Below the Radar: Fast, Cheap and In Control

Home-building stocks don't typically create a lot of buzz, but they certainly have delivered significant returns over the past year. This week's Below the Radar turns to Beazer Homes(BZH Quote), the eighth-largest publicly traded home builder with a foothold in the fast-growing South and Southwest, to examine its prospects.

Beazer soared 107.8% in 2000 and is up 50% year to date. These are strong returns, indeed, compared with the home-building industry's rise of 30.1% in 2000 and its decline of 8.3% so far this year. Trading at $60, the stock also has a relatively low price-to-earnings ratio of 8.5 and a solid, five-year earnings growth rate of 38%. By comparison, the home-building category is up 25% over the past five years.

This positive trajectory is expected to continue for Beazer. Its earnings per share are expected to rise 40% in the 2001 fiscal year ending in September, according to I/B/E/S, and management recently increased its EPS target for 2001 from $6.25-$6.50 to $7.00-$7.25.

Strong Demand for Homes

The home-building sector overall appears poised for growth in both the near and the long term, and with most of the 29,000 lots Beazer owns located in the South and Southwest, where the National Association of Home Builders expects the greatest growth to occur over the next decade, Beazer should be right in the middle of this boom.

In the near term, the Federal Reserve is expected to keep interest rates low, meaning that 30-year mortgages should stay in the 7% range for several months to come, and new home sales clearly have been benefiting. The most recent reading of housing starts indicates a total of 1.609 million homes will be built this year. While this isn't up much from the 1.592 million homes built in 2000, it at least indicates that the home-building industry has continued to remain strong.

"Beazer and other home builders have been terrific investments for the last 18 months, and we suspect they will be for the next few years, as home builders tend to perform well in weak economies, as well as into the first three or four years of a recovery," says John Stanley, an analyst at UBS Warburg. This is because the Fed has been vigilant about keeping interest rates low when the economy is weak.

To be sure, some out there are less sanguine about the prospects for the home-building sector.

Stephen Kim, an analyst at Salomon Smith Barney, recently issued a bearish report on six home builders, including Beazer, warning that national housing figures are likely to weaken by the middle of the year. Kim also said he thought mortgage rates have bottomed and warned that lumber prices are about to spike.

Most statistics show, however, that demand for housing will continue to be strong in the long term. The NAHB forecasts that 18.22 million new homes will be built in the 2001-2010 period, up from 16.64 million new homes in 1991-2000, and U.S. Census data released recently support these projections. Those figures show that the vacancy rate for owner-occupied homes fell from 2.1% in 1990 to 1.7% in 2000, which indicates a looming need for housing and pressure to push prices higher.

Beazer's Strengths

Beazer operates in 13 states -- including California, Nevada, Arizona, Florida and Tennessee -- under its own name and the names Hancock Homes, Panitz Homes, Gulfcoast Homes, Phillips Builders and Squires Homes, all of which are regional home builders that Beazer acquired over the years. Working with subcontractors, Beazer develops subdivision plots, typically creating 100 to 150 single-family homes per development, each home selling for an average price of $190,000.

For fiscal 2000 ended in September, Beazer sold 7,857 homes and earned a net income of $43.6 million on sales of $1.527 billion.

Home Improvement Beazer's annual revenues, in millions

Source: Beazer Homes

Beazer has distinguished itself somewhat from other home builders through customization and use of the Internet, says Ronald Muhlenkamp, portfolio manager of the (MUHLX Quote)Muhlenkamp Fund, the second-largest institutional holder of Beazer shares, with 1.73% of its $367 million of assets invested in the stock. Beazer allows home buyers to customize such interior features as cabinetry, flooring, fixtures, appliances and wall coverings. The company also provides interior design services for an additional cost, Muhlenkamp says.

Further, Beazer has effectively used the Internet to bring down the expense of working with customers and subcontractors, says Dirk Van Dijk, an equity strategist for the (DASCX Quote)Dean Small Cap Value fund, which has 1.71% of its $13 million in assets invested in Beazer. Home buyers can check a personal Web site that Beazer creates for them to learn about the daily progress on the construction of their homes, Van Dijk notes. Beazer also posts floor plans and virtual tours of its homes on the Internet to attract customers.

In terms of financials, Beazer has improved its gross margins over the past few years. Although much of this has to do with declining lumber, wallboard and cement prices, Beazer has also been able to increase home prices and manage its inventory effectively, Muhlenkamp says. As a result, Beazer's margin has improved from 15% in 1997 to 19.2% for the quarter ended in March.

But the overriding reason investors like Beazer is that it's simply a cheap stock.

"Beazer's compound annual earnings growth rate over the last five years has been 38% and Cisco's(CSCO Quote) has been 33%," says Van Dijk. "Cisco is trading at 45 times earnings, and Beazer is trading for a princely 8.6 times earnings. What's not to like? It's been an absolute home run, with earnings going through the roof," Van Dijk says. (To be sure, though, Beazer's P/E is not that low compared with most of its peers in the cyclical home-building sector).

"I had to hold myself back from holding nothing but home builders," adds Van Dijk, who says he has five home-building stocks in his portfolio.

If you believe the data showing continued strong demand for housing and think Beazer is in a strong position because it already has a large inventory of 29,000 lots at a time when land is scarce, then this home builder merits a closer look.