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5 Homebuilders to Watch on Interest Rate Cut Expectations
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The sagging homebuilder stocks thrived last week following the release of several key measures of inflation data that came in soft. Since the beginning of 2022, the homebuilding industry has been reeling under the impact of rising mortgage rates and escalating building costs.
In early May, mortgage rates soared to the highest level of the year, and despite decreasing slightly since then, they remain near 7%. This surge in borrowing costs has coincided with a steady climb in home prices. These factors have severely hampered new home construction, leading to the lowest level of housing starts in May in nearly four years.
Meanwhile, a few recently released weaker-than-expected key inflation data and soft data for several important economic variables, especially labor market data, have boosted investors’ hope of interest rate cuts by the Fed.
Inflation is Dwindling
The Department of Labor reported that the consumer price index (CPI) decreased 0.1% month over month in June, in contrast to the consensus estimate of an increase of 0.1%. The reading for May was flat month over month. This marked the first monthly decrease in headline CPI since May 2020. Year over year, CPI increased 3%, marking the lowest level in more than three years. The metric for May was 3.3%.
The core CPI (excluding volatile food and energy items) increased 0.1% month over month in June, lower than the consensus estimate of an increase of 0.2%. The reading for May was also 0.2%. Year over year, core CPI increased 3.3%, marking the smallest annual increase since April 2021. The metric for May was 3.4%.
The Department of Commerce reported that the core personal consumption expenditure (PCE) price index (excluding volatile food and energy items) rose 0.1% month over month in May compared with 0.3% growth in April. Year over year, core PCE inflation — the Fed’s most favorite inflation gauge — rose 2.6% in May compared with 2.8% in April. May marked the lowest monthly rise of this metric since March 2021.
Rate Cut Expectations Rise
Following the release of several key economic data that were softer than estimates, a section of economists and financial experts already raised the alarm that the Fed should start reducing the benchmark lending rate from September. Otherwise, it will be too late and the economy may enter into a recession.
Notably, the benchmark interest rate is currently in the range of 5.25-5.5%, marking the highest level in 23 years. The yield on the benchmark 10-Year U.S. Treasury Note fell to 4.186% from 4.793% in mid-April.
The CME FedWatch tool currently shows a 96.3% probability of a Fed fund rate cut by 25 basis points in September. This probability was around 62% just two weeks ago. Moreover, the interest rate derivative tool also shows a 94.3% probability of two rate cuts by the end of 2024.
Homebuilders to Benefit
The mortgage rates are in part determined by the Fed fund rate and partly by the yield of the 10-Year U.S. Treasury Note. The lowering of both these key interest rates will reduce mortgage rates, influencing home buyers to generate more demand.
Moreover, lower inflation and market interest rate will reduce input costs for homebuilders. They will also get a cheaper source of credit to expand their businesses. Thus, it may become a double whammy for homebuilders.
Stocks in Focus
We have narrowed our search to five homebuilders’ stocks that have strong growth potential for the rest of 2024. These stocks have seen positive earnings estimate revisions in the last 60 days. Each of our picks carries a Zacks Rank #2 (Buy) or 3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
The chart below shows the price performance of our five stocks year to date.
Image Source: Zacks Investment Research
D.R. Horton Inc. (DHI - Free Report) is benefiting from a limited supply of both new and existing homes at affordable price points, alongside favorable demographics supporting housing demand. DHI’s strategic shift toward more entry-level affordable homes has been paying off, with the segment experiencing strong demand and limited supply.
DHI’s production capabilities, industry-leading market share, solid acquisition strategy, broad geographic footprint and diverse product offerings across multiple brands and price points are encouraging.
Zacks Rank #2 D.R. Horton has an expected revenue and earnings growth rate of 4.5% and 3.4%, respectively, for the current year (ending September 2024). The Zacks Consensus Estimate for current-year earnings has improved 0.4% over the last 60 days.
KB Home (KBH - Free Report) has been pursuing a Returns-Focused Growth Plan that is designed to drive revenues and homebuilding operating income margin, return on invested capital, return on equity and leverage ratio. The plan’s main components are executing KBH’s core business strategy, improving asset efficiency and monetizing significant deferred tax assets.
KBH is now in a better position to expect meaningful growth in the future, attributable to the increase in backlog and its ability to match housing starts to net orders. KBH is executing its plan to expand the scale of operations while driving both margins and returns.
Zacks Rank #2 KB Home has an expected revenue and earnings growth rate of 4.5% and 18.2%, respectively, for the current year (ending November 2024). The Zacks Consensus Estimate for current-year earnings has improved 3.7% over the last 30 days.
