Rebound in Housing-Related Stocks Likely to Contin

Dan Oppenheim
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SEE LAST PAGE OF THIS REPORT Dan Oppenheim, CFA

FOR IMPORTANT DISCLOSURES (415) 889-5617

doppenheim@ssrllc.com

January 11th 2019

Rebound in Housing-Related Stocks Likely to Continue

  • Housing turnover to improve in non-western markets in 2019. We expect rising existing home sales through much of the country, as the slowing activity in 2018 resulted from a) desire of existing homeowners to not give up the low rate on their existing mortgage, and b) affordability issues related to interest rates (not surging home prices) in most markets. We expect January pending home sales to show the initial improvement from the 45-basis point decline in 30-year mortgage rates over the past three months (Freddie Mac), with mortgage rates now back to the same level as March 2018. As every 10-basis point change in mortgage rates has a similar impact on the mortgage payment as a 1% change in the home price, we believe that this 45-basis point decline in mortgage rates will spur greater activity and have heard early confirmation of this from our agent contacts in key markets. We would focus on trends away the West, as we believe that the challenges on the west coast result from price-driven affordability issues and the negative impact of the limit on state and local tax deductions, with many west coast markets now experiencing higher inventory and pressure on home prices.
  • Home improvement likely to hold up, with solid sales activity for home centers. We believe the home centers struggled in late 2018, given worries of declining housing turnover and easing price appreciation. As a result, we would expect multiple expansion for the stocks as worries about turnover ease. In addition, the home centers have limited exposure to the west coast, with HD having 12% of its store base in California (higher percentage of sales given greater productivity) and LOW has less than 10% of its stores in California. We believe the focus for the stocks will then shift to the company-specific issues for HD (productivity and supply chain) and for LOW (merchandising, efficiency, and share gains with pro contractors). In addition, we expect upside for building products stocks as investors gain confidence in recovering housing turnover.
  • Further upside for homebuilders, but with challenges on the west coast. Even after the early-year rally, homebuilders trade at 1.0x estimated 2019 book value, the lower end of the range where homebuilders generally trade. We are increasing our stance to Overweight from Neutral and would favor DHI, LEN, MDC, MTH, PHM, and NVR, given lower exposure to the west coast, but see more challenges for KBH and TOL due to their higher west coast exposure.
Exhibit 1: SSR’s Preferences Among Housing-Related Sectors
Source: SSR Analysis

Rebound in Housing-Related Stocks Likely to Continue

Uptick in sales in 2019 likely as conditions remained healthy with low inventory. Home sales slowed in many markets in late 2018, but not by so much that it altered the overall supply-demand dynamics, as inventory remained reasonable in most parts of the country. Our confidence in healthy housing fundamentals (away from the west) in 2019 is driven by the still-low inventory levels in most parts of the country. That is, while sales slipped due to the higher mortgage rates, that slowing of sales was brief enough and inventory levels were low enough that the markets are still in good shape. For example, our analysis of MLS trends and Redfin data indicates that inventory levels were flat to down year/year as of the end of November in key markets such as Atlanta (down 2% year/year), Austin (up 5%) Charlotte (down 7%) Miami (up 6%), Orlando (up 3%), Phoenix (down 4%), San Antonio (down 2%), and Washington, D.C. (up 2%).

West coast markets saw sharp increase in inventory. In contrast, inventory levels rose sharply in west coast markets from San Diego (up 45%) to Seattle (up 98%) and in between – Orange County, up 24%; Riverside up 11%, Sacramento, up 20%; and Portland, up 44%. In some of these west coast markets, bulls could argue that the months of supply of homes for sale remains at low levels, with the months of supply being more meaningful than the year/year increase in inventory. However, given that much of the affordability challenge in these markets resulted from escalating home prices in recent years and not just higher mortgage rates, we believe it is less likely that sales will rebound in these west coast markets.

Exhibit 2: Modest Valuations for Homebuilders at 1.0x 2019E Book Value
Source: Company reports, S&P Capital IQ, and SSR Analysis

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