Markets & Finance

Lots to Like about Horton


By Michael Jaffe With long-term fixed mortgage rates near their lowest levels in 40 years, and the prospect of a modest economic revival in coming periods, Standard & Poor's expects the level of home buying in the U.S. to remain strong over the coming year. One of our top choices in the homebuilding industry is D.R. Horton (DHI), which is one of the largest and most geographically diversified builders in the nation. The shares carry S&P's highest investment recommendation of 5 STARS (buy).

Although ongoing weakness in employment markets and a recent slump in consumer confidence have caused some concern over the future strength of housing markets, we at S&P continue to believe that still very low mortgage rates will stimulate active home buying activity. Mortgage rates typically have the largest influence of any factor driving home sales, based on their effect on mortgage payments and income needed to obtain a mortgage.

Horton has recorded tremendous sales and profit growth over the past decade. Its sales have risen at a compounded annual growth rate of 43% over that time, and its earnings per share have posted compounded gains of about 30%. Horton's excellent performance stems from an active takeover program plus a focus on internal growth. The company has also benefited from its concentration in demographically favorable areas such as California and Arizona; some 34% of its fiscal 2001 (ended September) home sales came from the Southwest and 30% from the West. On top of these factors, Horton is benefiting from its large size and financial muscle, which give it a major advantage in obtaining big land holdings in desired areas. We expect these conditions to drive further growth in coming periods.

We also believe that the entry-level and first move-up housing categories that D.R. Horton stresses (with some 70% of its homes sold in recent periods going for $250,000 or less) should benefit the most from the persistence of buyer-friendly mortgage rates. We base that forecast on our belief that exceptionally low rates enable renters or those who own modest homes to afford their first home or something nicer than what they have.

In coming periods, the company should meet its 15% minimum internal sales growth goal through ongoing new community openings and a modest rise in average sales prices. The company should also benefit from its takeover program. Horton has made a total of 18 acquisitions since fiscal 1993, including its most recent $1.8 billion acquisition of Schuler Homes in February 2002. The Schuler deal made D.R. Horton the second largest builder in California, and also added major positions in several other states.

We expect Horton to post a 20% increase in earnings per share in fiscal 2003, to $3.35 a share, from our estimate of a 27% gain to $2.80 in fiscal 2002. During fiscal 2003, we see revenues rising about 20%, on the full-year inclusion of Schuler, plus community openings and a modest rise in average prices. The higher average prices will be related in part to Schuler's big position in California, where home prices in many areas are more expensive than most parts of the U.S.

Horton's margins should widen slightly in fiscal 2003, on likely cost savings from the Schuler merger, the absence of about $61 million of expected Schuler purchase accounting charges, and increased purchasing leverage. However, EPS gains will be tempered by an increase of some 11% in average shares, as the cost of the Schuler takeover included 30 million shares.

S&P finds Horton's earnings to be of high quality, as its $2.21 of EPS in fiscal 2001 excluded only $0.03 of options expenses.

Shares of builders typically carry modest p-e multiples of about 8-10 times forward earnings. However, at their recent trading level of five times our fiscal 2003 forecast, Horton's shares seem to be factoring in the market's expectation of a housing downturn that we do not see occurring over the next year. In addition, using assumptions of 10% free cash flow growth in each of the next five years, followed by moderating gains over the next ten and a 2% sustainable growth rate, we calculate D.R. Horton shares to have an intrinsic value ranging from $26-$30.

Based on the above factors, we have established a 12-month price target of $26, which would represent appreciation of about 43% from the recent price of Horton shares. Analyst Jaffe follows homebuilding stocks for Standard & Poor's


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