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Homebuilding on Solid Footing Despite Coronavirus Pandemic

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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.

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

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

  • The U.S. Federal Reserve’s dovish monetary stance and lower mortgage rates have been driving this rate-sensitive housing market. 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 dropping. 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, while there may be anecdotal shortages of some inputs as the global supply chain buckles owing to the coronavirus outbreak, materials prices are set to decline. Additionally, the need to rebuild inventories is expected to drive the U.S. housing aggressively.
     
  • Meanwhile, the industry participants have been focusing on acquiring low-cost new home sites in well-positioned markets during the downturn, which placed the companies well to meet growing demand during the upturn, in turn lending them a significant competitive advantage. The companies have also been controlling construction costs by designing homes efficiently and also obtaining construction materials and labor at competitive prices. Homebuilders are also following a dynamic pricing model, which enables it to set price according to the evolving market conditions.
     
  • However, as the recent coronavirus outbreak has roiled global stock markets and in turn the world economy, how will the U.S. housing market fare in the near term when the lowest mortgage rates on record are colliding with the prospect of a coronavirus outbreak-induced economic downturn? The U.S. housing market — which was on a strong foothold before the crisis began — is likely to slow down a bit in the near term. It is reflected in the latest housing starts & permit data and monthly homebuilder confidence index. Notably, although confidence level remained solid, sales expectation for the next six months dropped, depicting the escalating economic uncertainties arising from the outbreak. Also, the U.S. housing starts dropped in February after surging for four straight months. Building permits also tumbled in February, reflecting builders’ inability to ramp up construction even though borrowing costs have been declining steeply. The COVID-19 outbreak and response to the health crisis in various countries are likely to have a lingering impact on the supply chain in the near term, which may impact builders’ ability to deliver in time. Overall, the pandemic is likely to weaken sales in the months ahead that could support economists’ anticipation of a consumer-led recession by the second quarter. Again, shortage of skilled labor continues to be a pressing concern. Homebuilders continue to be cautiously optimistic about the industry’s prospects owing to rising land and labor costs. Meanwhile, softness in home purchases in the high-end housing market segment, in response to affordability challenges and general market uncertainty, is a cause of concern. This has been impacting the order flow for luxury homebuilders like Toll Brothers.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Building Products - Home Builders industry is an 16-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #72, which places it at the top 28% 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 2020 and 2021 have gone up approximately 4.7% and 20.1%, 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 Lags Sector and S&P 500

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

Over this period, the industry has lost 34.9% compared with the S&P 500’s drop of 14.2% and the broader sector’s 29.1% decline.

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 5.6X compared with the S&P 500’s 15.7X and the sector’s 10.2X.

Over the last five years, the industry has traded as high as 14.4X and as low as 5.6X, with the median at 10.7X, 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. Also, disruption in the supply chain arising from the novel coronavirus outbreak may impact builders’ ability to deliver in time. That said, low mortgage rates and the Fed’s dovish stance should spur home buying activity in the near term.

Currently, there are three top-ranked stocks in the Zacks Building Products - Home Builders industry that are cashing in on the positive industry fundamentals amid the crisis.

Century Communities, Inc. (CCS - Free Report) : Headquartered in Greenwood Village, CO, this is a home building and construction company, mainly related to single-family attached and detached homes. This stock sports a Zacks Rank #1 (Strong Buy) and its earnings are expected to increase 11.1% in 2020 and 13.1% in 2021. The Zacks Consensus Estimate for its 2020 earnings has gone up 10.3% and 10.4%, respectively, over the past 60 days. You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: CCS


TRI Pointe Group, Inc. (TPH - Free Report) : Based in Irvine, CA, this company engages in the design, construction, and sale of single-family detached and attached homes in the United States. This stock also sports a Zacks Rank #1 and the Zacks Consensus Estimate for its 2020 and 2021 earnings has gone up 6.8% and 15.5%, respectively, over the past 60 days.

Price and Consensus: TPH


Taylor Morrison Home Corporation (TMHC - Free Report) : This Scottsdale, AZ-based homebuilding company engaged in building single-family detached and attached homes for first-time buyers, move-up families to luxury and active adult customers. The stock carries a Zacks Rank #2 (Buy) and the consensus estimate for its 2020 and 2021 earnings has moved up 1.7% and 3.4%, respectively, over the past 60 days.

Price and Consensus: TMHC


Additionally, investors may also hold on to the following stocks, which currently carry a Zacks Rank #3 (Hold) and have solid earnings prospects.

D.R. Horton, Inc.: This Texas-based homebuilder has an expected earnings growth of 20.1% for the current fiscal year.

Price and Consensus: DHI


PulteGroup Inc.: This Atlanta, GA-based homebuilder has an expected earnings growth of 14.3% for the current fiscal year.

Price and Consensus: PHM

 

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