4 Homebuilding Stocks That Are Suddenly at Risk

homebuilding stocks - 4 Homebuilding Stocks That Are Suddenly at Risk

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For now, the real estate sector, particularly homebuilding stocks, are enjoying a robust rally. Year-to-date, the Dow Jones U.S. Home Construction Index is up 25.5%. This easily beats out the broader benchmark SPDR S&P 500 ETF Trust (NYSEARCA:SPY), which has gained a comparatively pedestrian 9%. But like the old saying goes, “what goes up must come down.” And homebuilders might be the new risk sector of 2017.

4 Homebuilding Stocks That Are Suddenly at Risk
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Let’s first address the low-hanging fruit. As with several other sectors, homebuilding stocks face political risk.

Whether you voted for the real estate tycoon or not, President Trump has not exactly been popular. Neither the American public nor the Washington insiders are enamored with the administration.

Homebuilding stocks are especially worrisome because they jumped so much under Trump. With controversy on top of controversy, the Presidential catalyst may no longer be relevant.

The not-so-obvious element impacting homebuilding stocks is that real estate is a bifurcated market. First, the Economic Research department of the Federal Reserve Bank of St. Louis details that regional markets experience differing demand. Thus, what works in one market isn’t indicative of the nation as a whole. Second, new home sales have clearly risen since the lull of the Great Recession.

The question is, who’s doing the buying?

The biggest target demographic for homebuilding stocks is the millennial generation. Last year, the Pew Research Center declared that “Millennials overtake Baby Boomers as America’s largest generation.” Marketing to the declining baby-boomers just doesn’t make much economic sense. However, according to a CNBC report, homebuilders are having enormous difficulty selling to cash-strapped millennials. They further state that their margins are at the breaking point, and can no longer lower prices.

A major headwind for millennials — and indirectly, for homebuilding stocks — is the massive college debt burden. On average, the class of 2016 incurred over $37,000 in education-related debt. Of course, that’s just an average figure. For many students, particularly those that attend private universities, that figure could soar to high-five digits, and beyond.

Worse yet, college debt can’t be erased under current bankruptcy laws. Programs to forgive this debt exist, but only for qualified positions, and it requires 10 years of work experience. All told, this collective burden hinders the average millennial from purchasing their first home.

Since this condition is unlikely to reverse soon, homebuilders may be due for a market correction. Here are four homebuilding stocks you need to be wary of.

Homebuilding Stocks to Sell: Toll Brothers Inc (TOL)

Homebuilding Stocks to Sell: Toll Brothers Inc (TOL)
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Source: Source: JYE Financial, unless otherwise indicated

The market sentiment for Toll Brothers Inc (NYSE:TOL) is emblematic of homebuilding stocks as a whole.

Just recently, Toll Brothers released its Q2 earnings results, and it was a beauty. The company saw a 40% increase in quarterly profit, and new home orders spiked 26%.

However, TOL stock was a picture of contrasts. It dipped on the announcement, and it hasn’t moved much since then.

Adding to the perplexity are comments made by CEO Douglas Yearley, who remarked that “This was the best spring selling season we have had in over 10 years.” Did covering analysts just forget to put on their glasses?

Turns out that there is a reason for the hesitation in the markets. TOL revealed that the “average price of homes sold decreased to $832,400 from $855,500 a year earlier.” It was further reported that TOL wanted “to cater to millennials who are now entering their thirties and starting families.”

Thus, we come to the first major challenge facing homebuilding stocks post-Trump rally. They’ve enjoyed a spectacular run thanks to a recovery job market and a business-centric President. Unfortunately, those tailwinds may not be enough to overcome the financial burdens that millions of millennials face.

The markets are clearly wavering on TOL stock, and that’s not what you want to see.

