Nine homebuilder stocks have gained between 40% and 80% off their late October lows, according to a new Deutsche Bank analysis, stirring up potential concern among investors that the winning streak could be set to end.
Not so fast, Joe Ahlersmeyer, an equity research analyst at Deutsche Bank, wrote in a note to clients.
“With continued improvement in demand fundamentals and book valuations fairly attractive by historical standards, our view is that homebuilder stocks can climb meaningfully higher,” Ahlersmeyer wrote.
But not all of them.
“That said, we also overlay an actionable, stock-specific theme, encouraging investors to favor builders with executives dedicated to systematically and programmatically improving returns on inventory, growing tangible book value per share, and letting multiples follow those fundamentals,” Ahlersmeyer added.
Builders are coming off a lackluster year as mortgage rates soared to a two-decade high, sidelining many potential homebuyers. But as rates stabilized this year and more buyers came to accept the higher borrowing costs as normal, traffic returned.
Homebuilders also boosted their incentives, including rate buy-downs and price reductions, the analyst noted. Builders also benefited from the lopsided inventory dynamic that found new homes making up a third of for-sale inventory, up meaningfully from the usual 12% to 13%, because resale homes remain limited.
All of that helps Ahlersmeyer to “feel an uprising coming” among the homebuilders.
“We looked to identify those builders with higher post-pandemic returns on inventory, who can also be reasonably expected to make solid capital allocation choices that consistently improve return on equity,” Ahlersmeyer wrote.
Here are his picks.
D.R. Horton (DHI)
Ahlersmeyer gives the largest homebuilder a Buy rating with a target share price of $150 after its stock has climbed 30% this year.
The company has benefited from its strategic shift toward more entry-level affordable homes. Ahlersmeyer believes the company can sustain and expand its lead in its top markets and drive growth organically.
“Several years from now, we see DHI with a greater number of Top 3 market positions in the fifty largest markets, possessing higher share in each of those markets as well as higher overall national share, and we also expect stronger volume growth than any other builder under our coverage,” Ahlersmeyer noted.
The analyst anticipates shares to appreciate on its reinvestment strategy — which includes community count growth and spec starts — and share repurchases, both of which should "drive rapid growth in tangible book value per share." Also helpful to the upside is the company's continued outperformance versus its peers and higher returns on inventory and equity.
Meritage (MTH)
The analyst gives Meritage a Buy rating with a target per-share price of $200. The homebuilder has been riding high focusing on entry-level homes, which Ahlersmeyer said will lead to better margins and drive quicker sales turnover in each community. As a result, the successful execution will lead to higher returns on inventory of about 15%
“We envision MTH going from the fifth to the fourth-largest US builder by 2026," Ahlersmeyer wrote, noting later that "the market could be underestimating MTH's growth potential."
PulteGroup Inc. (PHM)
Ahlersmeyer has a Buy rating on Pulte with a target price of $95, forecasting that the homebuilder will have double-digit order growth for the remainder of this year and next, outpacing a steady market, while delivering higher margins.
The analyst noted that the builder's land investments support its growth outlook in communities, while its higher spec sales will drive higher absorptions.
“PHM should exhibit a smooth transition as strong profitability in backlog flows through, while the company puts a floor under returns with increases in specs,” Ahlersmeyer added. “With excess cash going to share buybacks, tangible book value per share growth supports a higher multiple.”
Tri Pointe (TPH)
Ahlersmeyer gives Tri Pointe a Buy rating with a target price of $42 per share, as the homebuilder shifts its geographic focus from California to Texas and the Carolinas.
Deutsche Bank anticipates return on investment to stabilize around 13-14%, with expectations that reinvestment will drive the community count up. The stock is undervalued, according to Ahlersmeyer.
Toll Brothers (TOL)
The analyst has a Buy rating and target price of $94 on the traditional luxury homebuilder, as Toll pivots in strategy to entice buyers looking for an affordable luxury home.
As a result, it's given the company favorable exposure to a “more resilient” consumer, Ahlersmeyer wrote. The company has also increased its spec homes — an unsold home with at least a foundation in the ground — which has captured demand for “move-in ready homes at higher price points that still have some customization opportunity.”
“We see a continuation of this strategy driving higher returns for TOL, and underwrite a 1.6x current price to tangible book value multiple that envisions TOL hitting mid-teens returns on inventory,” Ahlersmeyer wrote.
NVR, Inc. (NVR)
Ahlersmeyer is not so bullish on NVR, giving the builder of single-family detached homes, townhomes, and condominiums a Sell rating and target price of $4,400 per share.
Ahlersmeyer noted that management has shown a willingness to let cash pile up on the balance sheet, and sees the stock as pricey compared with its operating earnings.
“We are not arguing that we should look at NVR like we do other builders, but the business model hasn't changed, and the financial manifestation of the operating model should be materially the same and so we are inclined to listen to what the enterprise valuation relative to operating earnings is telling us relative to history,” Ahlersmeyer wrote.
Lennar (LEN)
The analyst also put a Sell rating on the second-largest homebuilder with a target price of $105, because Ahlersmeyer anticipates the company will lose national and local market share to D.R. Horton and others that are "investing in assets productive to the business of building homes."
“Ultimately, we see LEN fundamentally underperforming DHI within the homebuilding business over the near, medium, and longer term, and anticipate that the relative valuation gap between the two will also continue to widen," Ahlersmeyer wrote, "particularly as DHI's returns reset structurally higher while LEN's reset closer to prior levels."
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Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv
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