NVR Inc. (NVR - Free Report) is benefiting from improved demand trends, which resulted in higher order volumes. The improving trend is witnessed through increasing backlogs and reduced cancellation rates. NVR’s backlog at the end of Mar 31, 2024, improved 7% from the prior-year quarter’s figure to 11,189 homes and rose 9% on a dollar basis to $5.22 billion.
During first-quarter 2024, NVR’s new orders (net of cancellations) increased 3% from the prior-year quarter’s levels to 6,049 units. Also, the increased average selling price of new orders adds to the positives.
Zacks Rank #2 NVR has an expected revenue and earnings growth rate of 8.6% and 6.6%, respectively, for the current year. The Zacks Consensus Estimate for current-year earnings has improved 1.3% over the last 60 days.
PulteGroup Inc. (PHM - Free Report) is benefiting from favorable demand conditions and a balanced operating model. PHM’s solid operating model strategically aligns the production of build-to-order and quick-move-in homes with applicable demand across consumer groups. Furthermore, PHM’s land acquisition initiatives and other growth-driving strategies are encouraging for its prospects.
Backed by strong orders and closings, PulteGroup raised its 2024 guidance for closings to nearly 31,000 homes from 30,000 homes expected earlier. Although PHM anticipates land, labor and cost inflation to persist in 2024, it remains on track to invest about $5 billion in land acquisition & development during the year.
Zacks Rank #3 PulteGroup has an expected revenue and earnings growth rate of 7.9% and 10%, respectively, for the current year. The Zacks Consensus Estimate for current-year earnings has improved 9.5% over the last 60 days.
Toll Brothers Inc.’s (TOL - Free Report) emphasis on affordable luxury communities, build-to-order model and land acquisition strategies bode well. The lack of competition in the luxury housing market is a competitive advantage adding to TOL’s growth.
TOL plans to drive shareholder value by returning cash to shareholders through regular share repurchases and dividend payments, highlighting the company’s stable financial position that leads to its growth.
Zacks Rank #3 Toll Brothers has an expected revenue and earnings growth rate of 4.6% and 14.2%, respectively, for the current year (ending October 2024). The Zacks Consensus Estimate for current-year earnings has improved 2.8% over the last 60 days.
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5 Homebuilders to Watch on Interest Rate Cut Expectations
The sagging homebuilder stocks thrived last week following the release of several key measures of inflation data that came in soft. Since the beginning of 2022, the homebuilding industry has been reeling under the impact of rising mortgage rates and escalating building costs.
In early May, mortgage rates soared to the highest level of the year, and despite decreasing slightly since then, they remain near 7%. This surge in borrowing costs has coincided with a steady climb in home prices. These factors have severely hampered new home construction, leading to the lowest level of housing starts in May in nearly four years.
Meanwhile, a few recently released weaker-than-expected key inflation data and soft data for several important economic variables, especially labor market data, have boosted investors’ hope of interest rate cuts by the Fed.
Inflation is Dwindling
The Department of Labor reported that the consumer price index (CPI) decreased 0.1% month over month in June, in contrast to the consensus estimate of an increase of 0.1%. The reading for May was flat month over month. This marked the first monthly decrease in headline CPI since May 2020. Year over year, CPI increased 3%, marking the lowest level in more than three years. The metric for May was 3.3%.
The core CPI (excluding volatile food and energy items) increased 0.1% month over month in June, lower than the consensus estimate of an increase of 0.2%. The reading for May was also 0.2%. Year over year, core CPI increased 3.3%, marking the smallest annual increase since April 2021. The metric for May was 3.4%.
The Department of Commerce reported that the core personal consumption expenditure (PCE) price index (excluding volatile food and energy items) rose 0.1% month over month in May compared with 0.3% growth in April. Year over year, core PCE inflation — the Fed’s most favorite inflation gauge — rose 2.6% in May compared with 2.8% in April. May marked the lowest monthly rise of this metric since March 2021.
Rate Cut Expectations Rise
Following the release of several key economic data that were softer than estimates, a section of economists and financial experts already raised the alarm that the Fed should start reducing the benchmark lending rate from September. Otherwise, it will be too late and the economy may enter into a recession.
Notably, the benchmark interest rate is currently in the range of 5.25-5.5%, marking the highest level in 23 years. The yield on the benchmark 10-Year U.S. Treasury Note fell to 4.186% from 4.793% in mid-April.
