Housing’s Health? Good Enough To Consider Buying Homebuilders

Friday, August 20, 2010

Early this year, I speculated that housing could show improvement this year – “A Robust Housing Market – 2010’s Biggest Surprise?” (January 7). While some might argue with the adjective, “robust,” housing has moved ahead due to the factors listed in the article as well as the government’s incentive plan.

Incentive plan’s effect is a time shift

The home sales slump following the incentive’s end is a typical reaction. As we see with auto manufacturers’ rebate programs,  rewards encourage consumers to act now. Thus, some of the buying that would have occurred in the following months is shifted to the incentive period.

Data collection makes analysis cloudy

As I described in “Home Sales Down but Prices Up – What Gives?” (August 6), existing and new home sales are measured differently. Existing sales (which account for most of the houses sold) are counted when they close, meaning the April 30 incentive end is still affecting sales figures. New sales, on the other hand, are counted when the commitment is signed, so the effect was immediate.

That article’s first two graphs show the sales patterns. Likely, if existing home sales were measured the same way as new, they would have shown a similar, pronounced drop in May, followed by a partial rebound in June.

July and August data will provide better measures

Because the majority of existing homes close within two months of the sales agreement, the incentive effect should be mostly removed from the July and August numbers. So, the July sales reports (existing homes on Tuesday, August 24, and new homes on Wednesday, August 25) will provide better insight into how today’s housing market is doing.

Leading indicators of house sales

Expectations can be formed somewhat from the following reports of new house activity. In today’s environment, with existing home inventory swollen by bargain-priced foreclosures, new homes face added competition. In addition, many homebuilders struggled for months, so have a natural risk control strategy. For us, those factors mean any positive data for new home sales very likely implies good news for the entire housing market.

Note: I have left out the recently reported homebuilder confidence survey. For competitive reasons, each builder might understate confidence. Therefore, I prefer to see actions rather than hear comments.

  • Homebuilders’ land purchases – These commitments require confidence and finances. They are the earliest sign that a builder is gearing up. Unfortunately, there isn’t a consolidated report of this activity, but there are periodic reports, and we have been seeing them this year after last year’s silence. For example, “Home Builder Bets on California Revival – Standard Pacific Accumulates Bargain-Priced Land While Waiting for Housing Market to Improve” (The Wall Street Journal, by Dawn Wotapka, August 16, page B-8).
  • Housing permits and starts – Before a new house is sold, the builder needs to get a permit and then start construction. This week’s report gave us July’s numbers, and below are graphs of the historic data.

Very important – Note that the last three months (after the April 30 incentive expiration) have seen a stable level of permits and starts. And “stable” is good. Fears existed that, without the government’s incentive, sales would be weak. The data show that the builders are confident enough to continue producing at a decent pace.

Time to buy homebuilder stocks?

If homebuilders are acting confidently, shouldn’t we be, too? The Wall Street Journal addressed the question in “Home Builders: Beaten Down and Looking Up?” (By Steven Russolillo, August 17, page C-5). The article concludes with the thoughts of Phil Roth, chief technical strategist at Miller Tabak. He says that there could be a short-term rise,

“But over the longer term, Mr. Roth expects housing stocks to continue lagging behind the broader market until the sector can display a plethora of positive data.

“’Housing stocks are going to wallow around for a long time,’ Mr. Roth said. ‘It’s unlikely you’re going to see a sustained advance without considerable base building.’”

He could be right, but I doubt it. A weak company can “wallow,” but not every company in an industry as important as homebuilding. And he ignores the earnings available from a solid “base.” There are even growth opportunities because the homebuilders do not share the same strengths.

For example, this week there has been general stock market discussion about increased merger and acquisition interest and activity. Not to be left out, “Analyst: Home Builders Likely to Consolidate, Merge” (The Wall Street Journal – online, by Robbie Whelan, August 18).

Also… Waiting for a “plethora of positive data” is like those waiting for “the dust to settle.” In the stock market, postponing action until the skies clear and the situation is obvious means missing out.

Interested? Three homebuilders to examine

Here are three firms with differing operations, so they make a good starting point in deciding what to own.

  • NVR (NVR) – One of the largest (in terms of market capitalization). This high quality company has solid earnings and no debt.
  • PulteGroup (PHM) – Also one of the largest. Typical homebuilder finances with debt and losses but projected earnings. A special asset is Del Webb, a baby boomer growth company.
  • Standard-Pacific (SPF) – Smaller company. High debt but positive earnings. The land purchase mentioned above is the largest in the industry since 2006 – and is equivalent to almost one-half of SPF’s market capitalization.

If you prefer to consider a sector fund, look carefully at what is owned. I covered the problem with the so-called homebuilder ETFs in “Want To Buy A Sector Fund? Ignore the Label; Examine the Contents” (February 25).

So… Current data indicate that house sales are okay – lower, but stable, following the government’s incentive plan end. In addition, homebuilders appear to be maintaining their activity level at a reasonable pace. With stability comes the ability to better manage company strategy and resources, so homebuilder stocks could be a profitable investment.

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