Homebuilding Stocks to Sell: KB Home (KBH)

Homebuilding Stocks to Sell: KB Home (KBH)
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Source: Source: JYE Financial, unless otherwise indicated

On a year-to-date basis, KBH is up 35%, resoundingly beating the benchmark indices. More importantly, KB Home has a significant leg up against its publicly-traded competitors.

So why on Earth would anyone want to be cautious on the new homebuilder?

For one thing, KB stock hasn’t done much since enjoying the choice fruits of its remarkable rally. For the month so far, shares are up 2%. Although that’s still a respectable figure, the performance contrasts sharply with the 25% gains made between February and April. Also, some technical analysts have noted that KBH appears to be overbought at present levels. This implies that a potential correction is nearing.

It’s strange to note that for all the positives that KBH has accrued this year, analysts are not buying it. Overwhelmingly, the consensus calls for a “hold” rating, which might as well be read as a “sell.” You’d figure that more people would be bullish, but the optimists have declined in number.

The other oddity is financial performance. KBH stock has been buoyed by strong demand and lack of competition in the luxury home market. But building material and labor costs are steadily rising, which squeezes margins. And as the broader retail market demonstrates, rich people aren’t always a consistent panacea.

KBH stock has enjoyed a good run, but now it might be a time to take some profits off the table.

Homebuilding Stocks to Sell: Lennar Corporation (LEN)

Homebuilding Stocks to Sell: Lennar Corporation (LEN)
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Source: Source: JYE Financial, unless otherwise indicated

Contrasting with KB Home, analysts are much more favorable to LEN stock. The consensus is majority bullish, and no one is rating Lennar as a sell.

Zacks Equity Research recently upgraded LEN to a buy, stating that “Lennar is one of the best positioned homebuilders to capitalize on the housing recovery, courtesy of its diverse revenue mix, steady top-line performance, above-average order growth and improving SG&A leverage.”

Despite these accolades, LEN is not without challenges. In my opinion, the biggest problem is the shifting real estate market and its implication for future sales. According to Reuters, “U.S. home resales fell from a more than 10-year high in April, weighed down by a chronic shortage of houses on the market that is keeping prices elevated and sidelining prospective buyers.”

Such inflated markets are not at all conducive for the millennial generation. While LEN stock is benefiting from an improved economy, the reality is that younger people are the future. They will be starting families, rearing children and generally be in an expansive mood. The older generation, particularly the baby boomers, are looking to retire and downsize.

This is a very common theme among homebuilding stocks. They’re right to enjoy the benefits they’ve earned, but what comes tomorrow? Even though LEN has tore up the markets this year, I’m not sure if it has the legs to finish.

Homebuilding Stocks to Sell: D.R. Horton (DHI)

Homebuilding Stocks to Sell: D.R. Horton (DHI)
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Source: Source: JYE Financial, unless otherwise indicated

After the horrific slide in home sales following the 2008 financial crisis, this is a well-deserved victory. But at the same time, we have to face reality.

The trailing three months have been comparatively slow for DHI stock, having registered less than 3%. Is the best of D.R. Horton behind us?

If consensus is anything, Wall Street still believes in DHI stock. The company’s recommendation trend has been consistently optimistic. It certainly helps when shares have nearly doubled in market value over the last five years. But its ability to break through upside resistance in recent days is problematic.

This situation becomes more concerning when you look at the numbers. In its most recent earnings report, DHI improved year-over-year sales by 17%. However, we only saw a modest improvement in operating margins, parity in net margins and a decline in gross margins. That signals a profitability squeeze that has being covered up by the present robustness in real estate.

What happens if we enter a lull? Based on the financials, it appears that DHI does not have much buffer in the margins to address business slowdowns. Given the typically reduced purchasing power of younger millennials, this dynamic is not conducive for further growth.

This is where investors are having issues with homebuilding stocks. Individually, they’re fine companies. But it just seems like the industry is slowly caving in, and no one wants to bear the bad news.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2017/06/4-homebuilding-stocks-suddenly-risk-tol-kbh-len-dhi/.

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