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Homebuilder Confidence Bounces Back; Here's Why Real Estate Stocks Will Too

Stocks in this article: DRI FNMA FMCC LEN MTH NVR PHM RYL

NEW YORK (TheStreet) -- Homebuilders are getting much more confident about the economy as the summer wears on -- and their stocks should reap the benefits soon.

Homebuilder confidence pierced a pivotal level in July's survey by the Wells Fargo and the National Association of Home Builders, reaching 51 on a 100-point scale for the first time since January, when the polar vortex began cutting into sales. The index measuring today's sales conditions increased four points to 57, while the index measuring expectations for future sales rose six points to 64, the survey said. Traffic of prospective buyers increased three points to 39 on the survey's scale.

Investors should be moving now to consider whether this means building stocks can finally shake off their recent torpor -- most builders have trailed the broader market this year. Earnings reports begin next week, with NVR (NVR) reporting Monday, followed by Pulte Home (PHM), D.R. Horton (DRI) and Meritage Homes (MTH). Ryland Homes (RYL) delivers numbers on July 31.

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"The builders are still in the third or fourth inning of the recovery,'' Morningstar analyst Jim Krapfel said. "The confidence numbers are encouraging and build on new home sales and permits for May."

The PHL Housing Sector Index is actually down about 1% this year, trailing the 7% jump in the S&P 500 (SPY). The case for a bump in housing stocks soon lies in improving jobs numbers, MKM Partners analyst Megan McGrath and Krapfel said. As people get more confident about their prospects, and interest rates remain low, that could be the catalyst for better second-quarter new home orders. Those translate into better earnings later in the year when the homes are delivered.

"A fair number of institutional investors are circling the waters waiting for these stocks," McGrath said. 

Housing stocks are still not worry-free, though.

Institutional players are still waiting for a catalyst to get the stocks moving, McGrath said. The two potential catalysts out there are the broader economy's drive (finally!) toward full employment, or a 5.5% unemployment rate, and promises by the regulator of Fannie Mae (FNMA) and Freddie Mac (FMCC) to loosen credit, she said.

Credit has been much tighter for housing than for auto loans -- one reason that car and truck sales have virtually recovered to pre-recession levels while home building is still less than half of a more-normal pace, McGrath says. Recent surveys of realtors suggest that conditions haven't improved much, she said. The next step is up to regulators, she said.

The numbers to watch next week are new home orders at major builders, the analysts agreed. McGrath expects orders to rise 7%, blending a weak April and some rebound since. Pulte is likely to see orders decline because it has reduced the number of communities it's building, focusing on boosting profit margins more than volume, she added. But Horton could see orders jump 15%, she said. Lennar Homes (LEN), whose quarter ended in May, reported 8% order growth.

The other risk to consider is that profit margins may be pressed as the recovery takes root, Krapfel said. Builders are now using land they acquired during the building bust at depressed prices, letting them boost margins for houses built on those lots, he said. By next year, they'll be using more expensive lots, holding down profit margins as sales rise faster.

By recent standards, that's a high-class problem for builders, though. More traffic, more orders, and more confidence is a better climate than they've seen in years.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

TheStreet Ratings team rates NVR INC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate NVR INC (NVR) a BUY. This is driven by multiple strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, notable return on equity, good cash flow from operations and solid stock price performance. We feel these strengths outweigh the fact that the company shows low profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • NVR's revenue growth trails the industry average of 17.7%. Since the same quarter one year prior, revenues slightly increased by 5.3%. This growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share.
  • The current debt-to-equity ratio, 0.45, is low and is below the industry average, implying that there has been successful management of debt levels.
  • Current return on equity exceeded its ROE from the same quarter one year prior. This is a clear sign of strength within the company. Compared to other companies in the Household Durables industry and the overall market, NVR INC's return on equity exceeds that of both the industry average and the S&P 500.
  • Compared to where it was a year ago today, the stock is now trading at a higher level, regardless of the company's weak earnings results. Looking ahead, unless broad bear market conditions prevail, we still see more upside potential for this stock, despite the fact that it has already risen over the past year.
  • NVR INC's earnings per share declined by 24.6% in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, NVR INC increased its bottom line by earning $55.77 versus $35.18 in the prior year. This year, the market expects an improvement in earnings ($63.22 versus $55.77).

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