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Industry Outlook

Amid a volatile U.S. stock market, uncertainty surrounding the Fed rate hike, panic in the global financial markets triggered by the unexpected ‘Brexit’ vote and unstable gasoline prices, the homebuilding market remains a pillar of strength for the economy. The market in general believes that the departure of U.K. from the European Union will not have any major impact on U.S. homebuilding activity.

What Do the Numbers Say?

New U.S. single-family home sales rose an unexpected 3.1% in September from the prior month to a seasonally adjusted annual rate of 593,000 units. This clearly indicates that the overall housing market has made quite a comeback following the August slump. Sales data for August was revised sharply down to 575,000 units from the previously reported 609,000 units. New data show a sales decline of 8.6% in August from July. Notably, July 2016 marked the best month for home sales since 2007.

Meanwhile, the overall third-quarter picture is quite encouraging with new home sales, which account for a fairly small share of U.S. home buying activity, scaling higher compared to the Apr–Jun 2016 period. Through the first nine months of 2016, sales grew 13% year over year. That said, residential construction in the third quarter has somewhat struggled on gross domestic product (“GDP”) for a second straight quarter.

Meanwhile, existing home sales marked a strong rebound in September, buoyed by high first-time buys, per data released by the National Association of Realtors. Sales rose 3.2% to a seasonally adjusted annual rate of 5.47 million in September from a downwardly revised 5.30 million in August ¿¿¿ the highest in three months. All major regions registered a rise in closings in September. Notably, first-time buyers accounted for 34% of September sales, higher than 31% recorded in August and 29% a year ago.

The number of building permits — a gauge of future construction — rose 6.3% in the month of September. Buoyed by new-home sales, single-family permits and starts improved in 2016 when compared with the preceding year. On the other hand, the building of multi-family properties like apartments and condominiums slowed down in 2016.

Further, the National Housing Association of Home Builders or NAHB/Wells Fargo Housing Market Index or HMI scaled to 65 in September – the highest since Oct 2005. This reading mainly reflects builder perceptions of current single-family home sales and sales expectations for the next six months. Although HMI dropped 2 points to 63 in October, it remained steady over the trailing four months.

The Overall Outlook

Despite a weak start this year amid equity market volatility and global concerns, the construction sector seems to have recovered on the back of strong housing fundamentals.

Positives like an improving economy, modest wage growth, low unemployment levels, low interest rates, positive consumer confidence and a tight supply situation raise optimism about the sector’s performance for the remainder of 2016 and into 2017.

However, a tight labor market, limited land availability and constrained mortgage environment restrict the ability of homebuilders to quickly respond to growing demand.

Other than that, homebuilders are witnessing slowing demand trends in the Houston market due to lower consumer spending amid volatile energy prices.

Q3 Earnings Cycle

In September, homebuilders Lennar Corporation (LEN - Free Report) and KB Home (KBH - Free Report) reported better-than-expected results for third-quarter 2016. Lennar performed impressively, beating expectations on both top and bottom lines for the third quarter in a row. KB Home’s Q3 earnings surpassed analysts’ expectations by 7.7% and also increased 83% year over year. Although the company failed to meet the consensus mark for revenues, the reported figure surged 8.3% on double-digit growth in deliveries and housing revenues as well as improved operating margin.

Both companies recorded an increase in home deliveries and new home orders in the reported quarter. However, slower sales were recorded in the Houston market.

Among the large homebuilders, PulteGroup, Inc.’s (PHM - Free Report) Q3 earnings were in line with expectations while revenues missed the same. Although quarterly revenues increased 25.9% year over year, the home sales gross margin plunged 250 basis points (bps) to 21.1% in the wake of rising land and labor costs. Home deliveries and new home orders marked an increase.

Among the other major homebuilders, D.R. Horton, Inc. (DHI - Free Report) is due to report in November while Toll Brothers, Inc. (TOL - Free Report) is expected to release its financial numbers in December.

A look at the table below shows that among the five large homebuilders, three hold a favorable Zacks Rank, while two carry a Zacks Rank #4 (Sell) – which highlights a mixed outlook for the housing industry.

A look at the Earnings ESP does not clearly show an earnings beat for any of the homebuilders, barring D.R. Horton.

Zacks Industry Rank

Within the Zacks Industry classification, we rank all the 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.

As a guideline, the outlook for industries in the top 1/3rd of all Industry Ranks or a Zacks Industry Rank of #88 and lower is 'Positive,' the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is 'Neutral' and the bottom 1/3rd or Zacks Industry Rank of #177 and higher is 'Negative.'

The Zacks Industry Rank for homebuilding is currently at #224. This is in the bottom 3rd of all industries, highlighting the group’s negative outlook. Though the industry picked up pace in the third quarter, equity market volatility and labor shortage issues are dampening its prospects.

Additionally, one factor that could be dampening investors’ sentiments is the possibility of an interest rate hike.

Earnings Trends

If we look at the overall results of the Construction Industry as of Oct 28, 2016, earnings grew 5.5% and total revenues rose 7.3% in the September quarter. So far in the September quarter, the sector has witnessed not-so-impressive earnings beat ratio (the percentage of companies coming out with positive surprises) of 42.9% and a revenue beat ratio of 14.3%.

Overall, earnings and revenues for the quarter are expected to rise 6.1% and 7%, respectively. In 2016, these are expected to improve a respective 9.7% and 5.5%.

For more details about earnings for this sector and others, please read our “Earnings Preview” report.

Bottom Line

Despite some concerns regarding the health of the economy, homebuilders are increasingly optimistic about the opportunities ahead. However, labor shortages, a slight slowdown in sales in Texas/Houston, increasing competitive pressure and rising land and construction cost will be the headwinds to contend with.

 

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