D.R. Horton: Impressive Prospects in Housing

06/07/2017 2:52 am EST

Focus: REAL ESTATE

Richard Moroney

Editor, Dow Theory Forecasts

D.R. Horton (DHI) shares have surged 20% in 2017; that rally has been supported by a pair of solid quarterly reports, rising analyst estimates, and impressive prospects for the home-construction industry, says Richard Moroney, editor of Dow Theory Forecasts.

But it could also leave some investors wondering whether anticipated growth is now fully baked into D.R. Horton’s stock price. We see plenty of runway left for the stock.

Despite rising interest rates, we remain upbeat on the housing market, buttressed by strong demand, tight inventory, and a sturdy labor environment.

D.R. Horton said average selling prices for orders rose 3% last quarter — all the more impressive considering its recent shift toward emphasizing affordable, entry-level homes.

This segment accounts for roughly 26% of home closings, up from 5% two years ago. Considering the wave of millennials tiptoeing into the housing market, we view entry-level homes as a highly attractive pocket of a highly attractive industry.

Housing starts slipped 3% sequentially in April, entirely due to weakness in multifamily. Single-family starts edged up 0.4% from March and rose 9% from April 2016 to mark the eighth straight month of year-over-year growth. Single-family permits rose 6% year-over-year in April.

Sentiment among homebuilders rose in April to its highest level since 2005. Part of that optimism may stem from a lack of competition. The number of U.S. construction companies has fallen about 30% over the past decade, keeping supply tight, reported The Wall Street Journal.

In May, D.R. Horton said 2017 demand has been steady and slightly above expectations, especially for entry-level homes, allowing management to raise prices at low-single-digit rates. As happens most years, cash from operations turned negative in the seasonally light December and March quarters.

But management continues to expect operating cash flow of $300 million to $500 million in fiscal 2017 ending September. This time last year, D.R. Horton gave that same forecast and ultimately delivered operating cash flow of $618 million for fiscal 2016.

At 13 times trailing earnings and 12 times estimated 2017 profits, D.R. Horton’s stock trades roughly in line with the S&P 1500 homebuilding industry. However, it looks cheap versus its own five-year averages for trailing P/E (29% discount), price/sales (17% discount), and price/cash flow (9% discount) ratios.

The company has a two-year supply of owned land, which should help support double-digit growth for both profits and revenue.

The consensus forecasts 17% higher per-share profits in fiscal 2017 ending September on 15% sales growth. If D.R. Horton merely meets the most conservative analyst profit estimate of $2.69 (implying 14% growth) and its trailing P/E ratio rises to 14, the stock will climb 15% by early 2018. D.R. Horton remains a Buy.

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