Michael Rehaut, the senior analyst on the Homebuilding and Building Products research team at JP Morgan, is out with a new report that says the thrashing builder stocks have taken due to the meltdown in the subprime mortgage business is "overdone."
In the report and in a morning conference call with investors, Rehaut reiterated JP Morgan's positive sector stance regarding homebuilders. "The recovery itself might be slowed in '07," Rehaut said of the impact of the turmoil in the subprime market. "We do believe that the stabilization that we have seen emerge in the market?should continue."
During the conference call, Rehaut explained that even if defaults on subprime mortgages doubled from the 3.86% reported for 2006 by the Mortgage Bankers Association in Washington, the houses that were put on the market over the next two years as a result would amount to only 3% to 5% more than the average 4.1 million homes that are on the market at any given time. That increase, he said, "can be absorbed."
At the same time, Rehaut said, "We remain impressed with the vigilance" among builders regarding inventory management and cost cutting. "You're in a drastically different environment from a production standpoint that you were 18 months ago."
In the report, Rehaut explained "we believe the industry is much better prepared to handle a decline in demand, in contrast to 2006, when the speculative buyer largely left the market. Specifically, we point to the continued decline of building permits, and builders' actions curtailing starts and reducing spec inventory."
According to JP Morgan, builders reduced total starts between 40% and 50% in the past several months, and building on spec has been largely halted. Rehaut also noted thatt D.R. Horton and MDC Holdings are holding back starts on homes ordered by subprime customers until they are certain "the mortgage is going through."
The research team expects year-to-year comparisons to look better each quarter, partly because of the dismal numbers in 2006. Specifically, it is estimated orders to improve from -33% in the fourth quarter of 2006 to -22% in first quarter, 2007; -15% in second; -5% in third; and +5% in fourth. Rehaut also pointed out that cancellation rates have fallen from 42% in last year's third quarter to 34% in the first quarter of this year.
"We believe the industry's key leading indicators-inventories, can rates, and order trends-should continue to show signs of stability and even modest improvement, which should also result in decreased land charges versus 4Q06."