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An Opportunity for Homebuilders

- By Jonathan Poland

Last week, Redfin Corp. (RDFN) CEO Glenn Kelman warned of a housing slowdown that is beginning to develop across the country, even more so in expensive markets like Seattle and San Francisco. He said the two factors driving this trend are the consistently low supply of homes for sale and frustrated buyers that simply stop trying after getting beaten out on offer after offer.


In other words, higher prices were not the issue.

While this could simply be a Redfin issue, there are similar stories of high demand for tight inventory on the East Coast in Washington D.C. and Philadelphia, causing multiple bidding wars. Of course, owners and investors are witnessing redevelopment and new construction across those cities, pushing prices higher and higher per square foot. More importantly, total construction for 2018 is forecasted to grow 5% with residential and single-family housing set to increase by 6% and 9%. In other words, there's a big opportunity for homebuilders to fill the gaps between supply and demand.

These are the three best buys in the industry

Toll Brothers Inc. (TOL) has seen its stock fall 29% since the year started, but it has documented two of the best quarters in the company's history, and is on track to generate $7 billion in revenue this year. That will likely mean it books close to $650 million in net income.

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Economic conditions can have a profound impact on profitability. During the last housing downturn, Toll Brothers went from earning $4.78 per share in 2005 to losing $4.68 per share in 2009 as the collapsing market resulted in margin compression and large impairment charges. The company is much larger than it was in 2008, and the housing market is not about to fall off a cliff like it did back then.

Ray Dalio (Trades, Portfolio)'s Bridgewater Associates is the largest guru shareholder of Toll Brothers with just over 1 million shares, representing 0.38% of assets under management.

Lennar Corp. (LEN) is off 22% year to date. Like Toll Brothers, the company continues to have record-breaking quarters from a numbers standpoint, generating over $5.4 billion in revenue during the last quarter alone.

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In the last 12 months, Lennar has earned over $1 billion after taxes and is on track to continue this strong financial performance beyond 2020 due to corporate activity.The company completed its $9.3 billion merger with CalAtlantic, the nation's fourth-largest homebuilder, in February. The deal could help it surpass D.R. Horton (DHI) as the largest homebuilder in the United States over the next severaly years. Again, demand is still high and inventory is still constrained in many regions. With the stock trading at 7 times forward earnings, Lennar is one of the best bargains in the entire market. If the company can realize expected earnings between $6.50 and $7.00 a share in 2019, the stock price could easily double.

Daniel Loeb (Trades, Portfolio) is the largest guru shareholder of Lennar with 6 million shares, which translates to 2.19% of assets under management.

NVR Inc. (NVR) is down 25% on the year and 16% since July .

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NVR reported pretty impressive numbers on July 20 as revenue increased 15.5% year over year, including a 10,162-unit backlog of homes that have sold but not settled. Second-quarter earnings per share came in at $49.05, beating by $1.84.

The company's new homebuilding orders were up 6% year over year to 4,964 units at an average sales price of $376,300. More importantly, the homebuilder is still on track to earn over $220 a share in 2019, making this price even better. Investors that own it above $3,000 should look to dollar cost average at this price. Plus, NVR operates on a slightly different model than others in the industry as it typically can purchase completed lots at a discount, avoiding excessive leverage. Historically, the stock trades at 21 times earnings. If it does earn $220 in 2019, investors are likely to see the shares rise above $4,000, making today's price a massive bargain.

Diamond Hill Capital (Trades, Portfolio) is the largest guru shareholder of NVR with 27,820 shares, representing 0.42% of its assets under management.

Disclosure: I am not long or short any stocks mentioned in this article.

This article first appeared on GuruFocus.