Legg Mason Downgrades Homebuilders

Legg Mason downgraded a handful of homebuilders on Friday, saying the uncertainty surrounding an economic recovery limits valuation expansion for these companies.

The brokerage cut Pulte Homes ( PHM), The Ryland Group ( RYL), NVR ( NRV) and K.B. Home ( KBH) to hold from buy.

Legg Mason analyst David D. Weaver said his long-term outlook for housing remains positive but that mixed economic information makes it harder to predict when the homebuilders' valuations will improve.

Weaver also said homebuilders have benefited from falling borrowing costs. But Weaver believes affordability is at a peak, and said that if these benefits reverse, it will make the homebuilding companies' growth a challenge.

"If the economy begins to show meaningful signs of recovery, we will re-evaluate our position," Weaver said. Right now, though, signs of a recovery have yet to show, and job cuts are still taking place. "If the outlook for maintaining a job is cloudy, it can have a major impact on the home buying decision process, even if rates are low."

Ryland Group is Weaver's favorite stock in this category because of its high returns, high inventory turns and solid management. The brokerage expects 2003 earnings per share of $8 and 2004 EPS of $9.04.

Shares of the four companies were gaining ground in midmorning trading, with K.B. Homes up 2.2% at $61.27 a share, Ryland Group up 1.8% at $64.43 a share, NVR up 0.25% at $404 a share, and Pulte Homes up about 1% at $65.85 a share.

Weaver maintained his buy ratings on Toll Brothers ( TOL) and Dominion Homes ( DHOM) because he still sees upside potential to the stocks' valuations.

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