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D.R. Horton Back to Neutral

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On Sep 12, we reverted to a Neutral recommendation on D.R. Horton Inc. (DHI - Free Report) from Outperform following mixed results for fiscal third-quarter 2013.

Why Back to Neutral?

On Jul 25, 2013, D.R. Horton’s fiscal third-quarter adjusted earnings of 42 cents per share beat the Zacks Consensus Estimate of 35 cents by 20% and the year-ago earnings of 22 cents by 90.9%. A one-time litigation-related reimbursement largely pulled up earnings in the quarter. Moreover, solid pricing and margin gains and lower taxes made up for soft volumes in the quarter to boost earnings.

Homebuilding revenues of $1.64 billion climbed 47% year over year on the back of strong pricing. However, it missed the Zacks Consensus Estimate of $1.75 billion by 6.3%, due to soft net order growth.

Net orders grew only 12% in the third quarter, much lower than 34% in the second quarter and 39% in the first. A sharp increase in interest/mortgage rates slowed orders in the latter half of the quarter. However, pricing gains, lower incentives/discounts and better fixed cost leverage boosted profits in the quarter.

Despite improving profits, we prefer to remain on the sidelines until we see a rebound in volumes. Moreover, the recent increases in interest rates is concerning. The mortgage rates have started increasing from May. High interest rates decrease the demand for new homes as mortgage loans become expensive, thus lowering the buyers’ purchasing power. This can hurt volumes, revenues and profits of homebuilders. Any change in federal lending procedure could also add to the woes. Rising input costs, due to increasing costs of raw material and labor, is also a concern.

However, if market conditions remain stable, management expects the company’s profitability to increase in 2013 and 2014. This is expected to be driven by its solid balance sheet and improved liquidity position allowing it to re-invest in growth opportunities; increased pricing power; and rising home inventory and improving land position. The company’s geographic diversity and solid cost discipline are other positive factors that prevent us from being too pessimistic on the stock.

Other Stocks to Consider

D.R. Horton carries a Zacks Rank #3 (Hold). Some homebuilders with a favorable Zacks Rank are performing well and are worth considering. These include, TRI Pointe Homes, Inc. (TPH - Free Report) and Meritage Homes Corporation (MTH - Free Report) carrying a Zacks Rank #2 (Buy).  A specialty retailer of wood flooring products, Lumber Liquidators Holdings, Inc. (LL - Free Report) also carries a Zacks Rank #1 (Strong Buy).

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