MIZUHO SECURITIES USA INC. | US EQUITY RESEARCH
Summary
Homebuilders have outperformed the S&P by 1200+bps YTD and we think a favorable macro backdrop and a robust Spring selling season are priced into the stocks at current valuation levels. While we are positive on the near-term housing outlook, we see potential mid-year risk as the seasonal trade unwinds and the sector prices in slowing growth ahead. As such, we are launching coverage with a balanced near-term view and see the best relative value in LEN and TOL.
Key Points
Supportive Macro Backdrop. Our economist’s macro forecast for 2017, the basis for our Homebuilder industry macro call, calls for housing demand to outpace new supply again in 2017, supporting new single-family housing sales (+5%) and starts (+12%) in 2017. That said, rising costs (land, labor and materials), single-family home affordability and Trump policy risk (mortgage / lending standards) are key headwinds to monitor.
Valuations Look Fair - Beware of June Gloom? We are initiating coverage of the Homebuilding industry with a balanced view as: 1) the stocks trade at the upper end of long-term PTB range and PTB multiples and may be at risk near-term as we exit the Spring selling season; 2) our bottoms-up approach implies +11% orders growth for FY17e for our coverage group (vs +13% in ‘16), a level we think looks appropriate given current PTB (1.6x). While we think PTB matters more over the long run, bulls may point to lower P/E multiples and improved ROEs to support the stocks.
Favor LEN / TOL. Despite our view near-term, we see pockets of relative mispricing in two proven platforms, LEN and TOL, trading at 1.5x / 1.4x PTB, 11.3x / 11.9x ‘17e P/E and 14.8% / 12.7% ROE vs 1.6x / 11.7x / 14.3% sector average. We forecast +16% upside to our PTs for our Buys vs -4% for our non-Buy rated names.
Risks to our outlook include: 1) post-Spring selling season softer demand; 2) potential Trump policy tail / headwinds; 3) higher interest / mortgage rates; 4) a dramatic increases in labor or material costs (margin weakness); and 5) general economic weakness.
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