The U.S. housing space continues to grapple with accelerating mortgage rates, rising raw material and labor costs. That said, the rising need for more work-at-home space, lack of existing homes for sale, focus on cost control, more stabilized mortgage rates, increased operating leverage and important buyouts have been boosting the confidence of the Zacks Building Products – Home Builders industry players. Companies like D.R. Horton, Inc. (DHI – Free Report) , NVR, Inc. (NVR – Free Report) , PulteGroup Inc. (PHM – Free Report) , Toll Brothers, Inc. (TOL – Free Report) and Meritage Homes Corporation (MTH – Free Report) have been gaining from their fundamental strength and the above-mentioned tailwinds.
Industry Description
The Zacks Building Products – Home Builders industry comprises manufacturers of residential and commercial buildings. Some industry players are involved in providing financial services that include selling mortgages and collecting fees for title insurance agencies as well as closing services. The industry players are involved in building single-family detached and attached home communities; townhouses, condominiums, duplexes and triplexes; master-planned luxury residential resort-style golf communities; and urban low, mid, and high-rise communities. The companies are also involved in the purchase, development and sale of residential land. Additionally, the companies build and own multi-family rental properties; residential real estate; and oil and gas assets.
4 Trends Shaping the Homebuilding Industry’s Future
Suburban Shift, Lack of Supply, Improved Builder Confidence: The changing geography of housing demand has been supporting builder confidence. Demand for new homes is improving in lower-density markets, including small metro areas, rural markets and large metro exurbs, as people seek larger homes to work from home amid the pandemic. The desire for more space and amenities to accommodate working and learning from home should continue to boost the U.S. housing market in the near term.
Meanwhile, there is a sizable shortage of new homes after more than a decade of under-building compared with population growth. Although demand has slowed recently, supply remains very low. Continued demand for homes despite rising mortgage interest rates amid low supply has been generating profit for homebuilders.
Builder confidence in the market for newly-built single-family homes in May inched up five points to 50 points, according to the National Association of Home Builders/Wells Fargo Housing Market Index. This marked the fifth straight month of builder confidence increase and the first time of sentiment levels reaching the midpoint mark of 50 since July 2022. Homebuilders are getting a major boost from the lack of existing homes for sale, helping industry players to navigate some of the challenges they are facing from financial markets.
Cost-Control Efforts, Focus on Entry-Level Buyers & Acquisitions: Given the accelerated raw material prices, companies have been relying on effective cost control and focusing on making the homebuilding platform more efficient, which in turn is resulting in higher operating leverage. Homebuilders have been controlling construction costs by designing homes efficiently and obtaining construction materials and labor at competitive prices. Some homebuilders also follow a dynamic pricing model, which enables them to set the price according to the latest market conditions.
Again, the majority of companies are focused on the growing demand for entry-level homes and addressing the need for lower-priced homes, given affordability concerns in the U.S. housing market. Meanwhile, industry players have been acquiring other homebuilding companies in desirable markets, resulting in improved volumes, market share, revenues as well as profitability.
Higher Rates: The home affordability issue remains a headwind owing to accelerating mortgage rates. While remaining committed to combating inflation, the Fed raised interest rates last year at the fastest pace since the 1980s, pushing borrowing costs above 5% from near zero. On May 2023, the Federal Reserve raised the target range for its benchmark interest rate by 0.25% while leaving its options open on future rate hikes. The central bank’s move pushed the Fed funds rate to a new range of 5%-5.25%, the highest since September 2007. Notably, as part of the Fed’s rate hiking drive since the 1980s, the U.S. central bank has lifted the range for its benchmark interest rate by 5 percentage points since March 2022. This is less encouraging for this rate-sensitive market, which accounts for almost 3% of the economy.
Tight Labor & Credit Markets: Although there has been a modest improvement in the supply chain and some easing in labor constraints, supply-chain challenges are still expected to continue to impact the level of housing starts and construction cycle times to some extent in the near term. Continuous supply-chain issues in various countries have been impacting builders’ ability to deliver on time. With Europe facing severe energy crises, supply-chain disruptions are likely to persist in the near term as well. Again, the shortage of skilled construction labor continues to be a pressing concern. With the rising demand for construction, the industry requires more skilled professionals, which is vital to America’s economy and infrastructure rebuilding efforts. Meanwhile, although lumber price has been dropping since March 2023, there still exists supply shortages of building materials as well as tightening credit conditions for residential real estate development and construction due to the recent banking crisis and higher interest rates.
Zacks Industry Rank Indicates Bright Prospects
The Zacks Building Products – Home Builders industry is a 19-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #8, which places it in the top 3% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of a higher earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s earnings growth potential. Since April 2023, the industry’s earnings estimates for 2023 and 2024 have increased 7.4% and 8.3%, respectively.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Outperforms Sector and S&P 500
The Zacks Building Products – Home Builders industry has outperformed the S&P 500 Index and the broader Zacks Construction sector in the past year.
