| BUSINESSWEEK ONLINE : JUNE 28, 1999 ISSUE | ||||||||
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| BUSINESSWEEK INVESTOR
Building Stocks: Worth Moving Into? Earnings are high, prices low Despite more than a half-percentage-point jump in mortgage rates since last fall, new homes are going up from the West Coast to Westchester, N.Y., at a near-record pace, and builders are reporting impressive profits. But looking at the stock price of the top homebuilders, you would think the industry is in recession. Investors, worried about the impact of higher interest rates on homebuilders, have left the group languishing (chart). Wall Street's obsession with large-cap and Internet stocks hasn't helped homebuilding issues either. In fact, many investors think that after an unprecedented seven-year housing expansion, the next collapse must be imminent. They also maintain that cyclical stocks, such as homebuilders, tend to do better in the early stages of an economic recovery. But some savvy stockpickers see a rich opportunity in the builders' beaten-down shares. ''It will take more than a 100-basis-point move in mortgage interest rates to make any significant negative impact on builders' earnings or home-buying activity,'' says Goldman Sachs analyst Stephen Dobi. While many expect an increase of 25 basis points or so, no one sees any more of a rise than that. BETTER PLANNING. A vibrant economy, high consumer confidence, and positive demographic trends including purchases by immigrants, baby boomers, and retirees have kept homebuilders' profits high. In the fourth quarter of 1998 and the first three months of 1999, earnings per share were up an average of 59% over those of the previous year. The gain exceeded analysts' expectations by 13%. This year, analysts expect earnings per share to climb an additional 24%, vs. 10.5% for the Standard & Poor's 500-stock index. But homebuilders' price-earnings ratios are still down in the basement: Based on estimated 1999 earnings, they are averaging 8, vs. 26 for the S&P. ''There clearly is a disconnect between reality and perception,'' says Merrill Lynch analyst Robert Curran. Indeed, the housing industry has changed since the last recession in 1990 and '91. Major builders, such as Kaufman & Broad Home (KBH), Pulte (PHM), and Centex (CTX) have hired professional managers who are using technology and better marketing to anticipate demand, instead of building homes without knowledge of costs or customers' needs. Moreover, operating margins have improved as builders have become more sophisticated in design and scheduling. And consolidation is sweeping the business, with industry leaders acquiring smaller regional players to get into new markets. The result? ''Earnings are likely to be less volatile from peak to trough than they have ever been in the past,'' says Dobi. So even if the economy slows, he and other market-watchers don't think homebuilders will experience the same boom-bust cycle of the past that most investors still expect. If you're interested in making a value play on homebuilders, be aware that the industry isn't homogeneous, and some stocks are more attractive than others. For instance, homebuilders with a lot of exposure in California, such as Los Angeles-based Kaufman & Broad, should do well. California is the strongest market in the country and the latest to enter into the homebuilding recovery that began in February, 1992, so building there may expand longer than in other markets. Kaufman & Broad has become the largest homebuilder west of the Mississippi through a series of acquisitions and new startup divisions. The company also builds homes and commercial properties in and around Paris, one of the fastest-growing areas in Europe. Merrill Lynch's Curran expects Kaufman & Broad, which now is tradings at a price-earnings ratio of 7, to earn $3.23 per share in 1999, up from $2.32 last year. That's a 39% increase. You also might want to look for companies that are leaders in their niches. For example, Crossmann Communities, based in Indianapolis, is the top builder of low-cost, single-family homes in the Midwest and Southeast. Acquisitions and internal growth have been fueling the company's healthy 24% return on equity and 32% increase in earnings per share over the past four years. John Stanley, housing analyst with Warburg Dillon Read, expects Crossmann to earn $3.15 per share this year, up 23% from 1998. GOLDEN YEARS. Del Webb of Phoenix, meanwhile, is the leading builder of luxury retirement cOmmunities for active senior citizens. That's a lucrative sector: The number of Americans aged 55 to 74 is projected to rise by 25 million between 2000 and 2015. Warburg Dillon's Stanley thinks Del Webb will return $3 per share in 1999, up 31% over last year. Toll Brothers, based in Huntingdon Valley, Pa., is putting up another sort of luxury housing. It's the only major player in the market for homes that start at $400,000. Toll's higher-income buyers are less resistant to economic swings than most home buyers. The company also is expanding into such sectors as the empty-nester market. Ithas opened eight country club communities and will soon open the first of four active-senior retirement communities. Toll is moving into home-related services, as well, offering home security and lawn care. ''This is a great growth stock at a value price,'' says Todd Krieg, manager of Firstar Special Growth Fund. Merrill Lynch's Curran expects to see a 17% increase in earnings per share over last year, to $2.64. Despite its strong fundamentals, however, the homebuilding industry is still cyclical. Market- watchers currently see a slight falloff in housing starts by 2001. But for now, carpenters' hammers are flying, and value investors are taking the opportunity to pick up some premium names at deep discounts. BY TODDI GUTNER _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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