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Homebuilding Sluggish in May: 4 Stocks on Solid Ground

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Housing starts took a turn for the worse in May, as homebuilders slowed down the pace of construction for the third straight month. Does this poor show hint at sluggish economic growth in the second quarter?

Homebuilding stocks declined in the latest trading session on Jun 16 following the release. Shares of Lennar Corp. (LEN - Free Report) , D.R. Horton Inc. (DHI - Free Report) , Toll Brothers Inc. (TOL - Free Report) and PulteGroup Inc. (PHM - Free Report) declined 0.3%, 0.5%, 0.1% and 0.3%, respectively. Even the SPDR S&P Homebuilders ETF (XHB - Free Report) slipped 0.3%.

Weakening Housing: An Indication of Weak Q2?

As per the latest jointly released report from the U.S. Census Bureau and the U.S. Department of Housing and Urban Development, privately-owned housing starts decreased to a seasonally adjusted annual rate of 1.092 million, reflecting a 5.5% decrease from the revised April rate of 1.156 million and 2.4% from the May 2016 level. This comes after a 2.7% monthly decline in April and a 7.7% drop in March. Single-family housing starts made up 779,000, down 1.9% from the May level.

That said, housing starts was still 3.2% higher in May on a year-to-year basis. However, the increase has been too insignificant to address the deteriorating homes supplies.

Meanwhile, building permits -- an indicator of upcoming construction -- toppled 4.9% to 1.17 million units, the lowest in eight months. The May figure was also down 0.8% year over year. Single-family building permits fell 1.9% to a 779,000 unit-rate. This decline for the third straight month indicates that single-family homebuilding may remain weak in the coming months.

Again, builder confidence in the market for newly-built single-family homes appeared to be fading slightly in June, down two points to 67 from a downwardly revised May reading of 69 on the National Association of Home Builders/Wells Fargo Housing Market Index.

NAHB Chief Economist Robert Dietz, said, “As the housing market strengthens and more buyers enter the market, builders continue to express their frustration over an ongoing shortage of skilled labor and buildable lots that is impeding stronger growth in the single-family sector.”

It must be noted that these weak readings came despite a robust job market. Through May 2017, the U.S. economy added jobs for the 80th straight month. The unemployment rate was 4.3% in May, which was lowest since 2001.

Although the Fed raised interest rates last week, mortgage rates remain at near historic lows.

The homebuilding industry saw the fastest quarterly home sales in a decade in the first quarter of 2017, and lent some much-needed support to the economy. The economy grew at a 1.2% pace in the first quarter.

Indeed, the latest housing data further added to the weak reports that were released recently on retail sales, manufacturing production and inflation. Hence, prospects of speedy economic growth in the second quarter was much tempered.

On Jun 16, the Atlanta Federal Reserve cut its estimate for second-quarter GDP to a 2.9% annualized rate from a 3.2% estimate projected earlier.

Factors Denting the Industry

Though a healthy job market and an impressive demand will probably draw buyers, there are other factors that might deal a fresh blow to the housing industry.

At present, skilled labor shortages are a cause for concern in the homebuilding industry as demand continues to scale. Meanwhile, rising land and labor costs are threatening margins as they limit homebuilders’ pricing power.

Labor shortages are resulting in higher wages while land prices are inflating due to limited availability. There could be more inflation ahead. This is eating into homebuilders’ margins. Again, land supply has been an ongoing challenge for the housing industry.

Homebuilding Remains Steady Despite Headwinds

The 2017 outlook for homebuilding is quite compelling given historically low mortgage rates, healthy demand, consistent job growth, along with solid homebuilders’ confidence. Although homebuilders’ confidence dipped slightly in June, it still remained above the much confident level of 50.

Also, the housing/homebuilding industry has returned a lot higher than the S&P 500 Index in the 12-month period. The industry grew almost 22% in the said period compared with the S&P 500 Index’s gain of 16.8%.

The Zacks Industry Rank for homebuilding is currently at #56 (top 22%) that raises much optimism.

How to Play the Industry

Major homebuilders are well poised on the positive fundamentals of the housing market. Particularly, given the cheap valuation compared with the broader market, this is perhaps the right time to pick a few stocks from this space.

The valuation of the industry looks attractive at present. The industry currently has a trailing 12-month P/B ratio of 1.68. This is quite cheap when compared with the market at large, as the current P/B for the S&P 500 is at 3.63. Its lower-than-market positioning calls for upside in the quarters ahead.

Below, we have selected four homebuilders that are witnessing positive estimate revisions and carry a Zacks Rank #1 (Strong Buy) or #2 (Buy).

One such company is M/I Homes, Inc. (MHO - Free Report) . The company sports a Zacks Rank #1 and advanced 50.4% in the last one year. The stock has seen 17.3% upward revision in the Zacks Consensus Estimate for the current year and 12.8% for 2018, in the last 60 days.

Lyon William Homes (WLH - Free Report) , a Zacks Rank #2 stock, has gained over 38% in the last year. Earnings estimates for the current year and the next have also gone up by 8.1% and 2.7%, respectively, in the last 60 days. The upside in earnings estimate revisions point at unwavering confidence that analysts have in the company.

KB Home (KBH - Free Report) , a Zacks Rank #2 stock, has gained 49.2% in the period. Its earnings estimate for the current year has improved by 0.6% and 0.5% for 2017 and 2018 in the last 60 days. The company has solid expected earnings growth of 43.3% for the current year and 22.2% for fiscal 2018. Also, the stock surpassed earnings estimates by an average 7.3% in the trailing four quarters.

Lennar Corporation shares climbed 23% in the last six months, almost in line with the industry and carries a Zacks Rank #2. It has seen the Zacks Consensus Estimate for fiscal 2018 revising marginally upward in the last 60 days.

You can see the complete list of today’s Zacks #1 Rank stocks here.

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