Since the summer of 2011, the homebuilding index SPDR S&P Homebuilders (XHB) has more than doubled as the housing sector finally staged the start of a real recovery after a few false starts. I wish I could say my portfolio has been stocked full of homebuilders such as Toll Brothers (TOL) and KB Home (KBH) over the last 18 months, but that would be untrue. I suspect that like most investors, I completely missed this move. I will take solace that the banks and some consumer discretionary names in my portfolio over that time frame have benefited from the improving housing market.
At this point, I think that is how investors need to play the recovering housing market. After their huge run, homebuilders' valuations seem fully priced. However, there are several "backdoor" housing plays that are more reasonably priced and should have significant upside ahead of them. Here are a few I like.
Bed Bath & Beyond (BBBY): This retailer sells towels, linens, kitchen gadgets, dishes and just about everything you need to fill up the cabinets and cupboards of your new home. Trading at just 12x projected 2014's earnings, the stock is undervalued, and has a five-year projected PEG near 1 (1.06). The company also has a pristine balance sheet with no net debt and about $750 million in net cash. It should also benefit from a redesigned website (only 5% of overall sales currently come from online orders) and carrying consumables in its stores (excluding wine). The retailer received a positive write up in Barron's this weekend with the author positing that it could have 40% upside in a buyout http://www.reuters.com/article/2013/03/10/bedbathbeyond-idUSL1N0C23GH20130310?type=companyNews&feedType=RSS&feedName=companyNews&rpc=43.
KeyCorp (KEY): This regional bank has over 1,000 branches in more than a dozen states, primarily (based on deposits) in Ohio, New York and Washington. The bank did well in the just completed "stress tests" conducted by the Federal Reserve. It announced a $300-million-plus stock repurchase authorization after the results of the test were released and stated it will consider dividend increases as well. The bank experienced more than 6.5% loan growth in 2012. It also has more reserves (130%) against non-performing loans than its peers do. If credit quality continues to improve, this should allow the bank to drop significant reserves to the bottom line. The stock sells for under book value and at 11x forward earnings. It also currently pays a dividend of 2%.
Forestar Group (FOR): This holding entity owns real estate, energy, water and timberland assets. This includes more than 130,000 acres of real estate (mainly residential lots in Texas), 750,000 acres of oil-and-gas properties and 275,000 acres of timberland. Real estate contributes roughly two-thirds to the company's overall earnings and revenues. Forestar has been able to accelerate its sales of residential lots in Texas (up more than 20% in fiscal 2012) due the state's strong economy and the improving outlook for housing. It has generally leased its energy acreage, but recently bought a small exploration-and-production (E&P) outfit that will enable it to produce oil & gas on its own properties as well. This has the potential to significantly improve margins and increase sales. Revenues are expected to rise more than 40% in fiscal 2013. In addition, consensus earnings estimates for both fiscal 2013 and fiscal 2014 have risen sharply over the last two months. Of these three picks, this stock has highest risk/reward.
