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4 Stocks to Buy as Homebuilder Confidence Offsets Rate Hike

Zacks Equity Research

In spite on an apparent slowdown in the first quarter, the U.S. economy gave proof of its resilience with seemingly high homebuilders’ confidence and a tight labor market. Also, U.S. housing starts hit a four-month high in February as single-family houses touched an almost 10-year high level. These paint a pretty picture for U.S. homebuilding.

Pleasing Housing Data

Housing starts grew 3% to a seasonally adjusted annualized rate of 1.29 million units last month, the Commerce Department said. In fact, homebuilding got a 6.2% boost year over year, suggesting housing would contribute to economic growth this year.

Importantly, single-family homebuilding, which accounts for the largest share of the residential housing market, increased 6.5% to 872,000 units, the highest level since Oct 2007. Single-family starts increased in the West, Northeast and Midwest, but dropped in the South. However, starts for the volatile multi-family housing segment fell 3.7% to 416,000 units.

Also, permits for future home construction fell 6.2% to 1.21 million units in February. But single-family permits advanced 3.1% to 832,000 units.

Meanwhile, homebuilders’ confidence soared to a 12-year high in March, thanks to President Donald Trump’s decision to roll back Obama's 2015 Waters of the United States rule.

The National Association of Home Builders’ confidence index scaled 6 points to 71 in March, the highest level since Jun 2005 and a lot higher than what economists had predicted. It must be noted that a "50" mark on the index is considered positive sentiment.

Tightening Labor Market

The U.S. economy also got a boost from upbeat data revealing a drop in jobless claims. In a separate release, the Labor Department said initial claims for state unemployment benefits dropped 2,000 to a seasonally adjusted 241,000 for the week ended Mar 11 ??? the 106th straight week with claims below 300,000. This shows a fairly healthy labor market.

Clearly, a solid labor market is backing the housing industry, thereby offsetting other economic weaknesses.

Does Interest Rate Hike Really Matter?

On Mar 15, the Federal Reserve raised interest rates for the third time since the 2008 financial crisis. Fed Chair Janet Yellen said that the U.S. central bank was sending a message that "we have confidence in the robustness of the economy and its resilience to shocks."

The Fed increased its benchmark interest rate by 25 basis points to a range of 0.75–1% and also forecast two more rate hikes this year.

Although the recent bump up in interest rates has raised concerns over outlook of home prices in 2017, the rates should remain reasonable, in our view, keeping housing affordable. Modest hikes in interest rates in the context of an improving economic environment can be a positive for the housing sector.

Again, high mortgage rates dilute demand for new homes, as mortgage loans become expensive. That said, the underlying driver for a hike in interest rates is increased economic growth expectations. A booming economy boosts income as well. Thus, if the rise in income offsets the increase in mortgage payment, housing will do just fine.

Indeed, rising interest and mortgage rates, as well as land and labor shortages, raise concerns -- as do rising material prices.

The year 2016 was reasonably good for the housing market, and this year is expected to maintain the trend, courtesy of healthy demand-supply balance, modestly rising prices and escalating rent costs. Again, there are signs of increased inclination of home purchases among millennials, a generation that had to some extent refrained some from entering the market.

For that matter, there are plenty of reasons to be optimistic about the broader housing sector over both the short and the long term.

So, keeping the positive momentum in mind, we may zero-in on some housing stocks that have gained in the current mixed scenario and have the potential to rise further before mortgage rates start rising.

Winning Stocks

With the help of the Zacks Stock Screener, we have zeroed-in on four stocks in the homebuilding industry based on a good Zacks Rank and other relevant metrics.

Based in Atlanta, GA, PulteGroup Inc. PHM engages in the homebuilding and financial services businesses primarily in the U.S.

Shares of PulteGroup returned 26% in the last three months, outperforming 15.7% gain of the Zacks categorized Building-Residential/Commercial industry. The company’s value-creation strategy, prudent land investments and strategic initiatives should drive growth in the upcoming quarters as well.

PulteGroup has a solid 3–5 year earnings per share growth rate of 14%. This earnings momentum will likely continue in the near term, as reflected by the company’s projected EPS growth of 32.1% for the current year and 19.6% for the next year.

Over the past 60 days, the Zacks Consensus Estimate for PulteGroup increased 9.9% for 2017 and 9.4% for 2018. The positive earnings estimate revisions indicate analysts’ confidence and substantiate the Zacks Rank #1 (Strong Buy) for the stock. You can see the complete list of today’s Zacks #1 Rank stocks here.

NVR, Inc. NVR is involved in the construction and sale of single-family detached homes, townhomes and condominium buildings. The stock has a VGM or Value-Growth-Momentum of A. The stock carries a Zacks Rank #1.

The company is also expected to witness earnings growth of 23.6% for the current year and 17% for 2018. It has a solid 3–5 year earnings per share growth rate of 12%.

The stock’s rock solid trailing 12-month Return on Equity (ROE) ratio of 32.6%, compared with the industry average of 11%, indicates that the company reinvests more efficiently compared to its peer group.

The stock climbed over 24% in the last three months, outperforming the broader industry.

D.R. Horton, Inc. DHI, based in Texas, is one of the leading national homebuilders, primarily engaged in the construction and sale of single-family houses both in the entry-level and move-up markets.

The company remains committed toward achieving continued double-digit annual growth in both revenues and pre-tax profits, while generating positive cash flow and improved returns.

D.R. Horton’s shares returned 20.8% in the last three months, outperforming the broader industry. Estimates have moved north in the last 60 days for the current as well as for the next year by 2.6% and 2.4%, respectively. The company is also expected to witness earnings growth of 15.8% for the current year. D.R. Horton has a solid 3–5 year earnings per share growth rate of 10.46%.

This bullish analysts’ sentiment justifies the stock’s current Zacks Rank #2 (Buy) and why we are expecting outperformance from the company in the near term. The stock’s trailing 12-month ROE ratio is 14.1% compared with the industry average of 11%. This indicates that the company reinvests more efficiently as compared to its peer group.

Based in Miami, FL, Lennar Corporation LEN is engaged in homebuilding and financial services in the U.S. The company is one of the best positioned homebuilders to capitalize on the housing recovery, driven by diverse revenue mix, steady top-line performance, above-average order growth and improving SG&A leverage.

This Zacks Rank #2 stock advanced 22% in the last three months, above the industry level in the said period.

After a strong performance in 2014 and 2015, Lennar delivered outstanding operating results in 2016, beating the Zacks Consensus Estimate for both earnings and sales in all the four quarters of 2016, resulting in an average positive surprise of 12.66%.

The stock also flaunts a VGM score of “A,” a 3–5 year expected EPS growth rate of 8% along with a trailing 12-month ROE ratio of 13.8%.

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PulteGroup, Inc. (PHM): Free Stock Analysis Report
 
Lennar Corporation (LEN): Free Stock Analysis Report
 
D.R. Horton, Inc. (DHI): Free Stock Analysis Report
 
NVR, Inc. (NVR): Free Stock Analysis Report
 
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