By Theodore Kinni. Even though the market overall is heading downward, analysts continue to tout the stocks of the home builders. Why? One reason is the sector's robust performance during the past year. Even after factoring in the post Sept. 11, 2001 downturn (which affected earnings in the first half of 2002) and an uncertain economy, consumer demand is strong, finished product inventories remain low, and interest rates are a home buyer's dream come true. Barring unexpected events — a recessionary double dip, for instance — sector analysts are targeting double-digit earnings growth in 2002.
"Just to give you an average for 2002 year-over-year earnings growth," says Credit Suisse First Boston's Ivy Zelman of the 14 builders covered by CSFB, "we are looking for 21 percent, and there are only three companies that are down."
Better-than-expected backlog growth in the second half of 2002 translates into solid revenues in the first half of next year. Further, the so-called "easy" comparisons against the depressed second half of 2001 should make the final tallies of the sector's second half performance even more attractive to investors.
In addition, there are the successful — and continuing — efforts of the public builders to gain market share and squeeze some of the traditional volatility out of their operations, thus, establishing the sector as an increasingly secure investment arena.
That trend, which relates to builders' capital clout, has analysts thinking that flat growth or slight declines in starts could very well strengthen the position of the big companies in the housing market.
"My big trigger is the disparate access to capital between big builders and small builders," says Merrill Lynch's Joseph Sroka. "I think this is going to allow them to gain market share and that gaining of market share gives them better ups in up times and stems their downside to some extent in downturns."
That's good news for the future of the public builder stocks. So is the fact that the valuation multiples are trading at around a 60 percent discount to the S&P companies. Although this has been an ongoing source of dismay to the builders, the investment community is showing signs that it may be ready to begin reframing how it thinks about the home building sector.
"I would find it hard for these companies to continue to deliver superior earnings growth and still trade at such a disparate multiple," declares Raymond James & Associates analyst Rick Murray. He suggests that a more equitable valuation may be approaching for several reasons. For one, there are other sectors that are more cyclical and still trade at higher multiples. For another, the market share gains and the expanding territories of the home builders seem to be lowering both their exposure to cyclical forces and the volatility of their results.
—Theodore Kinni is based in Williamsburg, Va.
Published in BIG BUILDER Magazine, November 2002