2018 was a rocky year for the housing market, and many media reports — including from MarketWatch — speculated that the top of the cycle had been reached.
About a year later, that call seems to have been confirmed. But the cycle peak hasn’t led to a recession. Instead, the housing market looks to have come in for a soft landing and is now bouncing along. And that may be enough for residential builders to notch a favorable earnings season.
Wedbush Securities home-builder analyst Jay McCanless called himself “cautiously optimistic” in a note published in mid-July. Results from companies reporting earlier, such as Lennar LEN, -0.01% and KB Home KBH, -0.26% , “bolster our view that order growth has bottomed and should turn positive this quarter,” McCanless said. For one thing, poor sales in 2018 make this year look good by comparison, he acknowledged, going on to say “declining mortgage rates for most of the June quarter should also be a tailwind.”
Read: Home builders are a buy again, says Wedbush
Lower rates have indeed goosed demand for mortgages, as shown in data from the Mortgage Bankers Association. But demand for housing has been strong for several years. It’s supply that’s been missing, and that imbalance has pushed the market askew.
McCanless thinks many builders have gotten the message about affordability, he said, and he’s most bullish on those that have focused their businesses on entry-priced housing. Demographics — notably older millennials ready to start families and downsizing baby boomers — are a big tailwind for this segment of the market, he said.
Some of McCanless’s rosy forecasts for the quarter have already been proven out. Taylor Morrison Home Corp. TMHC, -0.05% pre-released some of its second-quarter results on July 18, sending its stock sharply higher on a day when most builders’ shares lagged. The company said it expected net sales orders to have increased 20% compared with a year ago in the quarter, with closings up 30%.
To be sure, home builders — like much of the economy — are a glass-half-full, glass-half-empty story. Raymond James’s Buck Horne said he sees the same demographic demand and lower mortgage rates that McCanless does, but through the lens of an aging economic cycle.
“Valuations are now above cyclical medians for much of the sector,” Horne noted. “Softening economic data points, reduced earnings expectations, and an inverted yield curve in the bond market are all signaling a potential late-cycle shift.” What’s more, he said, his own analysis suggests “a materially more competitive selling (and labor) environment which could further pressure gross margin trends.”
Related: Americans are driving until they qualify again, and builders are responding
Here are a few of the bigger names reporting over the coming weeks, and what analysts are expecting:
PulteGroup Inc. PHM, +1.40% : Wedbush’s McCanless rates the builder neutral with a $28 price target, lower than its Friday close of $33.23. Jack Micenko of SIG also assigns a neutral rating but has a $33 price target and calls himself higher than consensus on his expectations for orders. Pulte, Micenko said, has a “more diverse geographic offering” than competitor TRIPointe Group Inc TPH, +0.12% . Pulte reports its quarterly results Tuesday.
D.R. Horton Inc. DHI, -0.02% : Micenko said he’s above consensus on his forecast for per-share earnings, at $1.09, and orders, at 15,840, but his EPS estimate is a penny lower than he expected earlier in the quarter, and he has a neutral rating on the stock. Last month, Key Banc Capital Markets analysts raised their price target to $52, about 15% above D.R Horton’s Friday close. “We think a higher valuation range is acceptable as operational results have led to falling leverage and a net 20% debt-to-capital ratio demonstrating the benefit of higher turning assets,” the analysts noted. Horton reports July 30.
M.D.C. Holdings Inc. MDC, -0.16% : Buck Horne, the builder bear, calls MDC his top pick, “a company-specific turnaround story currently building momentum while still trading at an attractive valuation.” The company pre-released some second-quarter results on July 8 ahead of a July 31 earnings release. Net new home orders were up 32% compared with a year ago, and the number of homes in backlog was the most since 2006. McCanless has a lower revenue estimate than the consensus, which is for a 7.5% decline compared with a year ago.
Taylor Morrison: Taylor Morrison traditionally served a somewhat higher-end segment of the market but recently shifted its business mix to more active-adult homes and entry-level properties, McCanless said. He has an outperform rating and a $24 price target on the stock, and forecasts revenue of $1.09 billion, up 12.2% compared with the year-earlier period. Micenko’s rating on the stock is positive, and his share-price target is $27. The company is set to report results Aug. 7.
See: More new-home sales are for houses that haven’t even been started yet — and that’s not good