Why D.R. Horton’s gross margins will increase despite the decline

Market Realist

A key guide to D.R. Horton and its 3Q14 earnings (Part 3 of 5)

(Continued from Part 2)

D.R. Horton mentioned the first-time homebuyer is still struggling

D.R. Horton (DHI) characterized the spring selling season as “stable” during the conference call. It noticed more strength in the move-up buyer than the first-time homebuyer. The first-time homebuyer and the first move-up buyer are D.R. Horton’s bread-and-butter customers. That said, the company’s expanding into some of the higher price points.

As builders like Toll Brothers (TOL) have seen, the luxury buyer is doing extremely well these days as asset prices soar. The first-time homebuyer, on the other hand, is competing with professional investors, is often shut out of the job market, has a high level of student loan debt, and has difficulty getting a mortgage.

Company-wide gross margins declined sequentially to 20.7% in the third quarter from 22.2% in the second quarter of 2014 and 21.4% in the third quarter of 2013. The company said, “We expect further improvement in our margins to be challenging.”

Home prices appreciation is moderating. Costs are rising. Incentives are coming back to normal levels. Other builders such as PulteGroup (PHM), Lennar (LEN), KB Home (KBH), and Toll Brothers have reported increasing gross margins.

Prices and costs

The dearth of inventory is helping all the builders. Low inventory on existing homes is due to high professional investor demand and foreclosure laws in some states that require judges to sign off on foreclosures. So, this low inventory has kept the feared tidal wave of distressed homes from hitting the market. As a result, pricing has been relatively firm, as evidenced by recent housing indexes, which are showing double-digit year-over-year increases. These increases are reflected in higher average selling prices.

Costs have generally increased, although at a slower rate than the company has been able to raise prices. Lumber demand, and pricing, tends to be seasonal. The company expects to pay more for lumber going into the spring selling season. Drywall prices are also increasing. In some markets, labor costs are increasing—especially for skilled construction workers.

Continue to Part 4

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