Homebuilder Industry Stock Outlook - July 2016

Housing Stands Tall Amid Brexit and Other Commotion

Amid a volatile U.S. stock market, uncertainty surrounding the Fed rate hike, panic in the global financial markets triggered by the unexpected ‘’Brexit’’ vote and volatile gasoline prices, the homebuilding market remains a pillar of strength for the economy.

The market, in general, believes that the departure of U.K. from the European Union will not have any major impact on U.S. homebuilding activity.

What Do the Numbers Say?

Though recent new home sales and housing starts slowed down slightly, the rest of the housing data – released in June – has been fairly upbeat, clearly indicating that the overall housing market remains intact.

New home sales dropped 6% in May from a more than eight-year high in April.U.S. housing starts fell 0.3% from a revised April number to an annual rate of 1,164,000 in May due to a decline in multi-family production.

The number of building permits – a gauge of future construction – rose 0.7% in May. Further, the National Association of Home Builders (NAHB) reported that the home builder sentiment index (HMI) rose 2 points to 60 in June, after holding steady for the past four months. Moreover, existing home sales rose 1.8% in May – its highest pace in almost a decade, per data released by the National Association of Realtors. Construction spending touched a five-year high in April.

The Overall Outlook

Despite a weak start this year amid equity market volatility and global concerns, the construction sector seems to have recovered on the back of strong housing fundamentals. The spring selling season in 2016 was better than last year. The springtime weather boosts construction activity and traffic trends.

Positives like an improving economy, modest wage growth, low unemployment levels, low interest rates, positive consumer confidence and a tight supply situation raise optimism about the sector’s performance for the second half of 2016.

However, a tight labor market, limited land availability and constrained mortgage environment restrict the ability of homebuilders to quickly respond to growing demand.

Other than that, homebuilders are witnessing slowing demand trends in the Houston market due to lower consumer spending trends amid volatile energy prices.

Q2 Earnings Season in Sight

Last month, two homebuilders – Lennar Corporation (NYSE:LEN) (LEN) and KB Home (KBH) – reported better-than-expected second-quarter results, beating estimates for both earnings and sales. Both the companies recorded a double-digit increase in home deliveries and new home orders in a successful spring selling season. However, both witnessed slower sales trends in the Houston market.

Among the other large homebuilders, PulteGroup (NYSE:PHM), Inc. (PHM) and D.R. Horton, Inc. (DHI) are due to report next month while Toll Brothers, Inc. (TOL) should report in August. They all expect to do well in the upcoming quarter.

A look at the Earnings ESP does not clearly show that any homebuilder is likely to beat expectations when it reports its next quarterly result in July/August.

Zacks Industry Rank

Within the Zacks Industry classification, we rank all the 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.

As a guideline, the outlook for industries in the top 1/3rd of all Industry Ranks or a Zacks Industry Rank of #88 and lower is 'Positive,' the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is 'Neutral' and the bottom 1/3rd or Zacks Industry Rank of #177 and higher is 'Negative.'

The Zacks Industry Rank for the homebuilding industry is currently at #173. This is in the middle1/3rd of all industries ranked, highlighting the group’s neutral outlook. Though equity market slumps and labor shortage issues dampened the housing market at the start of the year, it picked up momentum in the spring selling season and is expected to do well through the second half.

Earnings Trends

If we look at the overall results of the Construction Industry, earnings grew 27.5% in the March quarter. Total revenues rose 3.9% in the quarter. The sector racked up an impressive earnings beat ratio (the percentage of companies coming out with positive surprises) of 84.6% and a revenue beat ratio of 76.9% in the March quarter.

Earnings and revenues for the June quarter are expected to rise 8.9% and 5.2%, respectively. For 2016, these are expected to rise a respective 11.8% and 5.9%.

For more details about earnings for this sector and others, please read our ‘Earnings Trends.'

Bottom Line

Despite some concerns regarding the health of the economy, homebuilders are increasingly optimistic about the opportunities ahead. However, labor shortages, a slight slowdown in sales in Texas/Houston, increasing competitive pressure and rising land and construction cost will be the headwinds to contend with.