Homebuilder Industry Stock Outlook - April 2016

After a good run in 2015 — possibly the best since 2007 when the housing recession had set in — the housing market had a shakier start this year.

The relentless drop in oil prices, China growth worries, sluggishness in other emerging markets like Brazil and Russia, and slowing growth in Japan and Europe, slumping commodities, geopolitical tensions, and a strong dollar took a toll on the U.S. stock market early in the year.

Homebuyers seemed wary of buying a home amid equity market volatility and global worries. However, the U.S. stock market has staged a dramatic recovery in the past month, easing fears of a recession in the U.S. and infusing signs of confidence into the economy.

Recent housing data has been rather mixed. U.S. housing starts rose 5.2% in February, a nice rebound after declining in January and December. However, the number of building permits — a gauge of future constructions — went down 3.1% in February, according to data released on Mar 16. Homebuilders’ sentiment index remained steady in March amid labor constraints and rising costs.

New home sales rose 2% in February, a rebound from the decline in January. However, existing home sales tumbled 7.1% in February after touching a 6-month high in January. Overall, we can safely say that the February data was better than the prior month.

The fundamentals also seem positive for the rest of the year. Construction activity is expected to pick up once the spring selling season gets into full swing. Steady job and wage growth, recovering economy, historically low interest/mortgage rates, moderating home price increases, rising rentals, rapidly increasing household formation and a limited supply of inventory — all point to consistently strong demand in 2016.

However, builders, in general, are facing problems regarding labor shortage and rising land and labor costs.

A shortage of buildable lots, skilled labor and available capital for smaller builders are limiting home production, thereby lowering the inventory of homes, both new and existing. Limited capital for land and land development has left entitled lands in short supply while increasing demand is driving land prices higher.

The labor market has tightened with limited availability of labor arresting the rapid growth in housing production. Labor shortages are leading to higher wages while land prices are inflating due to limited availability. Rising building materials and labor costs are threatening homebuilders’ margins as they limit pricing power.

How Did Homebuilders Fare Last Earnings Season?

PulteGroup, Inc. (PHM - Analyst Report) beat the Zacks Consensus Estimate for both earnings and revenues in the fourth quarter of 2015, quite a turnaround from the weak results it posted over the past three quarters. Moreover, earnings rose 36% year over year, backed by a 13% increase in homebuilding revenues and improved gross margins. Also, home deliveries, order trends, sales pace and ASPs improved in the quarter as overall demand trends remained positive.

D.R. Horton, Inc. (DHI - Analyst Report) missed the Zacks Consensus Estimate for sales while earnings came in line with expectations in the first quarter of fiscal 2016. Earnings rose 7.7% year over year as better profits offset weaker-than-expected sales. The company’s home deliveries have been soft over the past two quarters.

Toll Brothers, Inc. (TOL - Analyst Report) announced mixed first-quarter fiscal 2016 results – beating the Zacks Consensus Estimate for sales but missing the same for earnings.

Two homebuilders -- Lennar Corporation (LEN - Analyst Report) and KB Home (KBH - Analyst Report) -- have already reported results for the March quarter. Both companies reported stellar first-quarter fiscal 2016 results this month. They beat the Zacks Consensus Estimate for both earnings and revenues. Better-than-expected revenues were driven by strong housing demand and traffic trends.

A look at the table below shows that all the five largest homebuilders carry a favorable Zacks Rank – Zacks Rank #1, 2 or 3 – which clearly highlights a favorable outlook for the housing industry despite near-term headwinds.

A look at the Earnings ESP shows that Lennar is likely to beat expectations when it reports its next quarterly result in June/July.

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 the construction industry is currently at #145. This is in the middle1/3rd of all industries ranked, highlighting the group’s neutral outlook. Though equity market slumps and labor shortage issues dampened the housing market at the start of the year, it is expected to pick up momentum in the ongoing spring selling season.

Earnings Trends

If we look at the overall results of the construction Industry, earnings growth was flat in the December quarter. Total revenues declined 4.4% in the quarter. The sector racked up an earnings beat ratio (the percentage of companies coming out with positive surprises) of 50% and a revenue beat ratio of 41.7% in the December quarter.

Earnings and revenues for the March quarter are expected to rise 11.7% and 4.6%, respectively.

For more details about earnings for this sector and others, please read our ‘Earnings Trends.'
       
Bottom Line

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