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Why D.R. Horton’s gross margins have begun to contract

Brent Nyitray, CFA, MBA

Key investor takeaways from D.R. Horton's Q214 earnings (Part 3 of 5)

(Continued from Part 2)

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

While D.R. Horton remains optimistic about the spring selling season (which gets underway very soon), 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 is 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.

Gross margins appear to be peaking

Company-wide gross margins declined sequentially to 22.2% in the second quarter, from 23.9% in the first quarter of 2014 and 22.6% in the second quarter of 2013. The company was asked on its conference call whether gross margins can continue to can be maintained, and management said they expect to at least maintain these margins going forward if not to increase them slightly. Other builders, like PulteGroup (PHM), Lennar (LEN), KB Home (KBH), and Toll Brothers (TOL), have been reporting increasing gross margins.

Prices and costs

The dearth of inventory is helping pretty much all the builders. Low inventory on existing homes (due to high professional investor demand and foreclosure laws in some states that require judges sign off on foreclosures) 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 indices, which are showing double-digit year-over-year increases. These increases are reflected in higher average selling prices.

Costs have generally been increasing, although at a slower rate than the company has been able to raise prices. Lumber demand (and pricing) tends to be seasonal, and 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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