Zacks Industry Outlook Highlights: Lennar, PulteGroup, Toll Brothers, Ryland Group and D.R. Horton

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Sep 04, 2014, 09:30 ET

CHICAGO, Sept. 4, 2014 /PRNewswire/ -- Today, Zacks Equity Research discusses the Homebuilding, including Lennar Corp. (NYSE:LEN-Free Report), PulteGroup, Inc. (NYSE:PHM-Free Report), Toll Brothers, Inc. (NYSE:TOL-Free Report), Ryland Group, Inc. (NYSE:RYL-Free Report) and D.R. Horton, Inc (NYSE:DHI-Free Report).

Industry: Homebuilding

Link: http://www.zacks.com/commentary/34228/does-upbeat-housing-data-signal-better-2h-for-homebuilders

The housing recovery seems to be picking up after a softer-than-expected spring selling season. The buyers are back in the market now that they are more confident of a recovering economy and an improving job market. Still-low interest rates act as a further stimulus for home buying in spite of the Fed scaling back its bond-buying program.

The housing slowdown that began in the second half of 2013 was further handicapped by severe weather conditions, a biting winter and declining demand for homes in the first half of 2014. This raised serious doubts about the strength of the housing market.

Moreover, shortage of lots and skilled labor, rising costs of materials and declining inventory of new homes were not making things easier for the builders. Also, the spike in mortgage rates and rising home prices were hurting demand, which further added to the woes. As a result, many homebuilders witnessed declining order trends in the December quarter.

As the winter chill subsided, several homebuilders recorded improving order trends in the March quarter. However, the spring selling season failed to deliver on its promise as large homebuilders like Lennar Corp. (NYSE:LEN-Free Report) and PulteGroup, Inc. (NYSE:PHM-Free Report) saw a sequential decline in order growth in the June 2014 quarter.

Also, some negative housing reports around that time indicated skepticism among home buyers. Pending home sales, new home sales (single-family houses) and housing starts as well as building permits all declined in June.

However, a slew of data released in August raises hope that that the housing market recovery might finally be back on track. Housing starts surged to an 8-month high in July, growing 15.7% from the prior month to an annualized rate of 1.093 million units. The July increase beat market expectations and came as a breather from the declines seen in the past two months.

Building permits, a gauge of future construction, also bucked the previous trend. After declining in June, building permits grew 8.1% in July.

Homebuilder confidence data for August hit its highest level since January, clearly indicating that builders are upbeat about their prospects for future sales. Homebuilders' confidence, as indicated by the National Association of Home Builders (NAHB)/Wells Fargo housing market index, rose 2 points to 55 in August.

New homes inventory for sale rose 4.1% to 205,000 units in July. This is a 6-month supply at the current sales pace — the highest so far this year — which suggests that the supply picture is also improving.

Sale of existing homes rose 2.4% in July, for the fourth consecutive month this year. Pending home sales rose 3.3% in July after declining in June, having risen now in four of the past five months.

However, sales of new single-family homes in the U.S. dipped 2.4% in July. The decline was below market expectations and was quite a surprise considering that other housing indicators have been on the rise.

Kevin Kelly, chairman of NAHB, resonated that new-home sales is a "volatile metric that can fluctuate significantly from month to month." According to Kelly, the higher inventory levels suggest that builders are improving their inventory anticipating improvement in new home sales through the balance of the year.

It is generally believed that the construction gains should continue through the rest of the year driven by rising home demand, stabilizing mortgage rates this year, improving job market, good pricing environment and rising inventory levels.

OPPORTUNITIES

Firming Home Prices & Stabilized Mortgage Rates Can Spur Demand

Home prices have been rising in 2014 albeit at moderating rates. The median home price increased 4.9% year over year in July, down from a 13.1% gain last year.

Another report from the S&P/Case-Shiller home price data for June also showed a persistent slowdown in price increases. The year-over-year reading for the 20-city index showed price increases of 8.1%, well below the 9.3% increase in the year-ago month. Each of the 20 cities saw annual price growth slowdown for the first time since early 2008.

Meanwhile, mortgage rates have remained low this year even though the Fed continues to withdraw support from the system by scaling back its bond-buying program. According to the Freddie Mac mortgage survey, the 30-year fixed mortgage rate has gone down from 4.43% in January to 4.13% in July.

Though mortgage rates are higher than the average rate in 2013, they are still below historical levels, making housing affordable. The rising inventory, low mortgage rates and moderating home prices are expected to give homebuyers much-needed confidence, paving the way for higher home demand in the second half of the year.

Land as Native Strength

Homebuilders like Lennar and Toll Brothers, Inc. (NYSE:TOL-Free Report) with solid land positions, have been able to better capitalize on rising demand for homes during the upturn. This gave these companies a competitive edge over the likes of Pulte, which faced land availability constraints.

Toll Brothers has secured some of the most sought-after urban locations in the country – New York City, Northern New Jersey, Philadelphia and Washington D.C. – where land is scarce and approvals are not easy to obtain. Lennar has enough land in all major markets to satisfy deliveries well into 2015.

However, others like Pulte have intentionally slowed down the sales pace across some of their communities (thus lowering the community count) due to a lack of land development and scarcity of finished lots. Instead, Pulte has been more focused on driving price and margin in most communities.

This strategy hurt net order growth significantly with orders declining around 10% in fiscal 2013 – as against the increase enjoyed by most of its peers. Pulte's orders declined a further 4% in the first half of 2014. Though the price optimization initiatives are improving Pulte's pricing and profits, the below-average order growth raises concerns about the soundness of its strategy.

Other homebuilders have realized the importance of land investments. Small homebuilder Ryland Group, Inc. (NYSE:RYL-Free Report) has spent $258 million on land acquisition and $166 million on site development in the first half of 2014. Texas-based D.R. Horton, Inc (NYSE:DHI-Free Report) invested $2.6 billion in land, lots and development in 2013 and $1.7 billion in the first nine months of fiscal 2014, positioning it well to meet demand for fiscal years 2014 and 2015.

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