by Daniel Putnam | December 26, 2012 7:00 am
The recovery in the housing market was one of the most important stories of 2012. In addition to shoring up homeowners’ balance sheets and keeping the economy on a positive track, it has boosted financial stocks and propelled homebuilding stocks to a gain of over 80%.
While these beneficiaries generally receive the most attention, the housing rebound has also fueled excellent performance for companies that produce materials and furnishings for new homes. Now, with most names in this group already having delivered triple-digit performance since the lows of October 2011, the opportunities are much harder to come by than they were last year at this time.
The strong performance for stocks in the home “supply chain” stems from the same factors that have propelled homebuilders in the past year-plus: The housing market is on the road to recovery, new-home construction has resumed and demand for furnishings and building materials has picked up.
Just how strong have returns been? This table tells the story:
|COMPANY||TICKER||INDUSTRY||RETURN FROM OCT. 2011 LOW|
|Owens Corning||OC||Building Materials||80.3%|
|Mohawk Industries||MHK||Flooring Products||113.6%|
|Masco||MAS||Home Improvement Products||149.3%|
|Armstrong World Industries||AWI||Ceiling & Flooring||77.1%|
|Quanex Building Products||NX||Window, Door, & Building Products||119.1%|
|Lennox International||LII||HVAC Products||113.8%|
|Leggett & Platt||LEG||Residential Furnishings||57.0%|
|A.O. Smith||AOS||Water Heaters||113.2%|
|Fortune Brands Home & Security||FBHS||Security & Home Improvement Products||146.6%|
The question now is whether any buys are left in this group. Keep in mind that each of these companies offers its own fundamental story — and that many, such as Whirlpool (NYSE:WHR), have significant international business lines. Still, some general statements apply across the entire group.
First, these housing supply-chain stocks are on track for growth that’s much better than the overall market next year. The vast majority of these companies are estimated to generate earnings growth north of 15% in 2013, more than triple the 5% growth analysts see for the S&P 500.
At a time in which U.S. GDP is expected to expand by only about 2%, this type of growth — and continued headlines about the strengthening housing market — will continue to attract buyers in the months ahead.
That’s the good news. Unfortunately, another similarity is that valuations are no longer cheap based on forward price-earnings ratios. Trailing P/Es don’t carry much weight here because many of these suppliers are coming off periods of depressed earnings. However, with the exception of Quanex Building Products (NYSE:NX) and Whirlpool, are all trading with forward multiples that are at premium to the S&P 500’s P/E of 13.9.
|COMPANY||2013 EPS GROWTH (EST.)||2013 ESTIMATES (90 Days)||P/E Trailing||P/E 2013 (EST.)|
|Armstrong World Industries||16.5%||Falling||22.8||17.4|
|Quanex Building Products||342.9%||Flat||37.2||10.4|
|Leggett & Platt||8.7%||Flat||21.9||16.9|
|Fortune Brands Home & Security||30.7%||Flat||164.0||25.9|
Bulls will argue that these stocks deserve such a premium multiple given that they’re in the midst of a recovery, and that’s true to some extent. But as is the case with the homebuilders, investors need to be careful here because much of these companies’ stock prices already reflect the good news. These are no longer beaten-down, contrarian plays that investors can pick up on the cheap.
As a result, there’s much less room for continued good news from the housing market to propel further gains as there is for a disappointment to lead to meaningful downside. Also, any combination of fiscal-cliff disruptions, renewed problems in Europe, slowing U.S. growth or — especially — rising interest rates, and the housing supply-chain stocks are almost certain to underperform.
Investors, therefore, need to pick their spots. While one more upleg is likely in store for both the homebuilding and housing supply-chain sectors, it’s going to take good old-fashioned stock-picking, rather than a broad-based sector bet in an fund such as the SPDR S&P Homebuilders ETF (NYSE:XHB), to make money from here on out.
A good starting point for ideas is to look for opportunities in stocks that have lagged the broader group, offer fairly reasonable valuations, have flat to rising earnings estimates and that are trading near breakout levels rather than being hugely overextended such as SherwinWilliams (NYSE:SHW) or Lumber Liquidators (NYSE:LL).
Among the names that warrant consideration are Lowe’s (NYSE:LOW), Quanex Building Products, Lennox International (NYSE:LII), and Leggett & Platt (NYSE:LEG).
Still, even these stocks will be vulnerable if the broader market encounters rougher sledding. For now, investors will be better served by waiting to buy a dip rather than expecting the home suppliers to deliver much more upside from here.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.
Source URL: http://investorplace.com/2012/12/can-housing-related-shares-keep-rallying/
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