U.S. Home Builders Defy Repeated Doomsday Predictions

Fox News | 3-20-04

[Indy Pendance]

NEW YORK — Now is not the time to put the "for sale" sign out on U.S. home builder stocks.

A few months ago, there were plenty of pundits prepared to predict that the housing industry was about to face a bust. They said that house prices in recent years had risen to excessive levels and suggested the tipping point would be higher interest rates.

But with the economic recovery producing few new jobs, home loan rates sinking again, and the Federal Reserve (search) apparently in no hurry to push rates higher any time soon, the doomsayers are less vocal.

And some investors say that despite shares of some home builders more than doubling last year, they may still be relatively cheap compared with some other sectors of the stock market.

"I think they're a buy," said Ron Muhlenkamp, portfolio manage of Muhlenkamp Funds. "You've got companies earning 18 to 20 percent return on equity. They're getting market share from their competitors, and they're selling at roughly nine times earnings. Period."

It's not only the change in interest rate expectations. It's that the biggest home builders have strong balance sheets, and have kept costs under control, putting them in a position to buy growth through acquisitions if the market slows.

"They are cheap," said A.G. Edwards & Sons Inc. analyst Gregory Gieber. "They are all selling around half the market."

Gieber said that while the average top home builder share is selling at a price-to-expected 2004 earnings ratio of 8.8 percent, the average S&P 500 stock trades at 17.8.

A tight supply of buildable land and rock-bottom mortgage rates have helped plump up earnings for some of the larger home construction companies last year.

This week the Federal Reserve kept interest rates at 1958 lows and signaled that it was in no rush to raise borrowing costs until the job market posts a meaningful rise.

Muhlenkamp said he believes the industry has changed, that the top players, whose market share has gone from 10 percent to 20 percent in 10 years, are no longer rate sensitive and that Wall Street has not caught up to the fact.

"We're not saying the industry is going to grow by 10 percent a year," he said. "We're saying the big companies are going to grow 5 percent faster than the industry. They make good cash flow, and they don't do dumb stuff with it. Wall Street has played it simply as an interest rate play and that's been helpful but that's not the reason for you to own the stocks,"

Muhlenkamp has invested in Centex Corp. (CTX), Lennar Corp. (LEN), Pulte Homes Inc. (PHM), Beazer Homes USA Inc. (BZH), Meritage Corp. (MTH) and about a half dozen other large publicly traded home builder stocks.

Gieber, who holds no stock in the sector, has a buy rating on five home builders, Pulte Homes, Lennar, D.R. Horton Inc. (DHI), Toll Brothers Inc. (TOL) and Standard Pacific Corp. (SPF). He said he expects the earnings growth to slow to about the high teens this year and still the stock will be cheap.

However, not everyone agrees that a cheap price means a good profit. Natexis Bleichroeder analyst Barbara Allen said the stocks now trade at their traditional peak, and has advised selling them now and buying them back at a lower point.

To see the home builder stocks as cheap, an investor has to believe either the rate will continue to remain low for the next six to 12 months or that the traditional top values of the group will change, she said

"You have to believe, on the basis of no evidence whatsoever, that the valuation of the group is going to change for the positive," she said. "You have to say, 'This time it's different."