No Housing? Homebuilders Win

Homes in the U.S. are the least affordable they’ve been in decades.

Despite the rate on a 30-year mortgage nearly doubling from a year ago, listed homes don’t last long.

A combination of factors has led to an inventory shortage most of us haven’t seen in our lifetimes.

So, it makes all the sense in the world that homebuilders would be doing well.

In fact, every homebuilder stock in the top 5 searches by financial pros made a multi-year high this summer.

With those same stocks pulling back, we wanted to dig into the top pick by financial pros and see if we could find a lucrative investment opportunity.

D.R. Horton’s Business

One of the largest home builders, D.R. Horton constructs and sells single-family houses for entry-level and move-up markets.

The company operates in 113 markets in 13 states across the U.S. with no exposure to the Northeast and upper plain states.

Source: DHI Investor Relations

Homebuilding accounts for 98% of DHI’s revenues, with the remaining 2% derived from financial services.

DHI has chosen to expand through acquisition, acquiring Truland Homes in June 2023, which operates in Alabama and Northwest Florida. This comes after DHI purchased Riggins Custom Homes in Northwest Arkansas and Braselton homes in Corpus Christi, Texas, in late 2022 and late 2020, respectively.

The chart below illustrates an important point for DHI and homebuilders in general:

Source: DHI Investor Relations

After The Great Recession, new come sales plunged and never returned.

It’s believed that it took us all of the next decade to work through the excess from the 2008 market collapse.

Notably, DHI’s market share of new home sales climbed over the years. 

However, all homebuilders pulled back from the breakneck pace of the prior two decades.

This is why we don’t have new homes coming online to relieve supply issues.

Financials

Source: Stock Analysis

With a shortage of homes and climbing demand, DHI has done very well for itself.

Revenues grew double digits for the last few years as gross down through free-cash-flow margins expanded.

Heck, even EPS margins improved.

DHI  carries a paltry $3 billion in net debt, allowing them to take their $3.4 billion in operating cash, repurchase nearly $1 billion in stock, and pay out $335 million in dividends.

Valuation

Source: Seeking Alpha

All the homebuilders look cheap…because they are.

For a group that lagged the market, each trades at an attractive price, whether we’re talking price-to-earnings ratio, price-to-cash flow, or price-to-sales.

However, DHI is the most expensive of the group. But it’s still cheap.

Growth

Source: Seeking Alpha

Part of DHI premium comes from its higher than average revenue growth over the last 3-5 years relative to its peers.

Plus, it’s done a great job of improving EPS and EBIT.

Toll Brothers (TOL) has done better in several categories. However, its high-end home niche exposes it to a specific market risk the others don’t face.

KB Homes (KBH) displays substantial free cash flow growth. However, the company’s revenue outlook has investors a bit skittish.

Profitability

Source: Seeking Alpha

Compared to its peers, DHI has one of the best net income margins. However, its free cash flow margin is the worst.

That seemed odd, so we checked the calculation by hand, and it turns out the actual number is 9.6%. That’s not top of the list, but much better than what it was showing.

Our Opinion 8/10

In our mind, each of these homebuilders has something to like and dislike.

DHI delivers decent growth, but its margins underwhelm.

KBH has great margins but no growth.

TOL has everything but is exposed to the high-end home market risks.

Our best strategy here is to make a basket of these homebuilders (there isn’t a great ETF we like for this category).

That way, you gain exposure to the sector without putting all your eggs in one basket.

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