Homebuilder stocks, which include stocks of companies like DR Horton and Lennar, have presented a puzzling picture this year.
While they enjoyed significant gains in recent years, their performance has dipped since March. As of Thursday afternoon, Toll Brothers (TOL) was down 11 percent, Lennar (LEN) 13.5 percent, and DR Horton (DHI) a steeper 14.5 percent, compared to a healthy 4 percent gain for the broader S&P 500 during the same period.
This raises the question: With positive earnings reports from some major players this week, are homebuilding stocks poised for a comeback, or will headwinds continue to hold them back?
Challenges facing homebuilding stocks
Signs point to a recent cool-down in the U.S. housing market. Data from the U.S. Census Bureau and the National Association of Realtors showed a 16.3 percent year-over-year increase in available housing inventory in April, reaching 1.21 million units.
New home sales also painted a concerning picture, declining 4.7 percent in April to a seasonally adjusted annual rate of 634,000 units. This translates to a 7.7 percent drop compared to the previous year.
In May, the housing market again showed a slowdown in existing home sales but a rise in prices.
The main culprit behind the sales decline might be rising mortgage rates, which make homeownership more expensive.
Many homeowners with low locked-in rates are understandably hesitant to move into higher rates. A June study by Redfin shows that a significant portion of outstanding loans (around 62 percent) are fixed below a 4 percent mortgage rate, with 82.4 percent fixed below 5 percent. While the reluctance to sell, known as the lock-in effect, is understandable, it seems to be impacting overall demand.
Lennar and KB Homes show promising signs in quarterly report
Despite broader economic challenges, recent earnings reports from home builders Lennar and KB Homes offered some promising signs for investors.
Lennar delivered a strong quarter, exceeding expectations with 19,690 homes sold, a 15 percent increase year-over-year. Net earnings increased 9 percent compared to the prior-year quarter.
Lennar also reported a healthy 19 percent rise in new orders, reaching 21,293 homes. However, Lennar’s stock price dipped about 5 percent after the report, possibly due to concerns about their third-quarter home delivery forecast falling short of analyst estimates.
KB Homes also presented some positive developments. The company significantly ramped up investment in land acquisition and development, repurchased additional shares and increased their quarterly dividend. The average selling price for their homes also showed a slight uptick, rising from $479,500 to $483,000.
Revenue of $1.71 billion surpassed analyst expectations of $1.66 billion. However, revenue dipped slightly compared to the $1.77 billion reported in the year-ago quarter, and total home deliveries also saw a small decrease, with 3,523 units delivered compared to 3,666 in the same quarter last year.
Despite these mixed results, both builders expressed optimism about buyer resilience despite the volatility in mortgage interest rates.
Homebuilding ETFs are performing well
Two exchange-traded funds (ETFs) that track the home-construction industry are showing strong returns, despite recent declines from individual home builder stocks.
The iShares U.S. Home Construction ETF (ITB) was up 46 percent on June 20 over the last year, though it’s risen only 4.6 percent since the start of the year. D.R. Horton (DHI), Lennar and PulteGroup (PHM) comprise the fund’s top three holdings, representing over 35 percent of the fund. The ETF has an expense ratio of 0.4 percent.
Meanwhile, the SPDR S&P Homebuilders ETF (XHB) has shown stronger performance. XHB shares have seen an impressive one-year return of 54 percent as of June 20. Even its year-to-date returns are attractive at 10.3 percent, and with an expense ratio of 0.35 percent, its fees are a bit lower.
The SPDR S&P Homebuilders ETF tracks 36 companies, and its top holdings include Williams-Sonoma (WSM), Carlisle Companies (CSL) and Johnson Controls International (JCI), which make up about 13 percent of the fund’s assets. It’s more focused on companies in the industrials and materials sectors than home builders, with more equal weighting across its holdings than the iShares fund.
Thematic ETFs can be a good way to gain exposure to a specific industry or sector because they spread investment dollars across several companies instead of just one.
Outlook for homebuilding stocks
While predicting the short-term future of the housing market remains challenging, certain factors could catalyze a rebound for homebuilding stocks.
A crucial element is the persistent undersupply of homes in the United States. This decade-long trend of underbuilding should set up major housing players with plenty of demand, which could lead to sustained volume and revenue growth in the long run.
Another silver lining is the possibility of at least one interest rate cut by the Federal Reserve before the end of the year, although the exact timing is uncertain. Lower rates could energize the housing market, benefiting companies including Lennar and DR Horton.
If construction materials such as lumber see some price declines, this could further bolster homebuilder profitability.
Bottom line
Ultimately, homebuilder stocks are navigating a complex landscape. While a cooling housing market and rising mortgage rates pose challenges, positive earnings reports from some key players and potential future interest rate cuts offer hope. A persistent housing shortage could also provide long-term support for the sector.
Investors in homebuilding stocks should carefully consider these mixed signals and conduct their own research before making any investment decisions.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
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