratio, which is commonly used for valuing homebuilding stocks, the industry is currently trading at 7.9 compared with the S&P 500’s 17.5 and the sector’s 13.6.
Over the last five years, the industry has traded as high as 14X and as low as 4.2X, with a median of 8.9X, as the chart below shows.
Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500
D.R. Horton: Based in Texas, this homebuilder offers a diverse line of homes across various price points through multi-brand platforms like D.R. Horton, Emerald Homes, Express Homes and Freedom Homes. Further, the company enjoys one of the broadest geographic diversities in the industry and is not dependent on any particular market. It has a strong presence in 106 markets across 33 states in the East, Midwest, Southeast, South Central, Southwest and West regions of the United States. With 573,000 lots in inventory in fiscal 2022, D.R. Horton is well-poised for the future. Although the company’s total homebuilding lot position decreased by 25,000 lots from June to September 2022, the company has been actively managing the lot and land pipeline and investments in lots, land and development to meet needs during this transition in the housing market. Impressive performance, industry-leading market share, a solid acquisition strategy, a well-stocked supply of land, lots and homes along with affordable product offerings across multiple brands are expected to drive growth.
D.R. Horton’s earnings are expected to grow 1.7% in fiscal 2023. The stock has gained 24.9% over the past three months, outperforming the industry’s 19% rise.
Price and Consensus: DHI
Toll Brothers: Based in Horsham, PA, Toll Brothers is a leading builder of luxury homes. The company has been benefiting from its strategy of broadening the product lines, price points and geographies. Also, it has been gaining from the lack of competition in the luxury new home market, its build-to-order approach and solid backlog level.
Earnings of Toll Brothers are expected to grow 1.3% in fiscal 2023. The stock has gained 14.9% over the past three months.
Price and Consensus: TOL
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2 Homebuilding Stocks to Watch in a Challenging Industry
The U.S. housing space continues to grapple with accelerating mortgage rates, and rising raw material and labor costs. Disruption in the supply chain has been impacting builders’ ability to deliver on time. That said, the rising need for more work-at-home space, lack of existing homes for sale, focus on cost control, increased operating leverage and important buyouts have been somewhat aiding the Zacks Building Products - Home Builders industry. Companies like D.R. Horton, Inc. (DHI - Free Report) and Toll Brothers Inc. (TOL - Free Report) have been gaining from their fundamental strength and the above-mentioned tailwinds.
Industry Description
The Zacks Building Products - Home Builders industry comprises manufacturers of residential and commercial buildings. Some industry players are involved in providing financial services that include selling mortgages and collecting fees for title insurance agencies as well as closing services. The industry players are involved in building single-family detached and attached home communities; townhouses, condominiums, duplexes and triplexes; master-planned luxury residential resort-style golf communities; and urban low, mid, and high-rise communities. The companies are also involved in the purchase, development and sale of residential land. Additionally, the companies build and own multi-family rental properties; residential real estate; and oil and gas assets.
3 Trends Shaping the Homebuilding Industry's Future
Higher Rates: The home affordability issue remains a headwind owing to accelerating home prices and mortgage rates this year. While remaining committed to combating inflation, the Fed has raised rates four times since March this year, with a 75-basis-point increment at each of its last two meetings. On Nov 2, 2022, the Fed raised the rates by 75 basis points so as to maintain the federal funds rate in a target range of 3.75 to 4%. Although Fed chairman Jerome Powell’s recent comment about lowering the magnitude of the rate hike from December 2022 has come as a breather, fears of a global slowdown and a recession loom over the stock market. This is less encouraging for this rate-sensitive market, which accounts for almost 3% of the economy. Rising borrowing costs and elevated risk of recession have been driving the single-family homebuilding market into recession.
