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5 Homebuilders With the Brightest Outlook for 2012

Frank Byrt|Analyst
Wednesday, 30 Nov 2011 | 2:24 PM ET

How could anyone bet on the housing industry when a national headline Tuesday exclaimed "Home Ownership Heads to New Lows" even as prices today are a third less than at their peak five years ago?

But residential-construction stocks are coming to life, gaining 6.5 percent in the past three months, with five of the biggest companies producing double-digit returns, according to Morningstar.

The broader Standard & Poor's 500 Index has risen 1.9 percent in the same period.

For all of 2011, homebuilder stocks are down 26 percent versus the benchmark index's 3.4 percent decline.

Still, something's at work here.

Back to the bad news: Standard & Poor's analysts said Tuesday that home prices across the nation are now right back to where they were in the second quarter of 2003, dispiriting news for potential investors.

Nevertheless, the "smart money" in the form of institutional investors, such as mutual funds, are buying homebuilder stocks heading into 2012. They're selecting the few that survived the worst housing-market decline since the Great Depression.

And the economy has been tossing the housing sector's prospects the occasional bone as well.

For example, new-housing starts surged 15 percent in September to the highest level in 1 1/2 years, according to the Commerce Department.

A slowly recovering economy after a recession and a decade of overbuilding contributed to the worst housing-market conditions in a generation, and that, coupled with high unemployment, low consumer confidence, tough new lending standards and banks' reluctance to lend have hamstrung the industry over the past few years.

But record-low interest rates, and an outlook that things can't get worse than they are now, has boosted the fortunes of the homebuilding industry.

"Following historical precedent, the currently depressed housing market holds high potential for a dramatic rebound in the coming years, providing a major upside opportunity," Morningstar analysts write.

But they throw in the catch-all caveat: "While we expect a long, bumpy bottoming for this industry, an eventual major rebound in housing demand sometime in the next several years looks all but certain."

The question is how long can an investor hold out versus, say, a huge mutual fund that can afford to sit and wait? Here are the five leading homebuilders and what analysts are saying about them:

1. Lennar is one of the largest and most geographically diverse U.S. homebuilders, with operations in 15 states. It also provides title and mortgage-related services, is involved in about 50 joint ventures, and owns a distressed real estate unit Rialto Investments.

Lennar's shares have rallied 24 percent in the past three months, and though they're in the hole 10 percent this year, they're up 13 percent over the past 12 months.

Morningstar has a $26 price target on it, a 53% premium to its current price. Morningstar analysts said in a recent research note that Lennar's third-quarter results "indicate that no other public builder is currently operating on a higher plane.

Roughly flat revenue, strong gross margins, and increased deliveries and orders make Lennar's recent performance really stand out."

2. Pulte Group is the nation's largest homebuilder after the company acquired Centex for $1.3 billion in 2009. Pulte's shares are up 23 percent in the past three months, although they're down 27 percent on the year. The company has a $2 billion market valuation.

S&P's analysts have Pulte rated "buy" and forecast that revenue will decline 12% this year and rise 9% in 2012 in an expected housing market recovery.

That means Pulte "will be able to gain market share as the housing market slowly recovers." Morningstar analysts also sound bullish, saying "Pulte's massive scale should, theoretically, provide major opportunities to leverage sourcing, marketing and administrative costs in a rising sales environment.

"Further, the company's active, adult-oriented Del Webb division should benefit from a secular boom in retirement among baby boomers over the coming years. This ramp in business activity should propel Pulte's results solidly into the black," said the Morningstar report.

3. The second-largest U.S. homebuilder, D.R. Horton, has seen its shares gain 16 percent in the past three months. They have a three-year average annual return of just under 20 percent — in the weakest new-home market in a lifetime. Its shares have a market value of $3.4 billion.

The company is one of the largest new-home builders and operates in 72 markets across 26 states. D.R. Horton targets entry-level and first-time home buyers. It also offers finance and closing services.

S&P reports that for fiscal 2012, analysts estimate the company will earn 49 cents per share and that will jump 73 percent to 85 cents in fiscal 2013.

The top 10 institutional investors own 45% of the company, led by mutual fund giant Fidelity, at 14 percent. The company reported last week that it earned 11 cents per share in its fiscal fourth quarter, compared with a loss of 3 cents a year earlier.

Significantly, D.R. Horton said its sales backlog as of the end of the third quarter increased to 4,854 homes from 4,128 homes, positioning the company for a stronger start to fiscal 2012.

The company said it expects to be profitable next year. Analysts expect the company to earn 51 cents per share in 2012.

4. Toll Brothers, which focuses on high-end new homes, gets a "strong buy" recommendation and a five-star corporate rating from Standard & Poor's, its highest recommendations.

And Morningstar is upbeat as well, saying Toll is "one of the more attractive businesses in homebuilding, in our view, represented in part by its narrow economic moat.

The firm's well-managed indebtedness, lean operations, and disciplined adherence to the luxury market make it a likely big winner once volumes normalize." Toll Brothers' shares are up 17% in the past three months, but are about break even on the year.

It's worth $3 billion. Almost 85% of its shares are owned by institutional investors, about half that by the 10 largest ones, including a 15% stake by Fidelity. The top 10 institutional investors raised their stake by 1.4 million shares in the third quarter.

5. KB Home, a top-five homebuilder with a $530 million market value, gets a "hold" rating from S&P, but the ratings firm says optimistically that it expects "revenues will rebound 20% in fiscal 2012 from an expected recovery in the housing market."

KB Home's shares are up 16 percent in the past three months, but down 38 percent this year, although the three-year average annual return is 17.5 percent. The top 10 institutional investors own 57 percent of its shares.

Morningstar gives the company a five-star rating, its highest, and has a $21 "fair value" price target on its shares. The stock trades at less than $7 today.

Morningstar says in a recent research note that KB Home "operates as one of the more forward-thinking and pragmatic firms in our homebuilder coverage.

The firm holds a deep-rooted merchant-like approach to its business, a differentiated strategy in an industry often dominated by more maverick, real-estate-centric mindsets."

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Disclosures:

TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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