Builders Catch a Break

A JPMorgan upgrade sends the sector soaring, overshadowing a big order drop at D.R. Horton.
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D.R. Horton

(DHI) - Get Report

, the country's largest homebuilder, said Tuesday that its fiscal fourth-quarter sales orders fell 25% from a year ago as cancellations surged.

Nonetheless, D.R. Horton and other builder stocks jumped Tuesday morning after JPMorgan analyst Michael Rehaut issued a bullish call on the homebuilding sector and upgraded D.R. Horton and

Standard Pacific

(SPF)

to overweight from neutral. He also boosted

Toll Brothers

(TOL) - Get Report

to neutral from underweight.

"While pricing, orders, and starts may still show negative trends in the near-term, we believe inventories -- the leading driver of the market's pullback, in our view, as well as our prior cautious stance -- have begun to stabilize, and in turn should drive a market recovery," Rehaut wrote in his note.

The note sent D.R. Horton up 4.3% to $24.87, Standard Pacific up 5.7% to $26.82, and Toll Brothers higher by 5% to $30.26.

Other builder stocks also jumped on for the ride.

Hovnanian

(HOV) - Get Report

was up 3.8% to $31.79, and

Ryland

(RYL)

advanced 2.8% to $46.27, as the upgrade was just what fund managers and investors were looking for.

"This guy ranks as a savvy guy," says one hedge fund manager who switched to mostly long positions on the builders in recent months. "My respect went up for him today."

While there isn't anecdotal evidence that the housing market is improving, the manager notes that mortgage rates are low and most of the negative news could be behind the builders. Typically stocks turn six months before the business does. And with the recent rally in place for the builders, fundamentals could start improving in mid-2007.

"It ain't about what's happening now. It's more a function of, these are manufacturing companies that are going to take a year off," the manager adds.

The JPMorgan upgrade came as D.R. Horton said the value of sales orders for the quarter ended Sept. 30 fell to $2.5 billion from $3.8 billion last year. For the year, order value slipped to $13.9 billion from $14.6 billion in fiscal 2005.

The company's cancellation rate in the quarter jumped to 40% from 29% at the same time a year ago.

"The current selling conditions in the homebuilding industry continue to be challenging, with higher than normal cancellation rates and increased use of sales incentives in many of our markets," said Chairman Donald Horton.

Meanwhile, rival

KB Home

(KBH) - Get Report

said it would delay a third-quarter filing with regulators to continue a review of stock-option granting practices.

KB Home estimated earnings of $1.93 a share for the quarter ended in August, above the $1.88-a-share Thomson First Call average analyst estimate. Last month, KB Home reported that its sales for the quarter rose to $2.67 billion from $2.53 billion, but the company delayed giving bottom-line figures because of the ongoing options probe.

Also on Tuesday, small-cap builder

M/I Homes

(MHO) - Get Report

cut its earnings guidance to a range of $5.25 to $5.75 a share. The builder's earlier forecast called for earnings of $6.30 to $6.65 a share; analysts predicted a profit of $6.09 a share.

M/I said new order contracts tumbled to 571 in the quarter from 1,163 a year earlier because of an increase in cancellation rates.

The company said the oversupply of inventory in most of its markets, coupled with weak demand, has hurt results, and "at this point, there appears to be no evidence that conditions will improve in the near-term."

M/I Homes fell 4 cents to $36.31.