Negative Analyst Sentiment Grows Against Home Builders
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By Janet Morrissey
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--Several more analysts cut profit projections and one downgraded the home-building sector as negative sentiment toward home-building stocks accelerated Thursday.
"Much like lemmings going over a cliff into the sea, sell-side analysts appear to be in a race to the bottom," Susquehanna Financial analyst Stephen East said in a note. "Our fear is that the race to the bottom is based less on fundamentals and more on the desire to set the bar so low that builders 'can't miss our numbers."'
Morgan Stanley analyst Rob Stevenson downgraded the sector to cautious from attractive and cut his price targets and earnings projections for KB Home (KBH), Lennar Corp. (LEN) and Pulte Homes (PHM) for 2006 and 2007.
Stevenson noted that the group is down 30% so far in 2006. "One could easily argue that our downgrade is 'too little too late,"' said Stevenson. However, he believes there's still more downside to come, based on the supply-demand imbalance, the increasing odds of further Fed rate increases, and the probability that fundamentals will get worse before they get better.
He noted that the yield on the 10-year treasury rose 80 basis points between mid-January and mid-May. In general, he said, homebuilders tend to underperform the broader market by 16% when the 10-year yield increases 100 basis points. "With continuing inflation concerns and the increasing likelihood that the Fed will continue to raise rates in June and August, we expect interest-rate headwinds to continue to negatively impact the homebuilder stocks for some time," he said.
Stevenson said home-building stocks could potentially fall another 15% to 25% before they bottom.
Susquehanna's East, whose earnings projections had been on the lower end of analysts' estimates over the past six to nine months, trimmed his projections further in light of the weaker-than-expected housing environment.
"The selling season turned out to be a much bigger flop than virtually anybody had imagined," East said. "Consequently, we have gone through another round of estimate cuts."
However, East's cuts were less pronounced than some of his rivals' changes. "Possibly we are still overestimating on the way down, but we are trying to predict the most likely earnings scenarios given our data point today - not trying to sandbag the Street," he said.
East said order rates are down 20% to 50% in some of the hotter markets while incentives and inventories have climbed dramatically. "Late May and early June became the season of confession for builders, as one after another lined up to spill the beans on a very pathetic selling season," said East. "Against this backdrop, managements have been lowering guidance and we have been lowering estimates."
East said there's too much uncertainty in the industry to make longer-term predictions. "2007 is a crapshoot," he said. However, he said there have been some signs that cancellation rates and inventories are beginning to stabilize.
East is predicting earnings will be down 4% on average in 2006, with Pulte Homes Inc. (PHM) seeing the biggest decline at 17%, and Meritage Homes Corp. (MTH) seeing positive earnings growth of 14%. He expects earnings to fall 6% on average in 2007, with Standard Pacific Corp. (SPF) taking the biggest hit with a 15% decline, and Centex Corp. (CTX) enjoying 4% positive earnings growth.
JMP analyst Alex Barron cuts his estimates and price targets on home builders across the board Thursday. "We believe the worst is yet to come," he said. He sees home builders' earnings plummeting 20% to 40% in 2007. He also cut his ratings on D.R. Horton and Meritage to market outperform from strong buy, and lowered KB Home to market perform from market outperform.
Merrill Lynch reinstated coverage of the group late Wednesday, with a buy rating on Centex, and neutral ratings on D.R. Horton (DHI), KB Home, Lennar, Pulte and Toll Brothers (TOL). Analyst Kenneth Zener expects home builders' earnings to decline in 2006 and 2007, but remain positive. He noted that housing stocks have fallen 43% since their peak in July 2005, and he believes the stocks already reflect the negative earnings revisions which began in April 2006.
The downgrades and earnings cuts are just the latest in the sector.
Earlier this week, UBS analyst Margaret Whelan cut her earnings per share estimates for home builders by 20% in 2006 and 27% in 2007. She said new-home sales had been falling at a faster pace than anticipated.
Last week, Wachovia analyst Carl Reichardt downgraded the sector to market weight and cut earnings projections, where he's now predicting home builders' earnings-per-share to fall 11% on average in 2006 and 32% in 2007. "We clearly misjudged the magnitude and sharpness of the decline in new-home demand and increase in new and existing home supply," he said in a note. However, he said, he doesn't expect an extended downturn similar to that of the early 1980s or late 1980s without a housing liquidity crisis.
Last month, Banc of America Securities analyst Daniel Oppenheim slashed price targets by 17% and earnings guidance for 2007 by 15%. He expects earnings to fall 22% on average in 2007.
Still, Morgan Stanley's Stevenson said he believes the underlying demographic and operational trends still make home builders a good long-term investment. However, investment in the next nine to 12 months would be "challenging."
All of this could change if a major builder decided to do a leveraged buyout or if interest rates moved materially lower, Stevenson said. If a major builder opted to go private, he said, it would "significant impact valuations in the sector for quite some time."
All of this comes as two major builders - KB Home and Lennar - are poised to release their fiscal second-quarter results over the next few days.
-By Janet Morrissey, Dow Jones Newswires; 201-938-2118; janet.morrissey@dowjones.com
(END) Dow Jones Newswires
June 15, 2006 11:03 ET (15:03 GMT)
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