Macro Wrap – Housing Ho-Hum? $KBH and $LEN Report Earnings Tomorrow

by Enis September 23, 2013 7:58 am • Commentary

Housing has been a special sector of focus for policymakers ever since the financial crisis.  The Federal Reserve explicitly cited the threat to the housing recovery in last week’s statement.  Housing-related stocks have shown relative weakness since May 2013.  Many of the homebuilders are actually down in 2013.  KBH and LEN report tomorrow morning, and my ears are perked.

First off, we’ve been skeptical about the homebuilders all year.  My Macro Wrap post back in February laid out the main reasons for that skepticism:

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.
Homebuilders have been weak stocks since the spring.  The rapid rise in interest rates was the catalyst, but these stocks were priced for perfection to start.
This sector was a lynchpin of the rally off the Oct 2011 market low.  This week’s reports from LEN and KBH will be telling from both a fundamental perspective (particularly in terms of order growth, since it will capture the higher interest rate environment) and a risk appetite perspective for the broader market (what’s the reaction to a good number or a bad number).
KBH is more exposed to the first time home buyer, so the effect of higher rates could have more of an impact.  LEN is the larger company ($6.5 billion market cap vs. $1.5 billion for KBH) and has the more reasonable valuation (19x forward P/E vs. 41x for KBH).  LEN has actually reported strong numbers all year, but stocks are an expectations game.  Expectations were elevated after the roaring advance in 2012, and the stock has declined since.
As for tomorrow’s numbers, LEN is expected to grow earnings about 13% from a year earlier, on around 25% order growth.  KBH is expected to earn $0.21 per share, vs. $0.04 per share in Q3 2012.  Its orders are only expected to rise about 7% year-over-year.  The options market is pricing in a 3.5% move for LEN, and a 9% move for KBH (calculated using our Implied Move Calculator).
LEN and KBH both have about 20% short interest.  Clearly, expectations have come down quite a bit from the spring of this year.  New Home Sales data on Wednesday at 10:00 am will also be closely watched.  To get a sense for why the homebuilders have struggled, look at this chart of New Home Sales:
New Home Sales (annualized), Courtesy of Bloomberg
US New One Family Houses Sold (in thousands, annualized), Courtesy of Bloomberg
All of a sudden, the housing recovery does not look too strong.  The real driver has been existing home sales, but new building has been stagnant.  We’ll get a much better sense from this week’s reports whether rates have further stymied the new home segment.