The CME FedWatch tool currently shows a 96.3% probability of a Fed fund rate cut by 25 basis points in September. This probability was around 62% just two weeks ago. Moreover, the interest rate derivative tool also shows a 94.3% probability of two rate cuts by the end of 2024.
Homebuilders to Benefit
The mortgage rates are in part determined by the Fed fund rate and partly by the yield of the 10-Year U.S. Treasury Note. The lowering of both these key interest rates will reduce mortgage rates, influencing home buyers to generate more demand.
Moreover, lower inflation and market interest rate will reduce input costs for homebuilders. They will also get a cheaper source of credit to expand their businesses. Thus, it may become a double whammy for homebuilders.
Stocks in Focus
We have narrowed our search to five homebuilders’ stocks that have strong growth potential for the rest of 2024. These stocks have seen positive earnings estimate revisions in the last 60 days. Each of our picks carries a Zacks Rank #2 (Buy) or 3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
The chart below shows the price performance of our five stocks year to date.
Image Source: Zacks Investment Research
D.R. Horton Inc. (DHI - Free Report) is benefiting from a limited supply of both new and existing homes at affordable price points, alongside favorable demographics supporting housing demand. DHI’s strategic shift toward more entry-level affordable homes has been paying off, with the segment experiencing strong demand and limited supply.
DHI’s production capabilities, industry-leading market share, solid acquisition strategy, broad geographic footprint and diverse product offerings across multiple brands and price points are encouraging.
Zacks Rank #2 D.R. Horton has an expected revenue and earnings growth rate of 4.5% and 3.4%, respectively, for the current year (ending September 2024). The Zacks Consensus Estimate for current-year earnings has improved 0.4% over the last 60 days.
KB Home (KBH - Free Report) has been pursuing a Returns-Focused Growth Plan that is designed to drive revenues and homebuilding operating income margin, return on invested capital, return on equity and leverage ratio. The plan’s main components are executing KBH’s core business strategy, improving asset efficiency and monetizing significant deferred tax assets.
KBH is now in a better position to expect meaningful growth in the future, attributable to the increase in backlog and its ability to match housing starts to net orders. KBH is executing its plan to expand the scale of operations while driving both margins and returns.
Zacks Rank #2 KB Home has an expected revenue and earnings growth rate of 4.5% and 18.2%, respectively, for the current year (ending November 2024). The Zacks Consensus Estimate for current-year earnings has improved 3.7% over the last 30 days.
NVR Inc. (NVR - Free Report) is benefiting from improved demand trends, which resulted in higher order volumes. The improving trend is witnessed through increasing backlogs and reduced cancellation rates. NVR’s backlog at the end of Mar 31, 2024, improved 7% from the prior-year quarter’s figure to 11,189 homes and rose 9% on a dollar basis to $5.22 billion.
During first-quarter 2024, NVR’s new orders (net of cancellations) increased 3% from the prior-year quarter’s levels to 6,049 units. Also, the increased average selling price of new orders adds to the positives.
Zacks Rank #2 NVR has an expected revenue and earnings growth rate of 8.6% and 6.6%, respectively, for the current year. The Zacks Consensus Estimate for current-year earnings has improved 1.3% over the last 60 days.
PulteGroup Inc. (PHM - Free Report) is benefiting from favorable demand conditions and a balanced operating model. PHM’s solid operating model strategically aligns the production of build-to-order and quick-move-in homes with applicable demand across consumer groups. Furthermore, PHM’s land acquisition initiatives and other growth-driving strategies are encouraging for its prospects.
Backed by strong orders and closings, PulteGroup raised its 2024 guidance for closings to nearly 31,000 homes from 30,000 homes expected earlier. Although PHM anticipates land, labor and cost inflation to persist in 2024, it remains on track to invest about $5 billion in land acquisition & development during the year.
Zacks Rank #3 PulteGroup has an expected revenue and earnings growth rate of 7.9% and 10%, respectively, for the current year. The Zacks Consensus Estimate for current-year earnings has improved 9.5% over the last 60 days.
Toll Brothers Inc.’s (TOL - Free Report) emphasis on affordable luxury communities, build-to-order model and land acquisition strategies bode well. The lack of competition in the luxury housing market is a competitive advantage adding to TOL’s growth.
TOL plans to drive shareholder value by returning cash to shareholders through regular share repurchases and dividend payments, highlighting the company’s stable financial position that leads to its growth.
Zacks Rank #3 Toll Brothers has an expected revenue and earnings growth rate of 4.6% and 14.2%, respectively, for the current year (ending October 2024). The Zacks Consensus Estimate for current-year earnings has improved 2.8% over the last 60 days.