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Homebuilders Spring Forward

With the housing market slowing, why bother investing in homebuilding stocks if the group's best days are behind them? Well, the sector is cheap, the bulls say, and even if fundamentals cool down, earnings won't drop off a cliff.

"Our view is that going forward, we're going to see a slowdown in activity, but not enough to derail anything," says Sam Lieber, portfolio manager of the Alpine US Real Estate Equity fund (EUEYX), which has about 50% of its holdings in homebuilders.

Builders' 2006 results are largely in the bag, because the bulk of revenue will come from the companies' backlog of homes already sold but not yet closed upon. The real issue keeping investors nervous relates to the scenario for 2007, and orders in the all-important spring selling season will provide a crucial look at homebuilders' prospects.

Recent order numbers from the group have been mixed. Large builders like D.R. Horton (DHI - Get Report) and Pulte Homes (PHM - Get Report) posted net order growth of 16% and 10%, respectively, for the fourth quarter. However, smaller builders focused on fewer geographic markets have reported disappointments, such as Standard Pacific's (SPF) 13% year-to-date order decline and MDC Holdings' (MDC - Get Report) 10% fourth-quarter order fall.

"I think the larger builders are showing the benefits of their diversification," says Jack Lake, an analyst for Victory Capital Management, which owns Pulte and Lennar (LEN - Get Report).

Toll Brothers (TOL - Get Report), which doubled earnings in 2005, has been the recent black sheep of the large builders, as it reported a 29% drop in fiscal first-quarter new orders for its luxury homes. Analysts' average estimate now calls for Toll to see earnings per share drop 4.6% in 2007 from 2006.

It takes roughly seven to nine months for orders to convert into revenue, which means the order numbers that builders report in the coming months will provide more transparency for late 2006 and early 2007.
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