Home Builders Offer Educational Value and Little Else

By: Steve Rubis

Industry: Residential Construction
Number of Companies: 19
Total Capitalization: $60.841B

Thesis: the Residential Construction industry offers investors many stocks trading at a discount to theoretical fair value. Unfortunately, current macro economic conditions suggest that these discounted prices are accurate.

Problems facing Residential Construction:
1.) Rising Interest Rates: home builders are susceptible to profit declines at current interest rate levels. Currently, debt is expensive in comparison to the recent past.

2.) Credit Markets: in a rising interest rate environment, the amount of debt available for lending contracts. If lending contracts, home builders will find it difficult to convert their newly built homes into sales

3.) Sub Prime Lending: unprecedented lows in interest rates made ample credit available to people that are high credit risks. As these creditors default, lending institutions will become stricter.

4.) Loan Defaults: as creditors default on exotic financing, lenders will be unable to provide financing to new home buyers. The hits taken on defaults will cause debt markets to contract

5.) Housing Prices: Stock Research believes that the current level of home prices is unsustainable

6.) Current Assets: the best options among the Residential Construction industry are exposed to high inventories on their respective balance sheets.

The chart below shows the metrics for which the Residential Construction industry trades on average:

Table 1: Residential Construction Industry Metrics


At first glance, the metrics suggest that the home builders are undervalued. The negative capitalization rate poses a problem. Next, investors should analyze the financial health of the home builders.

The next table illustrates the Altman Z Score for selected Residential Construction stocks.

Table 2: Altman Z Score for Selected Residential Construction Stocks


There are two main take aways in regards to the previous illustration. First, investors should be critical of the cells highlighted in red. Each company's score derives the majority of its Z Score from these highlighted cells. The problem is that these values are associated with one of the lowest rated components of the Z Score.

Second, there are a few companies whose Z Scores are highlighted in yellow. This suggests that they are on the brink of entering dangerous territory. These two items, taken together, suggests that the home builders are a risky investment.

Next, Investors should be interested in determining fair value targets for the Residential Construction Industry. The chart below shows the average values for home builders:

Table 3: Average Fair Value Targets for the Residential Construction Industry


Undervalued (Bold means we will preview the specific stock in the future):
1.) AVTR – Avatar Holdings
2.) NVR – NVR LP
3.) MTH – Meritage Homes
4.) RYL – Ryland Group
5.) BZH – Beazer Homes
6.) WCI – WCI Communities

The educational value of this article is caveat emptor (buyer beware). Some of the equities within this industry seem attractively priced. Unfortunately, the economic factors facing the Residential Construction industry suggest that these stocks are fairly priced.

*The author holds no positions in any stocks mentioned in this analysis. The purpose of this article is only informational, and is mean to give investors a guide to values.