Homebuilders are not one of the easiest spaces to follow. When was the last time you visited a residential construction site and analyzed the materials being used to build a McMansion? Exactly.
Even yours truly, armed with mystical analytical powers, has always found assessing homebuilders tricky from the standpoint that the market switches what metrics are super important. Is it backlog totals? Is it sequential average selling price growth? Is it gross margins? What housing market is the most important? Many considerations, all requiring a person with ambition to invest in the sector to read an obsessive amount of wonky investment bank research notes and industry pieces.
But there is a situation brewing now in the homebuilder sector that has a uniform hypothesis: Gross profit margin pressure hints at underwhelming demand for homes during the upcoming spring selling season. That may weigh on the jobs outlook just as the Federal Reserve begins to raise rates, which, theatrically, could pressure the homebuilder sector further.
Here are a couple things going on in the industry that may be a tell for a deeper pullback in equities markets in the not so distant future:
- Lennar (LEN) and KB Home (KBH) voicing concern on gross profit margins amid an increased pace of sales incentives to spark buyer interest.
- The plunge in oil prices stands to dent demand in the Texas market, in particular Houston. For a bit of perspective, Lennar has 12.4% exposure to Houston, Hovnanian (HOV) 21.3%, KB Home 12.7% and Ryland (RYL) 10.9%.
- The prospect for a demand slowdown in Houston, and the impact to the broader appetite for homes with rates set to rise, is leading to a wave of downgrades in the sector currently. The stocks are reacting harshly to these downgrades, suggesting possible bad news this spring is not priced into valuations. Year to date, stock price performances include: Meritage Homes (MTH) 11%; DR Horton (DHI) -9.8%; Standard Pacific (SPF) -8.9%; Ryland -8%; and PulteGroup (PHM) -4%.
These are the primary fundamental industry trends (and budding sentiment on the Street) to consider when pulling apart housing starts and permits data. Unless the numbers are robust (which I don't think will be the case in light of seasonal effects), the sector should be avoided. Avoided but not forgotten, as how the stocks are acting today provide valuable clues on the broader market's direction six months from now.
Note: Home Depot (HD) and Lowe's (LOW) are known as "late cycle" plays, meaning their financials will continue to be solid even as homebuilders hit a rough patch in terms of sales and profits. The home improvement names, should housing weaken considerably in the warmer months, wouldn't be negatively impacted (I think) until early 2016.
Follow-Up: McDonald's/Restaurants
I want to re-emphasize how dismal the numbers will be from McDonald's (MCD) this coming Friday. The biggest takeaway is likely to be the ineffectiveness of recent marketing investments. That, in turn, could definitely frazzle its long-term buy-and-hold investors. In other words, this earnings report and set of January sales numbers will likely cause long-term believers to forget the dividend check and seriously consider exiting positions.
I remain very concerned about the marketing disconnect between McDonald's HQ and its franchisee network. For example, in New York City, many franchises are now promoting burgers and other fattening foods in a new coupon book, completely opposite the messages being found on the latest round of national advertisements. Moreover, the company just brought back the triple cheeseburger amid touting healthier items on the menu.
The company has big time work to do, and it's unlikely we will see signs of a lackluster sales and margin turnaround until late 2015 (maybe).
I am asked why a greater number of retailers are not benefiting from the drop in gas prices. Simple: If you save $10 a week on a fill-up at the pump, it's likely to be spent quickly at Starbucks (SBUX), Dunkin' Donuts (DNKN) or other restaurant chains. I, for one, have noticed a nice lift in weekend traffic at DineEquity's (DIN) IHOP brand in the past month. That's instead of being saved for a $50 pair of Levi's jeans at Macy's (M). Restaurant stocks remain the way to play the consumer having more spending power due to declining gas prices and normalizing food inflation. I also suspect many restaurants will raise prices in the first quarter of 2015 to offset higher minimum wages that went into effect early on this year. That only bolsters their earnings potential.
