Housing stocks had a disappointing year in 2013 with many of the leading players down for the year. A large part of this shortfall was due to a booming 2012. Many housing companies doubled during 2012 as low interest rates began to stimulate an improvement in the housing market.
The 2013 shortfall was essentially a correction/breather from a great 2012. As we enter 2014, the housing market looks like it could be poised for another strong year due to improving jobs prospects, improving consumer confidence, easing credit conditions, still low interest rates and continued levels of record housing affordability metrics.
In that environment, housing stocks should be a profitable place to be. Two names that we find attractive at current levels are industry leading Toll Brothers (TOL) and DR Horton (DHI). Both are large and well capitalized competitors that will fully participate in any industry resurgence. Toll Brothers is more of a play on the growing trade-up and luxury oriented markets while D.H. Horton's strengths are in first time and first time move-up home buyers.
Of all the major home builders, Toll Brothers is probably best positioned for the current upturn. The firm's strong balance sheet allowed management to further reposition the company into the strongest home building markets around the major urban centers in the U.S. In particular, Toll made a meaningful push into the vibrant New York City metro area with major high-end projects in and around Manhattan for the $1 million-plus home buyer.
As a result, Toll has seen a substantial increase in its order rates, revenue and profitability. Over the past year, orders were up 36% while revenue rose 65%. Revenues are projected to rise to $4.1 billion in 2014 and there is a strong likelihood that revenue can return to pre-crisis levels of $6 billion by 2016/2017. Profitability continues to climb with operating margins getting back to double-digit levels of 11% for 2014. Net income is strongly in the black at a projected $305 million for 2014.
Because of these improving trends, there is a high probability that Toll Brothers can earn $4 per share to $5 per share in the upcoming cycle. At a recent price of $35.76, there should be upside to the share price. Toll Brothers is definitely a housing stock for a lower-risk housing industry investor.
For investors willing to weather more volatility, with the potential for greater upside performance, take a look at D.H. Horton. The company is a large and well-managed home builder based out of Texas. The company plays to a lower income oriented customer in the first time home buyer and first time trade-up buyers' markets.
Business has been slower here as low to moderate income buyers have been more likely shut out of the housing market due to a lack of job growth and tighter credit conditions in the current economy. Nevertheless, this demand is only being delayed and not permanently impacted. Over time, D.H. Horton's core customers should see a recovery. Orders, sales and margins are moving in the right direction.
By 2016/2017, revenue could top $10 billion or be back to two thirds of their previous peak levels. Earnings could easily top $3 under these conditions which would provide meaningful upside opportunity from the current $21.30 share price. However, D.H. Horton's recovery will be a lot bumpier than Toll Brothers. Nevertheless, both builders offer investors good potential in a more meaningful housing recovery.
