Homebuilding companies were piling up gains today as investors continued to believe the rate-cutting actions of the
Federal Reserve will continue to plank up the sector.
Dow Jones U.S. Home Construction Index
was recently up 3.1%. Earlier today, the index -- and a number of individual company stocks -- hit a new 52-week high.
When the Fed cuts rates, it essentially makes money cheaper to borrow, helping consumers who own or plan to buy a home, as well as the homebuilding industry. Low interest rates entice more homeowners to buy a house, refinance their mortgages, add on to existing homes or build new ones outright. Since the beginning of the year, the Fed has cut rates a full 2 percentage points in a series of four moves.
"These companies have been decimating earnings expectations for three years," said Carl Reichardt,
Bank of America Montgomery's
homebuilders analyst. "They're doing extremely well. Few other industries did that well. My view is that the current excitement is related to interest rates. Fundamentals are still pretty good. But, six to nine months from now -- that's where it becomes hazier." He says a lot of the goodwill toward the sector is due to the falling interest rates, growing consolidation in the industry and the fact homebuilders have consistently topped earnings estimates for the past three years.
The latest consolidation was last week, when
, a full-service homebuilding company, said it was buying
, an Arizona-based builder of housing for the elderly. The deal was worth $800 million in stock and $1 billion in debt. At the time, Pulte's stock felt the pressure of assuming all the debt, while Webb shares skyrocketed. Both have resumed their highflying ways. Webb recently rose 3.2% to $40.31. It hit a new 52-week high earlier today. Pulte rose 4.8% to $45.73.
Homebuilders are cyclical companies, doing well when the economy is strong and hurting when the economy is weak. Right now, Reichardt says visibility for homebuilders is quite good, with mortgage rates lower than six months ago and the Fed expected to make even more cuts. But occasional visibility issues make homebuilding companies trade at a discount to the
S&P 500. A bad winter, fewer locations to build and the uncertainty of interest rates makes it hard for these companies to know what business will be like down the road. "The perception is that these companies have poor earnings visibility," he says, "And in my experience, companies with allegedly poor earnings visibility trade at a discount."
Pulte currently trades at 9.5 times earnings, while Webb trades at 8.3 times earnings. Reichardt's top pick,
, trades at 11.3 times earnings. Of all the American names in the Dow Jones collection of homebuilders,
has the highest price-to-earnings ratio at 17.3, much lower than the S&P average P/E of 29.
Homebuilders, on average, have gained 40% in the past seven months and 130% since the
Nasdaq imploded in March 2000, so there is some speculation the sector could be overvalued -- or that the hot streak of earnings outperformance could be grinding to a halt.
On April 30,
analyst Christopher Winham told investors to take some profits in Pulte, downgrading it to market perform. He also started Webb at market perform. But not all analysts are in agreement about the companies' prospects. Throughout March and April,
John Stanley raised earnings estimates on the industry, as companies like Pulte and Lennar released boffo quarters.
Salomon Smith Barney
also upped their earnings targets.
As investors could expect with any sector that's experienced a better-than-100% run up in just over a year, Reichardt says it could be reaching the top of the near-term strength. "While there is some juice left, the near term is likely to be limited. I think you're also seeing a deceleration of new orders," he said, "but 2001 earnings are likely to be strong."