U.S. Homebuilders Tumble on Concern Stock Surge Overdone
The Standard & Poor’s Supercomposite Homebuilding Index slid 4.2 percent, the biggest decline since June 11. The Commerce Department said today that August new-home sales fell 0.3 percent to an annual pace of 373,000, compared with the 380,000 median estimate of economists surveyed by Bloomberg.
Homebuilders climbed about five times as much as the S&P 500 Index (S15HOME) in the past 12 months as low interest rates and a tightening supply of existing homes boosted demand for new houses after the worst slump since the 1930s. The 11-member S&P builder index is trading at its most expensive level relative to the S&P 500 ever, according to data compiled by Bloomberg.
“They haven’t been trading on fundamentals,” Michael Widner, a homebuilding analyst with Stifel Nicolaus & Co. in Baltimore, said in a telephone interview. “A lot of great expectations were priced in and you had a couple of data points that aren’t supporting the notion that things are accelerating.”
The S&P homebuilding index has retreated 7.1 percent since reaching a five-year high on Sept. 21. KB Home (KBH), a Los Angeles- based homebuilder that targets first-time buyers, on that day surged 16 percent after returning to a profit for its fiscal third quarter.
The price-to-book value for the homebuilding index reached 1.1 times the S&P 500’s multiple on Sept. 21, a record based on data going back to December 2001.
During that period, the average ratio between the two indexes has been 0.6 times, Bloomberg data show. Price-to-book value, or assets minus liabilities, for the homebuilder index has surged more than fourfold since 2008, while the valuation for the S&P 500 increased 51 percent at the same time.
“Early in a recovery, there’s a strong move in stocks,” Robert Curran, a managing director at Fitch Ratings in New York, said in a phone interview. “A lot of it is anticipatory. By their nature, they often get ahead of themselves to some degree.”
Joel Locker, an analyst with FBN Securities Inc. in New York, cut his ratings of PulteGroup Inc. (PHM), Beazer Homes USA Inc. (BZH) and the Ryland Group Inc. (RYL) to underperform, the equivalent of sell, on Sept. 24, citing concerns about future profitability in the face of potential interest rate increases.
“Our view is the homebuilding sector is roughly 60 percent overvalued,” based on a blend of earnings projections and price-to-book value, Locker wrote. “Sentiment and momentum have been extremely bullish in the past six months but a modest deceleration in year-on-year order growth in coming quarters could send the shares in a tailspin despite generational low mortgage rates.”
“The high-quality builder shares are pricing in perfection,” Stephen Kim, managing director at Barclays in New York, said in a phone interview. “What’s baked in is a full recovery that will take prices by 2015 to levels that are at or above the peak of the bubble. You might get that to happen. Even if you do, you’re not going to make lot of money in homebuilders from here.”
Mike Ashton, portfolio manager with Insight Capital Research Management Inc. in Walnut Creek, California, which had $360 million under management as of June 30, said his fund has been scaling back homebuilder investments for more than a month. Insight’s holdings include D.R. Horton, Hovnanian Enterprises Inc. (HOV), KB Home, Lennar, MDC Holdings Inc. (MDC), PulteGroup and Toll Brothers, according to an Aug. 14 regulatory filing.
“We got into a lot of them early this year and caught a lot of the run-up,” Ashton said in a telephone interview. “Now they’ve basically grown into their valuations.”
The rally is justified because new-home demand is poised to accelerate, said Jason Benowitz, a portfolio manager for Roosevelt Investments in New York, which holds stakes in D.R. Horton and Lennar. August new-home sales climbed 28 percent from a year earlier after July sales set the highest pace since April 2010, today’s report from the Commerce Department showed. The supply of homes at the current sales rate held at 4.5 months, the lowest level since 2005.
“You’re right at the beginning of this,” Benowitz said. “There’s pent-up demand.”
While demand is rising, a so-called shadow inventory of homes facing foreclosure is poised to hit the market at discounted prices, threatening a recovery, according to Jack McCabe, a homebuilding consultant in Deerfield Beach, Florida. He said the industry may be especially hard-hit in states such as Florida, where Mortgage Bankers Association data show about 563,000 home loans are more than 90 days delinquent. Existing home prices in the state, while rising, are about half of their 2006 peak, making them far cheaper than new houses, McCabe said.
“You dig underneath the skin and it’s still very, very troubled,” he said in a telephone interview. “Stocks are artificially inflated.”
Publicly traded homebuilders have reported sales growth at a faster pace than the U.S. total figures indicate as demand recovered in some of the hardest-hit housing markets, such as Arizona and Florida, where they tend to operate, Widner said. At Lennar, the third-largest U.S. homebuilder, home orders increased 44 percent for the quarter ended Aug. 31, the Miami- based company reported this week.
“Housing is undeniably continuing its recovery, but the homebuilding sector is now trading at valuation levels that are detached from any reasonable earnings growth scenario,” Wilkes Graham and Ryan Gilbert, analysts at Compass Point Research & Trading, wrote in a note to clients on Sept. 20. “As such, we believe there is a tangible level of irrational exuberance built into current homebuilder valuation levels as investors flock to the most direct recipients of the housing recovery.”
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