Supply Chain Hurdles & Tight Labor Market: Supply-chain challenges are expected to continue to impact the level of housing starts and construction cycle times. Continuous supply-chain issues arising from the COVID-19 outbreak and response to the health crisis in various countries have been impacting builders’ ability to deliver on time. Rising material costs are quite challenging. According to Associated Builders and Contractors' latest analysis of information provided by the U.S. Bureau of Labor Statistics, although construction input prices declined 0.9% in November from October, the metric was up 11.9% from a year ago. With COVID-related lockdowns continuing in China and Europe facing severe energy crises, supply chain disruptions are likely to persist in the near term as well. Again, the shortage of skilled labor continues to be a pressing concern.
Cost-Control Efforts, Focus on Entry-Level Buyers & Acquisitions: Given the accelerated raw material prices, companies have been relying on effective cost control and focusing on making the homebuilding platform more efficient, which in turn is resulting in higher operating leverage. Homebuilders have been controlling construction costs by designing homes efficiently and obtaining construction materials and labor at competitive prices. Some homebuilders also follow a dynamic pricing model, which enables them to set the price according to the latest market conditions.
Also, the majority of companies are focused on growing the demand for entry-level homes and addressing the need for lower-priced homes, given affordability concerns prevailing in the U.S. housing market. Meanwhile, industry players have been acquiring other homebuilding companies in desirable markets, resulting in improved volumes, market share, revenues as well as profitability.
Zacks Industry Rank Indicates Dull Prospects
The Zacks Building Products - Home Builders industry is a 19-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #210, which places it in the bottom 15% 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 bleak 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 positioning in the bottom 50% of the Zacks-ranked industries is a result of bleak 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 October 2022, the industry’s earnings estimates for 2022 and 2023 have decreased approximately 3.2% and 13.3%, respectively.
Despite the industry’s blurred near-term view, we will present a few stocks that one may consider adding to their portfolio. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.
Industry Lags Sector and S&P 500
The Zacks Building Products - Home Builders industry has lagged the S&P 500 Index and the broader Zacks Construction sector in the past year.
Over this period, the industry has lost 22% compared with the S&P 500’s decline of 16.7% and the broader sector’s 19.4% decline.
One-Year Price Performance
Industry's Current Valuation
On the basis of the forward 12-month price-to-earnings ratio, which is commonly used for valuing homebuilding stocks, the industry is currently trading at 7.9 compared with the S&P 500’s 17.5 and the sector’s 13.6.
Over the last five years, the industry has traded as high as 14X and as low as 4.2X, with a median of 8.9X, as the chart below shows.
Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500
2 Homebuilding Stocks to Watch Now
We have selected two stocks from the Zacks homebuilding space that currently carry a Zacks Rank #3 (Hold) and are expected to register growth. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
D.R. Horton: Based in Texas, this homebuilder offers a diverse line of homes across various price points through multi-brand platforms like D.R. Horton, Emerald Homes, Express Homes and Freedom Homes. Further, the company enjoys one of the broadest geographic diversities in the industry and is not dependent on any particular market. It has a strong presence in 106 markets across 33 states in the East, Midwest, Southeast, South Central, Southwest and West regions of the United States. With 573,000 lots in inventory in fiscal 2022, D.R. Horton is well-poised for the future. Although the company’s total homebuilding lot position decreased by 25,000 lots from June to September 2022, the company has been actively managing the lot and land pipeline and investments in lots, land and development to meet needs during this transition in the housing market. Impressive performance, industry-leading market share, a solid acquisition strategy, a well-stocked supply of land, lots and homes along with affordable product offerings across multiple brands are expected to drive growth.
D.R. Horton’s earnings are expected to grow 1.7% in fiscal 2023. The stock has gained 24.9% over the past three months, outperforming the industry’s 19% rise.
Price and Consensus: DHI
Toll Brothers: Based in Horsham, PA, Toll Brothers is a leading builder of luxury homes. The company has been benefiting from its strategy of broadening the product lines, price points and geographies. Also, it has been gaining from the lack of competition in the luxury new home market, its build-to-order approach and solid backlog level.
Earnings of Toll Brothers are expected to grow 1.3% in fiscal 2023. The stock has gained 14.9% over the past three months.
Price and Consensus: TOL