Still Plenty of Upside in Homebuilders

Still Plenty of Upside in Homebuilders

It looks like the major homebuilders have managed to cut costs nicely and are now ready for the upswing. What's one of the best ways to play this move? The nation's largest homebuilder, D.R. Horton , is a good start.

D.R. saw its contract backlog jump to $2.2 billion at the end of fiscal 2013, up from $1.7 billion at 2012 year-end. Third quarter earnings per share were up to $0.48 compared to $0.30 for the same quarter last year and beating estimates by $0.10. It still trades as one of the cheapest homebuilders in the industry. It trades at only 11 times forward earnings and 1.7 times book value. Compare this to the more than 2 times book value it traded at prior to the financial crisis.

Additionally, D.R. Horton has managed to reduce its leverage during the housing downturn. In 2009, the homebuilder's leverage ratio was 2.9, while it's now down to 2.1 for the trailing 12 months. This comes as the company boosted its cash flow by reducing its land inventory.

Continued strong housing headwinds
Driving the interim thesis for D.R. Horton is a continued rebound in the housing market. The homebuilding market has been on a steady upswing since the lows of 2006. And although interest rates have started to rise, they are still well below historical standards. As well, the potential loosening of credit availability should help further spur home buying.

The other big benefit for D.R. Horton is that it is shifting its buyer mix to include more move-up buyers. These buyers generally demand larger, higher-priced homes. Low mortgage rates should also help further drive a rise in first-time homebuyers, which is one of D.R.'s key target markets.

And one of the biggest tailwinds for D.R. Horton is the potential announcement of a new congressman to head of the FHFA. The beauty of that is that it could well lead to less strict mortgage underwriting standards. The new potential head will likely delay any pending increase in guarantee fees paid by mortgage originators to GSEs.

This is good news for homebuilders, where a move higher in guarantee fees will ultimately lead to an increase in mortgage rates. Thus, the fact that guarantee fees will remain at current levels through mid-2014 is a big positive for bolstering housing affordability. All in all, that's a big positive not just for D.R. but a couple other major homebuilders.

PulteGroup is another very cheap homebuilder. It trades at 1.7 times book value and less than 4 times trailing earnings. The real growth driver for PulteGroup is the aging baby boomers. PulteGroup owns the Del Webb brand, which is the nation's leading builder of active-adult communities. And on the other hand, PulteGroup caters to high-quality customers. Its average homebuyer FICO score is more than 740. This helps the company perform fairly well despite credit deterioration.

Meanwhile, Lennar is a major homebuilder, with its major geographical segment being the East, which accounted for more than a third of its revenue in 2012. This includes Florida, Georgia, the Carolinas, Maryland, New Jersey, and Virginia. Lennar is also the second largest homebuilder in the U.S. The thing about Lennar is that it trades at more than 2 times book value and has a debt-to-equity ratio of more than 126%.

Bottom line
Being the largest homebuilder in the U.S., D.R. Horton appears to be very nicely positioned for the continued rebound. It also happens to be rather cheap. Investors should look to D.R. Horton for impressive exposure to the rebounding homebuilding market.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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