D.R. Horton stock is a buy, according to J.P. Morgan.
Daniel Acker/Bloomberg
Home-builder stocks rose to new heights in 2021—but a J.P. Morgan analyst says earnings season could reverse that trend.
Michael Rehaut, an analyst covering home builders and building products, said in a Wednesday note that strong expectations could set home-builder stocks up for a pullback this earnings season. He sees two, however, that can outlast the dip: D.R. Horton (ticker: DHI) and Century Communities (CCS).
The supply of homes for sale has been notoriously tight throughout the pandemic, with the inventory of existing homes on the market at historic lows in January and February. Meanwhile, demand has remained elevated compared with the year prior. Last quarter, this dynamic helped send new home orders up—and, with it, home-builder stocks.
The analyst wrote that his universe of home-builder stocks is up 33% year to date—despite rising interest rates, which usually weigh on the sector’s stocks via mortgage rate increases. The average rate on a 30-year fixed-rate mortgage increased to 3.18% last week, up from an all-time low of 2.65% in January. “Interestingly, this strength has been particularly noticeable over the past two weeks, with our universe up 13%,” Rehaut wrote.
But that trend might be short-lived, as home builders are dealing with tough comparisons from prior strong quarters. Expectations for robust housing demand and high orders mean a smaller-than-expected earnings beat—let alone in-line results or a miss—could lead to a pullback in the sector, Rehaut wrote. And companies “will be hesitant to fully incorporate these stronger trends into full-year guidance,” he wrote.
Home builders could be affected by “a slight moderation in market demand as the impact of higher rates begins to be more broadly felt across the industry,” Rehaut wrote. That, however, isn’t the only headwind. Companies may have started to limit sales amid “extended backlogs and production constraints,” which could cut into order growth, he wrote. In addition, economists and analysts have warned that affordability concerns—spurred by rising home prices and mortgage rates—and higher materials costs could dent the market.
While Rehaut said the sector could experience a short-term pullback, he highlighted D.R. Horton and Century Communities as the best plays in the sector for the coming earnings season. The analyst expects that D.R. Horton, the largest public home builder by market capitalization, will outperform other builders in terms of order growth, gross margin, and operating margin. Century Communities, a smaller-cap builder with a presence in the West, South, and Great Lakes region, will also outperform its peers in terms of order growth, Rehaut wrote. Plus its stock trades at a lower forward earnings multiple compared with its small-cap peers.
Home-builder stocks fell on Wednesday, but have seen strong gains so far in 2021. The two largest home builders by market cap, D.R. Horton and Lennar (LEN), have risen 33.7% and 35.6% year to date respectively, while the S&P 500 has risen 8.6% in the same time. The iShares U.S. Home Construction ETF (ITB), an exchange-traded fund that tracks home builders and related companies, has returned 26.8% this year.
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