Markets & Finance

Second-Half Outlook: Housing


Homebuilders feel every quarter-point rate hike by the Federal Reserve like a punch in the gut. That's 17 punches now, going back to June, 2004, when the Fed decided that it was time to dry up some of the excess liquidity in the financial system. The increases in overnight lending rates have spilled over into higher mortgage rates—a huge problem since low-cost financing was the one factor that had kept houses affordable in spite of the huge price increases since 2000.

Builders withstood the rate-hike assault until last summer, but since then the sector has gone nowhere but down. Most stocks are off by a third to more than half from their 2005 highs. An index of homebuilder confidence recently hit an 11-year low.

So is there anything at all worth owning in the homebuilding sector? Actually, there might be. Several big builders have deep pockets that will allow them to survive the downturn, picking up land and market share from weaker public players and the 75,000 or so small, privately owned builders that have more fragile finances. Not only that, but the cost savings that big builders get from their economies of scale should help them if the battle for buyers leads to price wars—as is already starting to happen in suddenly soft markets like Miami, Phoenix, and Las Vegas.

HOSPITALS AND PRISONS. Several analysts recommend Fort Worth-based D.R. Horton (DHI

), which is the biggest builder by volume and sells lower-priced homes that might become more popular with families pinched by mortgage rates approaching 7%. Standard & Poor's equity analyst William Mack notes that in spite of Horton's average selling price of just $260,000, it manages to post a strong pretax operating margin of over 17%.

On the other hand, Mack thinks Horton is so big that it will have trouble meeting its growth targets. His only buy recommendation among homebuilding stocks is Horton's neighbor, Dallas-based Centex (CTX

). He likes Centex' strong balance sheet, financial transparency, and diversification. Centex has a reasonable 44% ratio of nonfinancial debt to capital, which will improve when it completes the sale of its subprime mortgage financing company to an unidentified buyer for about $600 million.

Unlike Miami-based Lennar (LEN

), another financially sound player, Centex doesn't rely on complicated joint ventures to build houses. And it's one of the few homebuilders with a substantial nonresidential business—about 20% of its revenue, Mack says. Its general contracting arm builds schools, hospitals, and prisons, among other facilities.

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