Over this period, the industry has gained 35.9% compared with the S&P 500’s rise of 2.2%. The broader sector has gained 8.4% over the time frame.
One-Year Price Performance
Industry’s Current Valuation
On the basis of the forward 12-month price-to-earnings ratio, which is commonly used for valuing homebuilding stocks, the industry is currently trading at 9.4 compared with the S&P 500’s 18.8 and the sector’s 14.7.
Over the last five years, the industry has traded as high as 11.6X and as low as 4.2X, with a median of 8.9X, as the chart below shows.
Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500
5 Homebuilding Stocks to Buy Now
We have selected five stocks from the Zacks homebuilding space that currently carry a Zacks Rank #1 (Strong Buy) and are expected to register growth. You can see the complete list of today’s Zacks #1 Rank stocks here.
Toll Brothers: Based in Horsham, PA, Toll Brothers is a leading builder of luxury homes. The company has been benefiting from its strategy of broadening its product lines, price points and geographies. Also, it has been gaining from the lack of competition in the luxury new home market, its build-to-order approach and solid backlog level. This, combined with its policy of boosting its supply of spec homes into the spring selling season and focus on operational efficiency, has been helping TOL to drive growth.
The Toll Brothers stock has gained 36.3% this year, outperforming the industry’s 26.5% rise. Earnings estimates for fiscal 2023 have increased to $9.45 per share from $8.66 per share over the past seven days. The company’s earnings surpassed the Zacks Consensus Estimate in all of the trailing four quarters, the average being 24.4%.
Price and Consensus: TOL
PulteGroup: Based in Atlanta, GA, this homebuilder has been benefiting from a prudent land investment strategy, focus on entry-level buyers and return of more free cash flow to shareholders. PulteGroup’s annual land acquisition strategies have been resulting in improved volumes, revenues and profitability for quite some time now. The company has been reaping benefits from the successful execution of strategic initiatives to boost profitability, with a focus on entry-level homes.
PulteGroup stock has jumped 44.7% year to date. The Zacks Consensus Estimate for its 2023 and 2024 earnings has been upwardly revised by 7.6% and 9.9%, respectively, over the past 30 days. Its earnings topped consensus estimates in three of the trailing four quarters and missed on one occasion, with the average surprise being 15.6%. Again, it carries an impressive VGM Score of A. This helps to identify stocks with the most attractive value, growth and momentum.
Price and Consensus: PHM
D.R. Horton: Based in Texas, this homebuilder offers a diverse line of homes across various price points through multi-brand platforms like D.R. Horton, Emerald Homes, Express Homes and Freedom Homes. Further, the company enjoys one of the broadest geographic diversities in the industry and is not dependent on any particular market. It has a strong presence in 110 markets across 33 states in the East, Midwest, Southeast, South Central, Southwest and West regions of the United States. With 83,119 homes closed during the 12-month period ended Mar 31, 2023, D.R. Horton has positioned itself as one of the largest homebuilders in the United States. Impressive performance, industry-leading market share, solid acquisition strategy, a well-stocked supply of land, lots and homes along with affordable product offerings across multiple brands are expected to drive growth.
D.R. Horton stock has jumped 19.7% year to date. DHI has seen an upward estimate revision of 4.4% and 7.5% for fiscal 2023 and 2024 earnings, respectively, over the past 30 days. Its earnings topped consensus estimates in three of the trailing four quarters and missed on one occasion, with the average surprise being 15.3%.
Price and Consensus: DHI
Meritage Homes: Based in Scottsdale, AZ, Meritage Homes is one of the leading designers and builders of single-family homes. Its focus on entry-level LiVE.NOW homes has been a major driving factor. Although the combined effect of greater sales incentives and continued elevated direct costs has been impacting the company’s gross margins, MTH is particularly focused on increasing gross margin and maximizing profits on every sale. To this end, it is making homes out of speculations that promise faster delivery at a lower cost. Meritage Homes’ strategic shift to a pure-play entry-level and first-move-up builder is expected to yield higher absorptions, aided by an improving community count growth trajectory.
Meritage Homes’ shares have gained 27% this year. MTH has seen an upward estimate revision for 2023 and 2024 earnings by 19.6% and 18% over the past 30 days, respectively. Again, it carries an impressive VGM Score of A.
Price and Consensus: MTH
NVR: This Reston, VA-based homebuilder is engaged in the construction and sale of single-family detached homes, townhomes and condominium buildings, all of which are primarily constructed on a pre-sold basis. In order to serve homebuilding customers, NVR operates a mortgage banking and title services business. A disciplined business model and focus on maximizing liquidity and minimizing risks have been aiding NVR. The lot acquisition strategy helps the company to avoid financial requirements and risks associated with direct land ownership and land development. This strategy allows it to gain efficiencies and a competitive edge over its peers.
NVR shares have gained 21.8% this year. NVR has seen an upward estimate revision for 2023 and 2024 earnings over the past 30 days by 1.4% and 2.1%, respectively. Again, it carries an impressive VGM Score of B.
Price and Consensus: NVR
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