The Q2 earnings season is gathering steam with 15.4% of the construction companies having already released their numbers. And they’re unblemished with earnings as well as revenue beat ratio of 100%. Major homebuilders such as KB Home (KBH - Free Report) , Lennar Corp. (LEN - Free Report) and Toll Brothers Inc. (TOL - Free Report) have outperformed the Zacks Consensus Estimate by 26.92%, 16.67% and 17.74%, respectively.
Investor sentiment is quite high at the start of the second-quarter reporting cycle given the solid earnings outlook and favorable homebuilding/housing industry fundamentals. The S&P Homebuilders Select Industry Index has returned 14.6% year to date. The Zacks categorized Building-Residential/Commercial industry has gained almost 30% so far this year, faring a lot better than the broader market (S&P 500) that has returned 9.3%.
The housing market stands tall courtesy of continued strong job growth. The 2017 outlook for homebuilding is quite compelling, given historically low mortgage rates, healthy demand, consistent job growth and solid homebuilders’ confidence. Although homebuilders’ confidence dipped slightly in June, it’s still above 50, which is encouraging. Moreover, mortgage rates are near historic lows even after the Fed’s recent interest rate hike. Through May 2017, the U.S. economy added jobs for the 80th straight month. The unemployment rate was 4.3% in May, the lowest since 2001.
Solid Earnings Outlook
Overall, homebuilding companies seem to be on solid ground. Notably, homebuilding companies are broadly grouped in the Construction sector (one of the 16 Zacks sectors). Per the Zacks latest Earnings Trends report, the construction sector’s earnings are expected to increase 15.7% in Q2 compared with 9% in the earlier quarter. Revenues are also expected to improve 8.4% (6.8% growth in Q1). For 2017, earnings will probably rise 18.3% (against 7.6% in 2016) on 10.1% revenue growth (6.9% a year ago).
Higher Demand Defying Weaknesses
According to recently released existing home sales data by the National Association of Realtors, existing home sales increased 1.1% to a seasonally adjusted rate of 5.62 million units in May. Sales were 2.7% higher than the year-ago level, growing at the third-highest clip in the last one year. It is important to note here that existing home sales make up a large part of all the U.S. homebuilding activity relative to new home sales.
Meanwhile, new home sales increased 2.9% month over month to a seasonally adjusted rate of 610,000 units in May, per the latest report released by the Commerce Department. April's sales pace was also revised sharply to 593,000 units from 569,000 units. Sales of new single-family houses in May 2017 were 8.9% higher year over year.
A rise in mortgage rates is undeniably the most dampening factor for the homebuilding industry. A tight labor market, limited land availability, higher material costs and a constrained mortgage environment are restricting homebuilders to respond to growing demand. Despite concerns over chances of a series of interest rate hikes by the Federal Reserve, optimism surrounding the housing market remains unruffled. The U.S. homebuilding industry is in good shape, and continues to be one of the pillars on which the economy rests.
Although homebuilders acknowledge the rise in labor shortage and land/labor cost, they in general expect the housing market to continue to recover this year in tandem with steady economic growth.
The case for investing in homebuilding stocks looks good in the light of the above arguments. So, it is a profitable strategy to zero in on a handful of homebuilders that are poised to beat earnings estimates this quarter. An earnings beat should help these stocks gain investor confidence, paving the way for strong price appreciation.
Which Are the Right Picks?
Picking the right stock for your portfolio could appear to be a daunting task given the wide range of companies in the construction space. An easy way is to look at stocks that have a solid Zacks Rank accompanied by a favorable Earnings ESP. The combination of a favorable Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) with a positive Earnings ESP usually hints at an earnings beat.
Earnings ESP is our proprietary methodology for determining which stocks have the best chance to pull a surprise in their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.
Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.
For investors seeking to apply this strategy to their portfolio, we have highlighted four housing stocks that may stand out this season.
Our first choice is Owens Corning (OC - Free Report) , engaged in the business of composite and building materials systems. The company delivered a positive earnings surprise in each of the trailing four quarters, with an average beat of 29.81%. For the second quarter, the Zacks Consensus Estimate for earnings is pegged at $1.02 a share.
For the upcoming release, the company has an Earnings ESP of +10.78% and a Zacks Rank #1. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.
The company is set to report second-quarter results on Jul 26 before the opening bell.
Secondly, Lennox International Inc. (LII - Free Report) , a leading global provider of climate control solutions, also seems to be a solid bet.
The company has remarkably beaten earnings estimates in each of the trailing four quarters, with an average beat of 8.81%.
For the upcoming release, Lennox has a Zacks Rank #2 along with an earnings ESP +1.82%. The Zacks Consensus Estimate for the to-be-reported quarter is pegged at $2.75 per share.
The company is expected to report second-quarter 2017 results on Jul 24 before the market opens.
Our third choice is a leading supplier of predominantly interior components to the recreation vehicle, manufactured housing, and industrial markets, Patrick Industries Inc. (PATK - Free Report) .
Last quarter, this company delivered a positive earnings surprise of 30.23% and is expected to continue the trend in the second quarter as well. The Elkhart, IN headquartered company carries a Zacks Rank #2 and has an Earnings ESP of +0.86%. The Zacks Consensus Estimate is pegged at $1.16 per share.
Patrick Industries will announce second-quarter 2017 results before the market opens on Jul 27.
Lastly, we picked an Irvine, CA headquartered homebuilder CalAtlantic Group, Inc. (CAA - Free Report) . The company topped earnings estimates in each of the trailing four quarters with an average beat of 13%. It looks poised to beat expectations in the second quarter as well. The company carries a Zacks Rank #3 and has an Earnings ESP of +7.69%. The Zacks Consensus Estimate is pegged at 78 cents per share.
CalAtlantic Group is scheduled to report second-quarter results on Jul 27 after the closing bell.
U.S. housing spending that had peaked in early 2006 has waned in the meantime due to various macro-economic factors. However, with a recovering economy and solid job market, the critical question is to choose the right housing stocks before they release their earnings numbers.
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