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The Rebound in the Housing Sector Begins

At the beginning of the year, I wrote an Investment of the Week focused on possible trends for 2012 (read the whole issue here). One of the sectors that looked promising at the time was housing. I wrote, “Stocks of companies that are finding success in the new, smaller...

At the beginning of the year, I wrote an Investment of the Week focused on possible trends for 2012 (read the whole issue here). One of the sectors that looked promising at the time was housing. I wrote, “Stocks of companies that are finding success in the new, smaller housing market will cease being punished for the past. That includes homebuilders that have streamlined themselves to bare bones, as well as retailers, construction suppliers and other companies leveraged to housing that may have been oversold. You can already see the beginning of this resurgence in the stocks of Home Depot (HD) and Lowe’s (LOWE), both of which have pulled off a gains of about 30% over the last three months, significantly beating the market.”

Since then (about five months) HD has run up another 20% or so. LOWE acted strong through April, but has broken down significantly this month.

While not exactly leading growth stocks, many homebuilders and housing related stocks have indeed managed to get off their knees this year, and several have pulled off market-beating gains. Today, I’d like to share two exceptionally strong housing sector recommendations from the latest Investment Digest (published May 16).

The first is homebuilder D.R. Horton, Inc. (DHI), recommended by Michael Cintolo in Cabot Top Ten Trader. As you can see in the weekly chart below, DHI has been on an unstoppable advance since it left the single-digits behind in October.

Even this month’s market collapse couldn’t shake the stock, which has been bumping back and forth in a trading range between 16 and 18 but refusing to give up any ground. Here’s what Cintolo wrote about the homebuilder in Cabot Top Ten Trader on May 14:

“We continue to see a slew of homebuilders (like D.R. Horton) and other housing-related stocks act resiliently and report better-than-expected results. Macroeconomic indicators are pointing toward a sustained housing rebound after six years of horrid action; new home inventories, for instance, recently reached an all-time low of 144,000 units (down from north of 550,000 in early 2006) or just 5.3 months of supply at the current sales rate, not too far off the 4.5 months seen during the bubble. Combine that with a (very) slowly recovering economy and rock-bottom mortgage rates (still below 4% for a 30- year fixed) and investors are betting that the rebound in housing has legs.

“With nearly $4 billion in revenue during the past four quarters, D.R. Horton is one of the larger homebuilders, and it’s cranking out encouraging data points along with the entire group—in the recently reported first quarter, revenues boomed 28%, new orders were up nearly 20%, its backlog in dollars was up 25% and its order cancellation rate was the lowest since before the bust! Analysts see earnings of 72 cents this calendar year, followed by $1.01 per share in 2013. We think even those bullish estimates could prove conservative as, after a six-year downturn, we think future surprises will occur on the upside.”

DHI’s sideways action has given new investors a chance to get on board within or close to Cintolo’s original buy range of 16-17. He recommends a stop around 15.

Our second stock today is a supplier to the homebuilding industry. Builders FirstSource, Inc. (BLDR) was recommended in the latest Investment Digest by George Putnam, editor of The Turnaround Letter. Here’s what he wrote in his May issue:

“Builders FirstSource is a leading supplier and manufacturer of building products for residential construction. The company was formed in 1998 through a leveraged buyout of the building products division of Pulte Group, a major homebuilder. It went public in 2005, just in time to catch the crest of the home-building bubble. The stock peaked above 26 in early 2006 before beginning a steady decline to the lower single digits, where it has been since late 2008.


“Builders FirstSource strikes us as a superior (albeit moderately risky) way to play the likely rebound in residential construction. Rather than betting on a single home builder, Builders FirstSource supplies many of the largest homebuilders in some of the fastest-growing parts of the U.S. Although the company was hurt by the industry downturn, it has the potential to rebound strongly for a couple of different reasons. First, it has become much more efficient, cutting out more than $140 million of operating expenses since 2007. Perhaps even more importantly, many former competitors have been forced out of business during the downturn. As a result, Builders FirstSource’s market share has grown steadily in recent years.

“The management team is very experienced. Both the CEO and the Senior VP of Operations have more than 40 years of experience in the industry, and many other key executives have more than 20 years in the business. The balance sheet remains quite leveraged, which is the biggest risk to the stock. However, the company appears to have enough liquidity to get by even if housing starts don’t turn up significantly for another 18-24 months. In addition, major stockholders include some very deep-pocketed private equity firms such as JLL and Warburg Pincus. They have a strong incentive to not only keep the company alive, but eventually to see its stock appreciate significantly.

“There are encouraging signs that the business is starting to turn. Revenues were up 11% in 2011 compared to 2010, with improving margins. The first quarter of 2012 was even better, with revenues nearly 35% higher than the year-ago quarter. Moreover, U.S. single-family home starts were up almost 17% compared to the first quarter in 2011. The stock has begun to respond, but we think it has a lot further to go. The housing industry is still down more than 70% from its peak, and even a modest rebound would bode very well for the company. We recommend buying Builders FirstSource up to 7.”

Like DHI, BLDR has demonstrated impressive resilience during the current correction, trading sideways between new-high territory at 4.55 and support around 3.50. And it has momentum: since October 2011 (BLDR bottomed around the same time as DHI) this single-digit stock has gained almost 200%! I don’t think it’s too late to get on board for the next phase of BLDR’s advance.

Wishing you success in your investing and beyond,

Chloe Lutts

Editor of Investment of the Week

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.