Housing has been a sector of focus to start the year given the rocket start after many years of depressed sentiment and share prices. Similar to the idea that we mentioned in the RF write-up earlier this week, all shares in the sector have been lifted when there are some significant stock specific differences within the sector. First off, as demonstrated by this week’s housing data, multi-family has consistently been stronger than single-family. Geographic and socioeconomic variances have also had a market specific impact. The varying business trajectories of Pulte and Toll Brothers provide a good example of these trends.
Let’s look at the words straight from the most recent management commentary for PHM:
The U.S. housing market and broader economy remain in a period of uncertainty. While we have experienced some stabilization in our local markets, homebuilding industry volumes remain at near historically low levels. This more stable environment has resulted in a significant reduction in the level of land-related charges recorded during 2011 compared with recent years. However, significant short-term uncertainty remains such that we are not anticipating a broad recovery in homebuilding in the near term…Our outlook is cautious for 2012 as the timing of a sustainable recovery in the homebuilding industry remains uncertain.
A much different message is evident from the management commentary for TOL
We continue to believe that many of our markets and housing in general have reached bottom; however, we expect that there may be more periods of volatility in the future. We also believe that our target customers generally have remained employed during this downturn, but that many have deferred their home buying decisions because of concerns over the direction of the economy and media headlines suggesting that home prices continue to decline…We also believe that the medium and long-term futures for us and the homebuilding industry are bright…Although, historically, our first fiscal quarter is the most challenging time to gauge sentiment among home buyers, in general, the market feels healthier to us than it did in the comparable period of fiscal 2011.
TOL management’s actions have followed their words, as they purchased CamWest last quarter and have increased owned land and community inventory over the last year to take advantage of a nascent recovery.
Moreover, while TOL focuses on housing communities, PHM is quite concentrated in single family. Again from the PHM 10-K:
Sales of single-family detached homes, as a percentage of total unit sales, were 79% in 2011, compared with 79% in 2010, 77% in 2009, 75% in 2008, and 74% in 2007.
YTD price performance for PHM is about 40%, while TOL is up about 15%, and while PHM was certainly the more beaten down of the two, the commentary above and their respective inventory situations indicate that TOL sees the light at the end of the tunnel and might be close to exiting but PHM is still mired in a downturn. What’s striking as well though is that after this year’s move, PHM Price-to-Book now trades above TOL P/B, an important metric for homebuilders with significant unsold inventory.
We see this as another opportunity to fade the outperformance, so here’s the trade we did:
TRADE: TOL (23.90) PHM (9.13)
Sell the PHM Jul 10 calls for 0.65
Buy the TOL Jun 26 calls for 0.75
This trade takes advantage of the higher implied vol level in PHM and also gives the trade one more earnings cycle to work, given our thought that the fundamentals should reassert themselves by that time. Moreover, TOL implied vol is not far from last year’s low spring levels while PHM implied vol has remained more elevated, so we prefer to buy premium in TOL and sell premium in PHM.
TOL implied vs realized:[caption id="attachment_9934" align="aligncenter" width="630" caption="TOL HV vs IV from LiveVol Pro"][/caption]
PHM implied to realized:[caption id="attachment_9935" align="aligncenter" width="630" caption="PHM HV vs IV from LiveVol Pro"][/caption]