I don't think the homebuilders are anywhere near the end of the boom (from an investment perspective). It would need rates to skyrocket past 7 percent in 2004 for there to be a perceptible effect on the homebuilders. I've been invested in Centex and Toll over the last couple of years, and these businesses are simply money-printing machines. Centex is earning nearly $10 per share this year, trading at p/e of 9 and it is growing more than 20% per year. I keep scouring the 10-q and 10-k to see what the catch is, why these companies are not valued by the market. But I can't see anything wrong. The problem is that historically the industry was boom and bust, and no amount of evidence can convince investors otherwise. Here's the case for the homebuilders as an investment:
1. Homebuilders have been very conservative relative to history. Most nationwide homebuilders have a backlog of nearly 2-3 quarters of home orders, each order backed by a several thousand dollar deposit.
2. Homebuilders have very strong balance sheets. This historically was not true, and that led to a lot of the bigger busts in the industry. Today, the homebuildersb generate so free cash flow they could easily handle more leverage. But they're saving for the inevitable rainy day.
3. Merrill Lynch's housing analyst put out an interesting report last week stating that the homebuilders have closed the historical gap relative to the S&P in balance sheet strength (z-scores), yet they still trade at a severe discount to the S&P. No one seems to have recognized this radical shift.
4. Homebuilders are a great value play. Unlike the S&P, which trades at a price-to-earnings-growth (PEG) ratio near 2.5, the homebuilders as a group are trading at a PEG well under 1. As I pointed out above, some builders like Centex have a PEG of less than 0.5, meaning that they are valued at less than half the anticipated earnings growth.
5. Homebuilders are a great play on the dividend tax cut. Homebuilders are spinning off so much cash it is very likely that they will start boosting their dividends this year. Lennar just bumped it's dividend to a $1.00/sh. from virtually nil. Since it is the industry leader, it is likely that others will follow.
6. Structurally, the US housing market has changed, to the advantage of large vertically integrated builders. I'm always a bit skeptical of people who say that there is fundamental change because its usually just a pretext for making a higher valuation of a stock, but in this case I think it's likely to be true. Land values have skyrocketed, and development regulation has squeezed out all but those who have the financial resources and regulatory expertise to get the deals done. Imagine mom and pop builders trying to compete for a tract of land with a giant with $1 billion in cash on the books. The giant has a huge advantage because it knows that it has 16 months before it needs to break ground on the development while mom-and-pop needs to get it done in 6 months. These are huge strategic advantages.
7. Nationwide homebuilders are protected from local bubbles. In the past, a bubble burst would take down a builder concentrated in Boston or Florida. Historically there have never been national real estate bubbles, and it is likely that we are not experiencing one today. In certain areas, prices are certainly stretched beyond their rational values (LA, Denver, Bay Area), but that's not likely to have much impact on a geographically well-diversified homebuilder. I note that while everyone has been wringing their hands about a bubble the last two years, new home prices are still steadily climbing and selling at record volumes. The rise in rates in the summer just spurred a run on some housing as buyers panicked that they would miss the lowest rates. It's all good.
Well, that's my two cents. |
