Homebuilding Stock Outlook - July 2015

Is housing poised for a bright 2H upon millennial buyers?

After a lull in the housing sector in the first quarter, construction activity picked up in the crucial spring/summer months, supported by an improving economic environment and a better employment picture.

The outlook for the second half of the year appears favorable as well. Higher job numbers, a recovering economy and improving consumer confidence, moderating home price gains, affordable interest/mortgage rates, rising rentals, recent federal initiatives to increase mortgage availability and a limited supply of inventory all point to a redolent housing market in the second half.

Housing data released this month clearly indicates a healthy pace of growth. New home sales in the U.S. rose 2.2% in May -- the highest level in almost seven years. Though housing starts fell 11.1% in May, building permits – a gauge of future construction -- increased almost 12%, hitting a new six-year high. Existing home sales grew 5.1% in May, their highest pace in nearly six years.

Homebuilder sentiment is also upbeat. The National Association of Home Builders (NAHB)/Wells Fargo housing market index rose five points from May to 59 in June, the highest reading since September 2014. Moreover, U.S. construction spending touched its highest level in more than six years in April, gaining 2.2%.

With stabilizing demand, housing price gains are also moderating. Moreover, housing should remain an affordable option in the near term as mortgage rates are still below historical levels. Even if mortgage rates rise in the latter half of the year -- as is widely anticipated -- the rates should still remain reasonable. Low mortgage rates and moderating home price gains give homebuyers the much-needed confidence paving the way for higher home demand.

Apartment rental rates have also continued to move up, making home buying more attractive than renting. Also, the millennial generation is finally leaving the safe cocoon of their parents’ homes. A sharp spike in the formation of new households is translating into demand for new homes.

Further, there is a production deficit of both rental and new homes as compared to housing demand resulting in pent-up demand against a very limited supply.

To add to the positives, plans from the White House to cut premiums on mortgage insurance should increase mortgage availability and thereby encourage home buying among first-time buyers. With oil prices remaining subdued and the job market looking good, the dream of a new home is now a reality.

How Will the Players Fare This Earnings Season?

Among the homebuilders that have reported second-quarter fiscal 2015 results so far -- Lennar Corporation (LEN - Analyst Report), KB Home (KBH -Analyst Report) and Toll Brothers, Inc. (TOL - Analyst Report) -- Lennar beat the Zacks Consensus Estimate for both earnings and revenues.

Lennar’s earnings per share increased 30% year over year driven by solid revenues and improved SG&A leverage. Moreover, the company increased its home delivery expectations for 2015. According to Lennar, housing recovery continued at a steady pace in the second quarter. Management believes that the housing market is slated for a multi-year, slow-but-steady recovery

KB Home reported mixed second quarter fiscal 2015 results on Jun 19, beating the Zacks Consensus Estimate for earnings while missing the same for revenues. However, this Los Angeles, CA homebuilder provided an encouraging outlook for the rest of the year. It also expects strong momentum in 2016.

However, both Lennar and KB Home reported lower gross margins due to rising construction, labor and material costs. Encouragingly, gross margins improved sequentially at both the companies.  

Toll Brothers, however, reported disappointing top-line results for the second quarter of fiscal 2015 (ending Apr 2015). The company narrowed its guidance for the number of homes delivered and average prices of home delivered in 2015.  

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 the positive outlook of the investment community for the housing industry for the second half.

A look at the Earnings ESP in the table does not clearly show any homebuilder that is likely to beat expectations in the upcoming quarter.
 

Note: For PHM, the last reported quarter was Q115, while for others it was Q215

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 #43. This is in the upper 1/3rd of all industries ranked, highlighting the group’s positive outlook in the second half. The better-than-expected results of the homebuilders who have reported so far as well as the string of positive housing related data released last month have played their part in securing a positive outlook for the construction/housing industry.

Earnings Trends

If we look at the overall results of the Construction sector, earnings increased 4.1% in the March quarter, compared with an 18.6% spike in the December quarter. Total revenues increased 2.1% in the quarter, less than the 5.5% rise in the sequentially preceding quarter. The sector racked up an earnings beat ratio (the percentage of companies coming out with positive surprises) of 38.5% and a revenue beat ratio of 53.8% in the March quarter.

In fact, for the June quarter, both earnings and sales beat ratio are 100%, though only a few of the homebuilders have reported their results. Earnings and revenues for the quarter are expected to grow 5.4% and 6.6%, respectively. For 2015, earnings are expected to show an increase of 13.3% while revenues are forecast to grow 5.8%.

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

With the housing market gaining steam in the spring/summer months, homebuilders are increasingly optimistic of a pickup in sales in the second half. However, increasing competitive pressure and rising land and construction cost amid moderating home price increases will be the headwinds to contend with.