Name That Trade $LEN – Lend Me a Lennar Home

by Enis April 26, 2013 1:40 pm • Commentary

In the past week, there have been a spate of upgrades in the housing sector following decent earnings numbers from DHI and PHM.  Homebuilders have rocketed higher from their lowest levels in 2013, and are now mostly back near the highs.  Much of the commentary has focused on operational improvements that have driven earnings, as demand growth has been mixed (quite strong at DHI, weak at PHM).  

We have been bearish on the homebuilder sector for a couple months now.  Here were a few reasons in February that we started turning negative on the entire sector:

7:43 AM EST – FEBRUARY 20, 2013 BY 

Toll Brothers reported an earnings miss this morning, reporting 0.03 vs. consensus estimates of 0.10.  The housing sector is one of the most overvalued sectors in the U.S. stock market, for several reasons.  Here are 3 brief points on why I’m bearish on TOL and U.S. homebuilders as a whole:

1)  This is a housing recovery, not a housing boom.  The housing market has clearly improved in the past 12 months, but TOL’s current selling pace in its communities is still below its 25 year average
2)  Meanwhile, the stock is priced for more than a boom.  The stock is trading at 2005 levels, when the stock earned more than $4 per share.  In 2013, it’s slated to earn around $1.
3)  Relative valuation for other sectors much better than homebuilders like TOL.  If you want to get long the U.S. housing market, buy Toyota or Ford.
On a more macro basis, building has gotten very optimistic in the past 9 months, while the actual pace of sales has been more tepid.  As this Business Insider article from yesterday points out, housing completions are rapidly outpacing housing sales in the past year:
Screen Shot 2013-02-20 at 7.36.40 AM
Valuations for the entire sector still look very optimistic, essentially pricing in all the increased demand and operational improvement for a few years into the future.  LEN actually reported decent numbers back on March 20th, but that in fact marked a top for the stock.  That is one obvious sign that investors might have expectations that are too high.
Interestingly, LEN has now rallied back to near that March top (circled in red), as the whole sector has rallied this week.  The stock bounced off its 200 day ma (in black) last week, but might be tracing out a head and shoulders top here:
[caption id="attachment_25274" align="alignnone" width="640"]LEN 1 year daily, Courtesy of Bloomberg LEN 1 year daily, Courtesy of Bloomberg[/caption]

The right shoulder probably needs a bit more time to play out.  But the 36-37 area is crucial support.  We’re already short homebuilders through XHB, so we’re not doing any new trades.  But for someone inclined to play for a move back to that area, the June 42/37/32 put fly for around $1.10 is interesting.  Alternatively, one could just sell the June 44/46 call spread in June at around 0.65 if you did not think there was much downside, but the upside was limited, and you did not expect a new high.