Through the course of this week, we’ve received a number of positive data points suggesting the US housing recovery is well on its way. Long-time Valuentum members know that we’ve been very bullish on the housing turn since early 2012 (view the January 2012 edition of our Best Ideas Newsletter here). The S&P/Case-Shiller Index kicked off the week’s events with a 12% year-over-year price increase in the 20-city composite index for April (there’s a two month lag in the data). The 10-city index also rose 11.6% year-over-year. Both metrics have recovered to 2004 levels, but both remain well below the 2007 all-time (“bubble”) highs.
Image Source: S&P Dow Jones Indices
Image Source: S&P Dow Jones Indices
We were also very pleased to see just how broad-based the recovery was during April—only New York and Cleveland experienced pricing gains under 5% for the month. Although we have a long way to go to reach all-time price highs again, double-digit price increases like those in April will become increasingly hard to come by in 2014, in our view (as interest rates advance). But even if the velocity of price increases decelerates in coming periods, modest housing price expansion should continue to propel consumer confidence and a healthier domestic economy (assuming a China slowdown does not interfere).
Image Source: S&P Dow Jones Indices
Homebuilder Lennar (click ticker for report: ) added to the optimism, reporting fantastic second-quarter results Tuesday. The firm’s revenue jumped 53% year-over-year to $1.4 billion, roughly in-line with consensus estimates. However, earnings per share, adjusted for tax asset valuation charges, more than doubled to $0.43 per share, easily exceeding consensus expectations. New home orders advanced 27% year-over-year, and the unit backlog at Lennar jumped 55% year-over-year to 6,163 homes.
After years of underbuilding during the crisis, we believe Lennar is well-positioned to benefit. Management noted that the rebuilding process has been slow, limiting inventory growth, and thus, in our view, has added upward ‘stability’ to the housing price advance. CEO Stuart Miller added some interesting commentary on the conference call regarding the improving situation, saying:
“The increase in production has been slow and difficult because of 2 factors. First, there’s a shortage of entitled and developed land to build on and land prices have been moving higher. Secondly, the increased production has created labor shortages in many major markets. We hear of the labor shortage not just from the builders in the field, but also from the manufacturers and distributors that serve the industry. While these shortages add to the cost to build in the short term, they also fuel the longer-term prospects for housing, as employment drives confidence and the wage increases that lure workers off the sofa and back into the field to meet demand also enable more families to afford to purchase or rent.”
In addition to strong results from Lennar, pending home sales improved 6.7% month-over-month in May, largely due to accelerating mortgage rates (buyers on the sidelines don’t want to be priced out due to higher rates). With such strong growth in signed contracts to buy existing homes, we could see the rate of change in pending homes sales decline in the coming months, particularly if demand continues to be pulled forward in fear of higher interest rates. Regardless, we think the data point is a healthy sign.
Valuentum’s Take
Overall, we thought the past week reflects positively on the trajectory of the US housing market recovery, which will have a tremendous impact on several pockets of the economy. Still, we think the improving fundamentals of homebuilders are largely reflected in their share prices at the time of this writing. As always, valuation is paramount to any investment opportunity, and therefore, we remain on the sidelines with respect to the homebuilding group. Our favorite investment opportunities, as always, are located in the portfolio of our Best Ideas Newsletter.
For housing related ideas, see “The Impact of the US Housing Recovery Cannot Be Underestimated.”
Homebuilders: DHI, GFA, JOE, KBH, LEN, MDC, MTH, NVR, PHM, RYL, SPF, TOL