I bluntly advised selling the homebuilders in a February column titled, Time to Move Out. Since then, all of those stocks have declined. In this column, I'll review the near-term potential for the sector, considering other issues, and assess the near-term implications for the homebuilder stocks. In short though, I think they are all still way overpriced with respect to potential, and a decline of 50% or more from current levels is warranted, likely, and overdue.
In the past six months, since the column referenced above was written the, stock prices of all of the homebuilders have declined but not by nearly as much as fundamentals suggest that they should have.
Toll Brothers (TOL), PulteGroup (PHM), Lennar (LEN), KB Home (KBH), and D.R. Horton (DHI) are down 10%-12% in the past six months. Ryland Group (RYL) and Beazer Homes (BZH) are down by about 20%. The only builder with a significant decline has been Hovnanian Enterprises (HOV), which has lost about a third of its value in the past six months. Its performance is closer to what I believe the entire sector should be experiencing.
The relative strength in the sector vs. the fundamental outlook for it appears to be driven by investors continued belief that the traditional consumer lead increase in economic activity that signals a rebounding economy is still imminent.
One of the factors helping to depress stock prices in the sector is dilution of value caused by steadily increasing floats. Unlike many other sectors and companies wherein prices have been supported by way of share buybacks, the homebuilders have all experienced some degree of an increase in their float this year (Exceptions include a decrease in outstanding shares at Pulte, and no change at Lennar in the past six months.)
The inability or unwillingness of these companies to be able to access cheap debt capital in order to manage their stock prices is an indication of a lack of confidence in their ability to manage such as well as lenders willingness to provide it. Another issue impacting future potential for the industry is the nascent increase in the inventory of single-family dwellings that are now being brought to the market by the money centers.
As I noted last week in the Second-Quarter Money Center Review, JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C) have all accelerated the rate at which they are resolving their non-performing loans and inventory of foreclosed properties, which are called real estate owned, or REO.
Since the 2008 financial crisis, only about one-third of all of the nonperforming loans and REO have been sent through the process of recovery, which involves finally selling the physical collateral, and making it available to the market again. This slow rate of resolution and recovery has helped to artificially create a dearth of existing houses and supported the homebuilders as a result.
Now that the money centers are accelerating the rate of resolution that artificial reduction in available existing homes that's been supporting the builders will be removed. Even at the current faster rate of resolution, if it continues, will take another decade to be fully removed from banks balance sheets.
This is good for banks, especially the money centers, where the majority of the non-performing loans and REO are concentrated, and for the non-bank mortgage servicers including Ocwen Financial (OCN) and Nationstar Mortgage (NSM). However, it is bad for the homebuilders.
Another issue, which I referenced yesterday in the column The Fed: Something Is Wrong, is the growing awareness by the Fed that there may be structural or permanent issues concerning the economy that are preventing the housing sector from recovering.
In the speech given by Fed Vice Chairman Stanley Fischer two days ago, he mentioned structural issues eight times, and housing issues 11 times.
The prime catalyst for housing activity is the first-time home buyer, which has represented the majority of home purchases for the past several decades. Their activity makes it possible for move-up buyers and downsizing sellers. That activity is now absent because of falling incomes, rising debt levels, high unemployment rates in the key 25-34 year old demographic and declining access to mortgage financing as a result.
In short, both the cyclical and secular trends are against the housing industry. I believe it is probable that traders will soon realize that the sector and individual company stocks in it are priced in anticipation of a rebound that is not going to happen.
